Ruchir Sharma on bailouts, inequality and making markets free again
Keir Starmer, the new Prime Minister, has said that economic growth will be the “obsession” of his new government.
His focus on growth reflects the fact that the economy has essentially been stagnant since the pandemic and has performed only a little better since 2008.
State action, or lack thereof, is often considered a major explanation for economic stagnation. Chancellor Rachel Reeves has spoken about their admiration for Joe Biden’s economic policies and the larger role for the state that this entails.
But a new book by Ruchir Sharma, ‘What went wrong with Capitalism’, argues that a bigger state is exactly the wrong diagnosis for a government looking to boost growth.
“The era of small government never happened,” he writes. “Government has been expanding for nearly a century in virtually all measurable respects, as a spender, borrower and regulator”.
This is as true in the UK as anywhere else. The UK never ran a peacetime deficit until the 1970s. Since then it has run a deficit in all but five of the next 50 years.
Stop state interference
Growing interference with the business cycle, he argues, has been an important cause of the global slowdown in economic growth.
Every economic crisis around the developed world is met with a government bailout and a growing list of regulations to try and ensure the next one never happens. This constrains the dynamism of capitalism, Sharma argues, by limiting the destruction of old incumbents and the creation of new competitors.
“All these things are causing distortions to what capitalism is supposed to be that you’re not getting the efficient allocation of capital,” he told City A.M.
“If the government’s going to be constantly involved, then we’re going to end up with these consequences, which is lower productivity, lower net new creation of companies, and a playing field which favours the entrenched and often big businesses,” he continued.
“The analogy I use in the book is to the opiate crisis back in the US. If the patient has the slightest hint of trouble, you administer drugs which gets the patient hooks to opiates. You eventually lose the natural ability to fight off anything”.
Sharma argues that the distortions created through continued intervention in the economy has been a major factor in explaining why productivity, the elixir of capitalism, has slowed since the financial crisis.
The beneficiaries, to the extent that there have been any, are big businesses. Tighter regulations have stopped new entrants into the market while government bailouts have contributed to the concentration of market power.
Pro-business v pro-capitalism
Labour has repeatedly claimed to be the pro-business party at this election, but Sharma said this was different from being pro-capitalism. “A lot of people confuse pro-business with being pro-capitalism. It’s not, in fact, capitalism is pro-competition and pro-choice, exactly what big businesses don’t want,” he said.
One of the largest distortions to impact advanced economies since the 2008 financial crisis has been the advent of ultra loose monetary policy through rock bottom interest rates and quantitative easing.
Between late 2008 and early 2010 the Fed created $1.2 trillion, more money than it created over the previous century. This was repeated around the world. Between 2008 and 2019, for example, the holdings of the Bank of England grew tenfold, from four per cent to 40 per cent of GDP.
There’s a big problem with easy money. “Central banks can create all the money they want, but cannot control where it will go. Instead of fuelling growth in the real economy, as central banks hoped, easy money went into financial assets,” Sharma writes.
As a result of all these policies, financial markets are now four times the size of the global economy. Finance is no longer a reflection of the economy, it drives the economy.
This has fuelled inequality because financial assets are so unevenly distributed. In the US, the top 10 per cent own 72 per cent of all financial assets and 93 per cent of all stocks. The top one per cent alone own 54 per cent of all stocks, while the bottom half own just seven per cent.
Recognising inequality
With asset prices rising, so the wealth of the already wealthy rises. The top one per cent saw their share of wealth rise by more than half since 1980 to 35 per cent. The number of billionaires has increased from 300 in 2000 to 2,700 in 2020.
“Capitalist societies need to recognise when they are stepping too far out of balance, when wealth and income inequality is arising as much from dysfunctions in the system as from merit or hard work”.
The combination of easy money and a government that cocoons firms can be seen in the rise of zombie companies. Zombies are companies that earn just enough money to continue operating, but are unable to pay off their debt.
Having been virtually unknown before the 1980s, zombies now make up around 22 per cent of public companies in the UK, he said citing Deutsche Bank research on the topic.
To stop the steady ossification of capitalism, Sharma argued that the best thing a new Labour government could do is to step back and allow the price system to function with as few constraints as possible.
Discussing priorities for the government, Sharma said “I think one of them has to be deregulation of small businesses and the broader regulatory environment. There needs to be much more competition and more churn, rather than a system tilted in favour of big business.”
What Went Wrong With Capitalism, by Ruchir Sharma, is out now, Allen Lane.