The Perilous Fate of Modern Capitalism

The author’s remarkable career trajectory, first in England and Cambridge, and then in the U.S., spanned the extremes of Keynes’s three-way tradeoff. The intellectual environment at Cambridge skewed towards social justice, so much so thatKeynes’s most famous collaborator, the brilliant and wickedly funny Joan Robinson, eventually became a devout Maoist. Had the world’s central bankers only heeded Keynes’ magisterial prescription, the Cambridge school believed, they would have spared the world the wrenching Great Depression and the Second World War to boot, as easily as a diabetic avoids coma by injecting insulin.

After crossing the pond, he was met with a radically different milieu, one that favored liberty above all and dominated by the Chicago school, one of whose paragons, George Stigler, declared that “the professional study of economics makes one politically conservative.”Stigler posited in the American Economic Review in 1946 that minimum wage laws increased the marginal cost of hiring and thus decreased employment, and while his paper was replete with labor and wage statistics, it didn’t empirically test his hypothesis. Stigler argued that on some issues economists and policy makers alike had no need of mere empirical data; the iron laws of supply and demandper se mandated the counterproductive nature of minimum wage laws.

In fairness to Stigler, in 1946 he simply didn’t have access to the econometrics necessary to test his hypothesis; but in April 1992, the state of New Jersey allowedDavid Card and Alan Kreugerto test, for the first time, the Stigler hypothesis with a classic “natural experiment” when it raised its minimum wage. The two found that, contrary to Stigler’s conjecture, the rates of fast food employment did not vary between New Jersey and neighboring Pennsylvania, which did not raise the minimum wage.

Card and Kreuger subsequently figured out that Stigler’s simple supply and demand curves constituted an overly reductive labor market model. Fast food restaurants, it turned out, were “monopsonists” (a term invented half a century before by Joan Robinson), that wielded such power over local labor markets that workers had little employment choice, and so exploited their workers with low wages. When the law raised those wages, fast food restaurants were forced to pay them out of smaller profits. In the case of New Jersey fast food emporiums, minimum wage laws didn’t decrease employment; rather, they redistributed wealth from capital to labor.

The reaction from conservative economists and think tanks was instantaneous and angry, which Deaton found wholly unsurprising. It sent him straight away to crack his copy of The Wealth of Nations, in which Smith observed remarked on “the clamour of our merchants and manufacturers . . . for the support of their own absurd oppressive monopolies.” Deaton ends this chapter on wages with the observation that conventional economic doctrine “takes efficiency much more seriously than it takes equity, that power differentials are ignored, and that economics’ widespread acceptance bears some responsibility for the fortunes of workers.”

Deaton develops topics with a lucid first-principles approach combined with – rare for an economist – a healthy dollop of humor. The chapter onretirement, Social Security, and pensions, a subject that he notes puts the young to sleep and keeps the old up at night, is worth the book’s price alone. He observes that for most of human history, people worked until they became too infirm or died. In traditional cultures, the healthy were expected to support the sick, an arrangement untenable in an atomized modernsociety. Moreover, saving for retirement requires financial markets free from war, hyperinflation, and theft; Deaton warns, “For those of us born after 1945, long periods of peace and economic stability can seem like the norm. In truth, such prolonged periods have been historically uncommon.” The book was published well after the start of Russia’s invasion of Ukraine, but before Hamas attacked Israel.

There follows a deft discussion of the options open for reforming Social Security, capped with a light-hearted account of what happened to academic retirements following the expiration of faculty age limits in 1994; Deaton relates the unpleasant discovery by one junior faculty member that the chairman of his tenure committee was “someone he had long assumed to have departed not only the university but the world.” Detailed research into faculty age limits found that better paid faculty, contrary to expectation, retired later than those less well paid since, according to Deaton, “power and status are pleasurable in themselves and vanish in retirement.” He further observes that the job of the modern dean consists of three things: hiring minorities, finding jobs for faculty wives, and persuading tenured professors to retire. (One 85-year-old professor, having nearly been persuaded by a generous severance package to depart, put down his pen with shaking handand declared, “Damn it, I’m going to shoot for ninety.”

Deaton finds that our dysfunctional medical system lies at the heart of American economic inequality. Americans and their employers spent $22,463 per year to insure the typical family (exclusive of out-of-pocket costs). Atthat price employers can afford to offer generous coverage only to highly paid employees, but it is prohibitively expensive to cover the less well paid, who-wind up one medical illness away from living in their cars, a “precariat” that becomes fodder for populist politicians. And even the well-insured can find themselves squeezed, as did Deaton when he was about to be wheeled into the operating theater for a hip replacement and was informed by his anesthesiologist that without paying an additional $2,000 out-of-network fee he would not put him under: Better, Deaton realized with no small anger, not to tick off the medico passing one’s gas.

Informed consumers empowered by free market choice is the solution prescribed by conservatives to control healthcare cost. To Deaton, this is nonsense; the medical marketplace, in the words of one of his colleagues, is akin to “shopping blindfolded in a department store in which some items are charged at full price and some others at some fraction of full price, but with no advance knowledge of what one has bought or what it will cost.” An accident victim with multiple internal injuries and impaired by head trauma is no one’s model of a well-informed healthcare consumer.

In 1963, Kenneth Arrow described the thorny problem at the core of medical insurance: adverse selection. The healthy choose to forego medical insurance, which is bought only by the sick, which drives up its price. This is only the start of a vicious cycle in which the price of insurance progressively ratchets up as it next prices out the only moderately sick, which leaves an even sicker cohort to purchase insurance at a yet higher price.

A functioning market for medical insurance, Arrow realized, required a universal-purchase mandate, which half a century ago became the consensus conclusion of economists everywhere, eventually even in the U.S. In 1989, Stuart Butler, a distinguished fellow at the conservative Heritage Foundation, wrote, “If a young man wrecks his Porsche and has not had the foresight to obtain insurance, we may commiserate, but society feels no obligation to repair his car. But health care is different. If a man is struck down by a heart attack in the street, Americans will care for him whether or not he has insurance.”

Alas, when the Clinton health insurance proposals threatened the medical-industrial complex’s bottom line, the conservative economic establishment turned on a dime and argued that people should be allowed to buy whatever insurance they like. When in 2009 the Affordable Care Act outlawed inexpensive skimpy plans, consumers squawked that they had been happy with such plans (that is, until they got sick). The flood of rhetoric against the president’s signature legislation has had a lasting effect: Polls show that voters overwhelmingly oppose “Obamacare,” but when the act’s content is described to them as “The Affordable Care act,” they are marginally in favor of it.

Easily the book’s most enjoyable section is Deaton’s up-close-and-personal description of the ultimate travel fantasy, the Nobel award experience: an all-expense-paid luxury junket for the winner and a few dozen friends and family, an on-call limousine, and the joy of watching one’s nine-year old grandson flirt outrageously with an interviewer on the national TV station. Those afflicted with Sweden envy will not fail to notice that prize week is a popular national event in that country, on par with the soccer World Cup; one cabinet minister confided to Deaton that she looked forward each December toappearing in public with the winners, since it was the only way to convinceher mother that she was important.(U.S. presidents do treat our Nobelists with a White House ceremony; when Deaton won in 2015, Barrack Obama greeted him briefly before getting down to what he really wanted to do, which was to discuss with Deaton’s wife, Anne Case,her famous paper on deaths of despair. Alas, no Nobelists were spotted in the Oval Office between 2017 and 2020.)

Deaton acknowledges that the capitalist system allows visionary entrepreneurs to benefit society, but also notes thatthese tycoons usually become predators who block others and use their monopoly power to savage competitors, a phenomenon that began with Rockefeller and is all too obvious to anyone who defies Amazon’s, Google’s or Ebay’s marketplace mechanisms. If challenged to find a flaw in the book, it’s Deaton’s failure to acknowledge Mancur Olson’s seminal description of how stable, wealthy societies invariably spawn special interest groups that capture the legislation and regulation, a process that extends far beyond the commercial realm. (I also cannot resist pointing out that even Nobelists occasionally produce howling typos, in this case Deaton’s miscalculation of the ratio of Bill Gates’ net worth ($129 billion) to that of the median American ($121,700) as a factor of 1,000; what’s a missing comma between friends?)

The foregoing is only a sampling of the mind candy offered up by Deaton, which includes chapters on deaths of despair, the shocking nature of extreme poverty in America, his jaundiced view of free trade, the connection between inequality and social mobility, and the politics of the CPI (Conservatives have a vested interest in adjusting the CPI down, which decreases inflation-adjusted mandates such as Social Security. In the service of this strategy, one economist estimated that General Mills’ introduction of Apple Cinnamon Cheerios decreased the CPI by adding $60 million of consumer value).

Deaton is also scathing about academic endowments; Harvard, Yale, and Princeton, it seems are hedge funds to which some classrooms and hospitals are incidentally appended; during the global financial crisis, instead of increasing their outlays to needy students and necessary operations, they cut back on outflows to build their endowments back up. Finally, there is this assessment of the usefulness of economics itself: “In physics, Nobel Prizes are awarded for being correct, while in economics they are often rewarded for being brilliant.”

Deaton serves up this rich banquet of ideas, puzzles, and anecdotes in a mere 240 pages of tight, well-written text; it’s the perfect holiday gift for your favorite economics nerd, or for anyone interested in the fate of modern capitalism.

William J. Bernstein is a neurologist, co-founder of Efficient Frontier Advisors, an investment management firm, and has written several titles on finance and economic history. He has contributed to the peer-reviewed finance literature and has written for several national publications, including Money Magazine and The Wall Street Journal. He has produced several finance titles, and four volumes of history, The Birth of Plenty, A Splendid Exchange, Masters of the Word, and The Delusions of Crowds about, respectively, the economic growth inflection of the early 19th century, the history of world trade, the effects of access to technology on human relations and politics, and financial and religious mass manias. He was also the 2017 winner of the James R. Vertin Award from the CFA Institute.

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