First World Problems

Were the proverbial Martian to land near the U.S. Treasury and Labor departments, he would conclude that Americans, with their ever-increasing incomes, wealth, and access to whizzy modern conveniences, must be the happiest inhabitants in the history of mankind. Alas, further contact with ordinary people would quickly disabuse him of that notion.

Those wishing to explore the gap between the nation’s apparent macroeconomic success and its microeconomic malaise would do well to consult Ruchir Sharma’s What Went Wrong with Capitalism.

The author holds two bogeymen responsible for this disconnect: ever-worsening governmental elephantiasis and addiction to cheap money.

The book divides in half between the two topics. The first half, the documentation of the burgeoning dead hand of the regulatory state, is the weakest section, while the second half, an incisive indictment of the corrosion of our economic vitality by an ever more intrusive Federal Reserve, proves far more convincing.

Sharma documents the slow deterioration in per capita GDP growth/labor productivity across the developed world, from an average postwar rate of two percent to three percent per annum to the current one percent, alongside increasing government size. In the 1800s, most government budgets consumed just a few percent of GDP, then rose during the twentieth century to more than 50 percent in some northern European nations. Surely, he posits, there’s a direct causal connection between increasing government and decreasing growth.

While likely true, there’s a word missing from Sharma’s analysis of regulatory overreach, and that’s “externality.”

Consider the literal and metaphorical engine that powered the explosion of twentieth-century prosperity, the internal combustion machine, without which the United States, and the rest of the world, would be a less wealthy and healthy place.

Don’t dismiss the impact of lead poisoning

Well before climate change from the resultant burning of fossil fuels became a serious concern, other costs had already become manifest. In the late 1950s, a brilliant and humane pediatrician, Herbert Needleman, noticed that many of his inner-city patients suffering from acute lead poisoning subsequently returned to emergency rooms with unruly behavior. Suspecting that environmental lead also caused other, more subtle, neurological damage, he documented a robust negative correlation between lead levels in the baby teeth he collected and the IQ of their donors.

While Needleman was primarily concerned with lead from peeling paint, it soon emerged that atmospheric pollution from the lead used to improve gasoline combustion presented a greater public health hazard. His research inspired an atomic scientist named Clair Patterson to travel the world collecting environmental samples. Over the subsequent years, Patterson, in turn, engaged in a titanic battle with a pathologist employed by General Motors, Robert Kehoe, who did his best to disparage Patterson’s work.

Over the ensuing decades, the tide turned in Patterson’s favor, and in 1976 the nascent Environmental Protection Agency mandated a reduction in gasoline lead concentrations; on December 31, 1995 the agency completely prohibited the leading of fuel. (Patterson is better remembered for nailing down the age of the earth at 4.55 billion years; just before he died, a fundamentalist evangelical informed him that he was going to hell for his blasphemy.)

Regulation affects quality of life

Mr. Sharma is not old enough to remember the horrific air pollution that blanketed major American cities as late as the 1980s, to say nothing of the Love Canal disaster or that the Cuyahoga River regularly caught fire before 1970. Nor does he mention the untold number of deaths prevented by the FDA’s oversight of the nation’s food chain, or the fact that airline travel, once an almost predictably deadly activity, has now, thanks in no small part to the FAA and NTSB, become as risky as tying one’s shoelaces. Closer to home, who among this publication’s readership wants to repeal the Securities Acts of 1933 and 1934 or the 1940 Investment Company Act?

The EPA employs about 17,000 personnel; the FAA, 45,000; the FDA, 18,000; the SEC, 4,800; and NTSB, all of 433. Are those too many? The world before aircraft, internal combustion engines, coal burning power plants, and complex food chains didn’t need any of those agencies. Surely, overregulation carries substantial costs, but they must be measured against benefits not easily measured by GDP growth. Sharma doesn’t even begin to admit that trade off.

Consider, for example, that the EPA employs 0.01 percent of the domestic workforce. Is that too much of the nation’s manpower to protect the atmosphere from corporations more concerned with their bottom lines than with the neurological status of the nation’s children?

Looking at interest rates and central banks

In contrast, the book’s second half, which connects worldwide decreasing productivity and economic growth rates with ever more accommodating central banks, fairly sparkles with the author’s presentation and analysis of the underlying econometric research. It proceeds along the same lines as Edward Chancellor’s The Price of Time. That book posits that low interest rates, which lower the hurdle rate for investment capital, not only lead to its misallocation towards low-returning projects, but also hinder the process of Schumpeter’s “creative destruction” of capitalist deadwood. The result is the proliferation of corporate zombies that retard technological innovation.

Sharma starts with the sharp recession of the early 1920s, which the newly formed Federal Reserve treated with benign neglect, and which he credits for its brief duration. In comparison, a more activist Fed got nearly everything wrong before and after 1929, first fanning the flames with low interest rates designed to support the flagging pound sterling, then slamming on the brakes after the financial markets had collapsed.

Sharma dates the zombification of the world’s economy to the 1984 bailout of the Continental Illinois National Bank, which cost taxpayers $11 billion, followed quickly by the early 1990s S&L bailouts, which cost an order of magnitude more. At nearly the same time, the collapse of the Japanese bubble economy saw wholesale corporate zombification as money-losing firms were kept on life support with low-interest loans from banks too afraid to cleanse them from their balance sheets.

Spreading zombification

This process spread worldwide after the global financial and European debt crises of 2007–2014. The Bank of International Settlements currently counts roughly one in ten of the world’s corporations – and as many as one in five of American ones – among the walking dead, the epicenter of which Sharma places the Federal Reserve, whose swap lines provide major source of the world’s reserve currency – the dollar. As put by the author, “Every dollar the zombies in an industry borrow, every worker they hire, and every machine they buy makes it more expensive for healthy rivals to borrow, invest, and hire.”

Sharma also blames today’s increasing industry concentration on low interest rates, and the associated low cost of equity capital, which allow dominant companies to drive out competitors. In other words, low rates also give dominant companies staying power; only three of 1980’s largest U.S. companies by market cap remained there by 1990, whereas six of 2010’s largest made it to 2020. Worse, much of this competition-killing concentration is nearly invisible to consumers: the Zales, Jared, and Kay jewelry stores that dot American malls are owned by the same corporate parent, as are a large number of seemingly independent breweries (ImBev) and dating sites (Match Group).

In addition to stifling competition, low rates drive up the prices of stocks, owned largely by the rich, further increasing wealth inequality. Unsurprisingly, 77 percent of registered Democrats perceive this as a major problem, but so do even 53 percent of Republicans. High real estate prices borne on low rates make housing in many of the world’s major urban areas unaffordable to all but cash buyers. As put by the author, “When the price of money is zero, the price of everything else goes bonkers.”

Don’t overlook the impact of ‘demosclerosis’

It’s surprising that Sharma doesn’t discuss another major reason behind the developed world’s increasing economic sclerosis and decreasing productivity: the natural tendency for wealthy, stable societies to accrete layers of rent-seeking special interests, a process well described by economist Mancur Olson and labeled “demosclerosis” by author Jonathan Rauch.

Sharma, like many libertarians, approvingly points out that Singapore supplies its citizens with the social welfare benefits of a European nation with only half the taxes as a percent of GDP. The reason for this happy state of affairs is obvious to anyone familiar with the island nation’s history: In 1965 Singapore found itself unexpectedly kicked out of newly independent Malaysia and thus forced to invent on the fly clean-sheet governmental and social welfare institutions devoid of Olson’s layers of rent-seeking special-interest groups. Unfortunately, as both Olson and historian Walter Scheidel observe, the removal of the sclerotic layers seen in older societies rarely occurs without war or revolution.

The reader might also wonder about the contribution of social media and modern advertising, both driven by neuropsychological research, to the world’s increasing post-industrial malaise. As the pop psychology saw goes, “happiness equals reality minus expectations.” If individual well-being is driven by the gap between the two, then it’s no wonder that a population bombarded by Madison Avenue and Instagram has gotten grumpier.

Weakened antitrust enforcement

The author finds virtue in one area of government regulation, and that, unsurprisingly, is antitrust enforcement, which he correctly sees as atrophied beyond recognition in the U.S. Perhaps because of his libertarian bent, he neglects to assign proper blame for this. That belongs to the pro-business legal efforts and bias of future Supreme Court justice Lewis Powell and later to Robert Bork’s 1978 anti-regulatory bible, The Antitrust Paradox, whose monumental influence among Federalist Society types hobbles antitrust enforcement to this day.

Finally, Schumpeterian creative destruction, from the savaging of eighteenth-century English weavers to the vaporization of domestic high-paying twentieth century auto and steel jobs, is often, well, destructive. Sharma would have done well to consider just how far universal health insurance, free higher education, and a national pension system might go towards mitigating the U.S. populist revolt against the Schumpeterian mayhem that can flow from free-market orthodoxy.

What Went Wrong with Capitalism’s intended readership, which includes both financial specialists and the general audience, may not agree with everything between its covers, but nearly all will be entertained by his agreeable prose, stimulated by the author’s analyses, and informed by his deep research.

William J. Bernstein is a neurologist, the co-founder of Efficient Frontier Advisors, an investment management firm, and a writer with 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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