Capitalism in America: Book Review

February 10, 2019

Capitalism in America: A History (2018), Greenspan and Woolridge. Alan Greenspan was Federal Reserve Chairman for almost 20 years (1987-2006), called "The Maestro" for his mastery of monetary policy. Then the Subprime Meltdown of 2008 happened and he was given some of the blame for his emphasis on deregulation and low interest rates. His take on business history becomes important, because of his economic/libertarian perspective and how he viewed his own legacy. Adrian Woolridge is a journalist for the Economist, at one point "Schumpeter Columnist." The book is pro-capitalist and takes a "creative destruction" perspective on the ups and downs of the economy. Joseph Schumpeter described the term innovation as central to capitalism and the endless cycles as needed to revolutionize the economic structure (at both the micro and macro levels): "America's greatest comparative advantage has been its talent for creative destruction" (p. 389). Productivity and politics also are important themes.


This generally ignores the potential "evils of capitalism" and (where I would see corruption and scandal) considers it a necessary process given the economics of Adam Smith, neo-classical economics and Milton Friedman's libertarian perspective. Think of Bernie Madoff and Ken Lay as "destruction stagehands" rather than main characters in "capitalist scandals." Consequently, I'm not an unbiased reviewer. Our current problems such as growing inequality and the hollowing out of the middle class are described as poor handling of creative destruction: "Yet this highly productive America exists alongside a much more stagnant country. Look at any measure of creative destruction, from geographic mobility to company creation to tolerance of disruption and you see that it is headed downward" (p. 392). They point out: "the very things that drove economic progress, industrialization and urbanization, brought overcrowding, dangerous work, and contaminated air" (p. 426). I thought this would suggest the need for regulation, but no. Apparently the answer is more creative destruction in the private sector plus some unkind words for historical progressives like Teddy Roosevelt and Woodrow Wilson.


The book is well-written and covers many aspects of our economic history in interesting and informative ways. It is not a complete history, but focuses on individual episodes. [Alfred Chandler's The Visible Hand is thorough (up to the 1970's), but also has virtually nothing negative to say about American business.] Readers familiar with American history and economics will find the book useful, others may be confused. There are some aspects I was unfamiliar with and this perspective is one to grapple with.


I agree with the authors on the obvious cases. For example, most of the early settlers engaged in agriculture. This shifted with greater productivity in farming and the rise of manufacturing. Now, only about one percent of the population is in agriculture. A current example would be self-driving vehicles, which will put truck drivers and others out of work. Both of these are examples of creative destruction. Corruption becomes a bit more difficult. Consider the transcontinental railroad of the 1860's. There was vast corruption and Credit Mobilier (the construction company of the Union Pacific, which bribed members of Congress and other politicians) often considered the greatest business scandal of the 19th century. Does this fit creative destruction? Yes according to Greenspan and Woolridge. This looks like an outright scandal separate from creative destruction to me. Ditto for thousands of other examples. Apparently, criminal activity is an acceptable component to the creative destruction school of economics. 


The authors do not consider behavioral economics, which helps explain actions by top executives, politicians, consumers and the general public. This is not unusual in most economic analyses, but still a weakness. They also give little consideration to government regulation beyond criticism. Regulation has been a topic of economics especially since antitrust legislation started in the 1880's. I see regulation as the only possible (partial) solution to the abuses of big business and government capture. The libertarian perspective views regulation as harmful, inefficient and detrimental to innovation. The free market is the solution. My problem with that is the need for real competition and markets that are in fact free. Buying pharmaceuticals when the drug companies have monopoly positions is not a free market. Plus corruption and real crimes.


Now to the specifics of the book. 


The original colonies of Jamestown and Plymouth were joint stock companies with the colonists stockholders. Individual and property rights were determined by contracts and decisions at least somewhat democratic (commonwealths were company general assemblies). Self-sufficiency prevailed with colonist making their own clothes, even candles and basic tools. Self-reliance and hard work were needed for success, consistent with the "Protestant ethic." 


An interesting perspective was the American Revolution as a revolt against the British mercantilist system that required a positive trade balance, protectionist policies (e.g., no banks or manufacturing in the colonies), and basically no trade not sanctioned by Britain--all through English ports. The war devastated the US economy: national income fell 30% as international trade came to a standstill; the war was financed through paper money causing hyper-inflation; and a gigantic pile of debt accumulated at both the federal and state level. 


The Constitution not only created a unique democratic system, but banned internal tariffs which promoted industry and trade across the states and allowed regional specialization. It took the Revolution to create a banking system and Hamilton created a brilliant system modeled on British finance. The economy recovered and America expanded, especially with the Louisiana Purchase. America's comparative advantage was in agriculture, which Jefferson wanted to maintain but Hamilton wanted a growing manufacturing, finance and trade culture. Hamilton won out, in part by "implied powers" in the Constitution to promote these interests. [Of course, Jefferson thought a strong central government made more sense once he was president--pragmatism and opportunism were Jeffersonian strengths.] GDP rose an average 3.7% annually from 1800-50 (40% on a per capita basis), although in a boom-bust fashion with severe panics every 20 or so years. [The Jeffersonian and later Jacksonian destruction of Hamilton's banking system was part of the problem.] Later, it was reported that real per capita income rose 1.25% annually from 1820-1860 but only 0.24% from 1800-20 (p. 59).


Andrew Jackson brought the frontier culture to the White House, including popular democracy, the spoils system, killed the Second Bank of the US and promoted a gold standard--the Panic of 1837 followed. "New England was a land of textile mills powered by water, the South a land of plantations powered by slaves" (p. 69). Virtually all patents came from the North, mainly New England. By 1820, 86 firms were using 1,667 power looms, using the "American system of production" and interchangeable parts. Eli Whitney was followed by Samuel Colt; the military drove mass production of weapons. Many inventions were for agriculture, but still came from the North. The North developed a commercial infrastructure of innovation, finance, trade, education and innovation. 


Regional differences were emphasized. The Northeast founded by Puritans (moralizers but also institution builders); Quakers shaped Pennsylvania and Delaware (egalitarian but less successful at institutions); Cavaliers shaped Virginia, Maryland and the South in general (aristocratic, hierarchical and slave-holding); Scotch Irish claimed the frontier (independent and egalitarian). Plus other sub-cultures and the ability to merge different traditions. Thanks to Eli Whitney's cotton gin, cotton was half of all US exports by 1820. About half of the South's capital assets were slaves, around $3 billion in 1860 (p. 75). (Slaves could be collateralized for loans, p. 79, 86.)


The book emphasizes innovation from the start, mentioning Oliver Evans with advanced flour mills by 1785, then a high-pressure steam engine in 1801, Eli Whitney, Samuel Morse, Cyrus McCormick, John Deere, Isaac Singer, and Charles Goodyear. Resources of coal, iron and later oil were important. Canals, steamships and railroads were part of a transportation revolution. Steam engines grew from three in the 1780's to 2,000 by 1838. The information revolution started with the telegraph in the 1840's. The first transcontinental railroad was completed in 1869, but the first transcontinental interstate not until 1986. 


At the start of the Civil War the North has 70% of the wealth and 80% of the banking assets (p. 80). However, economic power is not military power and it took years to tap into its manufacturing potential. The South was shattered and did not regain its per capital income of 1860 until 1890 (p. 84). Sharecropping became the substitute for slavery.


The late 19th century period was identified as one of great innovation where business titans reorganized entire industries (better machines, better business processes, better information), resulting in productivity gains and creative destruction. A key point was that government protected property rights and enforced contracts, rather than specific regulation of business. Important were steel (making it in bulk), oil, electricity, telephone, and a bit later cars. General purpose technologies lead to more inventions. Fifty-three of the Fortune 500 of 2000 were founded in the 1880's, 39 in the 1890's and 52 in the 1900's (p. 91). America was good at making inventions user friendly, companies commercializing innovations, and production/management techniques (p. 104). During this period was the rise of managerial capitalism, non-owner professionals. Rockefeller's Standard Oil created the trust, followed by New Jersey's relaxing of corporate standards of ownership across state lines. The Sherman Antitrust Act followed in 1890. Note that it took decades to make innovative industries widely available (e.g., electricity). It took 39 years from the patent for the phone to the first long-distance service from coast to coast (p. 109). Entrepreneurs of the era (Carnegie, Rockefeller, Morgan, Ford) were organizers: spotting innovations, bringing factors of production together, and integrating activities from raw materials to sale of finished products (p. 127). The period 1895-1904 was merger mania (the consolidation of 1,800+ manufacturing firms), especially vertical mergers and Morgan mergers by industry (both horizontal and vertical) including US Steel, the first billion dollar corporation.


Chapter 5 was "The Revolt Against Laissez-faire," a period of progressive movements and presidents such as Teddy Roosevelt and Woodrow Wilson (versus sound money--gold, small government and sturdy self-reliance: Grover Cleveland, a Democrat). Roosevelt established a Commerce & Labor Department, including investigating business malfeasance. Legislation included the Pure Food & Drug Act and Meat Inspection Act. After the Panic of 1907, the Pujo Committee investigated the Money Trust and various business practices. Wilson passed the Clayton act and established the Federal Reserve. Until 1917, government spending at all levels (except for wars) was substantially less than 10%. Tocqueville--a government of town halls. Courts and Congress (e.g., Uncle Joe Cannon and Mark Hanna) worked hard to protect contracts and keep laissez-faire. Note Social Darwinists and Herbert Spencer's survival of the fittest. Railroads required government involvement ("railroaded" meant cheated), the ICC Act in 1887. Industrial pollution soon followed. Gigantic wealth showed the problem of equality of opportunity. Organized labor started in the late 19th century. Early in the century, craftspeople sold directly to customers. Big manufacturing meant a large labor force that could form unions and strike (37,000 between 1881 & 1905, 14,000 in 1886, p. 173)--fueled by outrage and organization. 


Before and after World War II, trade unions were powerful (mainly thanks to federal regulations). The authors viewed this as a constraint on growth and innovation, making flexibility difficult. Progressives wanted a better working capitalist system and labor wanted a bigger share of the rewards. The America after World War I has an income tax, central bank and big bureaucracy (p. 188).


Chapter 6 is "The Business of America is Business," the 1920's belonged to the Republicans. Too bad the Harding regime was corrupt and incompetent. Tariffs were big, global trade was not. The Smoot-Hawley Tariff of 1930 make the Great Depression worse. Andrew Mellon as Treasury Secretary was competent but a conservative banker unwilling to provide assistance even during the Great Depression. Labor progress of the progresive era was reversed during the 1920's. From 1921-1929 real GDP grew at 5% a year (p. 194): increased productivity especially in autos, expansion of the service sector and rise of cities, and (the authors claim) the democratization of great innovation due to laissez-faire. Early 20th century electricity industry had big boost in productivity as large central stations using turbines and power transmission networks; cost of electricity fell 89% from 1902 to 1929 (p. 200). This changed manufacturing as each tool had its own electric motor. Commercial radio came in the 1920's, with the introduction of the vacuum tube. Radio stations stimulated demand for radios. Companies went public and subject to broad ownership. Big companies got bigger, assisted by professional managers. "Welfare capitalism" with pensions, healthcare and profit sharing started. Small companies declined.

Ford's entrepreneurship versus Alfred Sloan's multi-division management, forecasting, installment buying [not mentioned: GM's great accounting], which GM won by the 1930's.


Chapter 7: "The Great Depression:" stock market crash caused a ripple effect to the rest of the economy. Rise of debt at the federal level and allies repudiated debt, debt deflation (obligations rose as ability to pay declined). Problems with farmers started in 1920's. Canada had four national banks with branches and deep pockets. US has 25,000 banks, most unitary and undercapitalized. Fed's open market policy happened by accident in 1922 (see p. 235), purchasing securities eased credit conditions and Fed kept interest rates too low in late 1920's, then raised rates too high, included during the depression to preserve the value of the dollar [and the gold standard]. Adolf Berle (New Deal brain trust): if left unregulated, corporations a threat to the public good. Louis Brandeis though bigness a curse & wanted to break up concentration. Bank holiday and Hoover's plan (p. 242) to reopen in stages based on financial health--FDR had a slightly different plan including guarantees of bank deposits. Discussion of deficiencies of NRA ("retarded the recovery and especially retarded reemployment--Irving Fisher) and AAA (combination of set-asides, price-fixing, and transfer payments"); all the Raw Deal according to Hearst. "FDR inherited a highly decentralized political economy committed to flexible markets and transformed it into a Washington-denominated political economy committed to demand management, national welfare programs, and compulsory collective bargaining" (p. 251).  "A talent as a salesman rather than as a policy maker" (p. 254). "Administration's prejudice against competition" (p. 256). "The New Deal was a hodgepodge of often inconsistent policies--at various times FDR tinkered with inflation and price controls, deficit spending and budget balancing, centralizing and trust-busting, bashing business and harnessing it for the common good, reclaiming land from the wilderness and consigning reclaimed land back to the wilderness" (p. 258). He created the gold exchange standard at an arbitrary price of $35 an ounce. [No mention is made of the SEC, accounting standards, or focus on required audits and corporate transparency; arguably among the most significant New Deal-related programs.] According to the authors the post-WWII boom was caused by the government capital stock taken over by the private sector plus the increased human capital. Problems were mass production for quantity rather than quality and sacrifice of human engagement for predictability [apparently, nothing of the New Deal helped the post-war boom; ditto the great compression].  Unions resisted any new ideas while Japan and Germany developed high-quality manufacturing techniques. Manufacturing reached its highest point in 1943 at 30% of the workforce.


Chapter 8: "The Golden Age of Growth 1945-1970. The economy grew an average 3.8% 1946-73 and real household income 2.1% (total 74%). The GI Bill is mentioned but not praised as a successful government program. The post-war international plan was rebuilding capitalism globally, free trade and providing help; the IMF, World Bank, and GATT (later World Trade Organization) were established, while the Marshall Plan provided rebuilding funds for Europe. They noted government funded basic research. The economy was dominated by giant corporations and managerial capitalism (GM, IBM, GE, P&G). Consumer research gave brands a personality. Products designed for one group were sold to new groups. Standardization brought increased productivity and reliance on unskilled workers; rapid expansion and economies of scale were possible, including Levittown and standard cargo containers, plus franchising. However, foreign competition was coming. 


Chapter 9 is "Stagflation," a major problem particularly in the 1970's. LBJ gets much of the blame because of the Great Society and Vietnam ("Government began to fail at everything it touched," p. 305). Nixon was just as bad because of new entitlement such as school lunch and the EPA.  Fed Chairman Paul Volcker jacked up interest rates to cause a recession and get a handle on inflation, jobs followed--thanks, in part, to Reagan's tax cuts (which were not matched by spending cuts). Nixon pulled the US out of the gold exchange standard in the early 1970's which added to inflation. Real wages peaked in 1973 and by the mid-1990's declined to 85% of the 1973 average (p. 301). Low tech manufacturing quickly moved to Asia. Various manufacturing problems were lack of innovation and overpriced labor, plus the focus on long runs of standardized production. American cars were: "overblown, overpriced monstrosities built by oafs for thieves to sell to mental detectives" (p. 312). Reliability and safety were additional problems. Japanese car markers were particularly effective competitors using new production systems based on just-in-time inventory and total quality management. American steel production fell from 43% of the world output in 1953 to 11% in 1982. Manufacturing of radios, televisions and other electronic products sailed overseas. US producers even failed to easily convert from vacuum tubes to transistors. The authors also pointed to a decline in the quality of management (apparently too many accountants, lawyers and MBAs at the top). They pointed out the rise of unsafe products (but did not suggest a government solution). The obvious solution reported was deregulation (true of airlines and trucking), which apparently resulted in Apple, Microsoft, pharmaceuticals and others. Banking deregulation was a Greenspan centerpiece.  


Chapter 10: "Age of Optimism," Reagan: the strengthening of business and weakened labor, the top tax rate dropped from 70% to 28%. High tech industries prospered. Deregulation meant: "In 1999, the Clinton administration finally passed a comprehensive financial reform that made it easier for Main Street banks to compete with their rivals" (p. 342). [As I remember it, this was seen as a debacle after the 2008 Subprime crash, plus other earlier financial crashes like the S&Ls.] Virtual integration: corporations replaced vertical integration with long-term contracts with suppliers around the world. IT companies mainly American: Apple, Microsoft, Google, and Amazon. Plus fracking.


Chapter 11 is "The Great Recession," which to me meant taking innovative financial instruments like derivatives and securitization to unethical extremes, which crashed (and the Feds rescued the big--and bad--players). Because Greenspan was part of the establishment, his perspective is important. Enron: "Wizardry tipped into fraud as the company tried to cover up its losses" (p. 369). The result of this and other scandals was awful: Sarbanes-Oxley, more regulation. Trading with China meant a surge of Chinese exports and fall in manufacturing employment. The authors claim the start of the 2008 crisis was the exuberance of the end of the Cold War, increasing globalization and economic growth; that and the nasty GSEs, Fannie Mae and Freddie Mac, that were government created. [Note that nasty stuff at the GSEs happened mainly after they were privatized. The push to require them to buy more subprime mortgages is certainly true.] But "The Federal Reserve's 'easy money' critics can't establish a clear link between monetary loosening and the crisis" (p. 384). Not exactly accepting any of the blame for Greenspan.  Productivity  was 2.5% annually 1948-2010, but .66% 2010-2017. (Also, 3.1% 1913-50, 3% 1950-73, 1.7% 1973-98 and 1.3% 2004-2016, p. 368).


Chapter 12 is "America's Fading Dynamism" and starts with the importance of creative destruction and how Americans pursued new opportunities while Europeans protected what they already had. They point out how companies "shed excess fat through repeated rounds of downsizing and restructuring [including massive layoffs and cutting employee benefits]. They have outsourced low-value-added jobs abroad" (p. 391), and sung the praises of Jack Welch. Then they complain about the stagnant country, in part caused by the destruction they just described as "shedding excess fat." They document the need for infrastructure in detail, which they claim is a failure of creative destruction (and no indication that conservative policies of tax cuts and simultaneous budget cuts are part of the problem). They recognize monopoly profits, but suggest more investment in R&D to stay ahead.


Business elites (the top 5%) are called frontier firms, while others are stagnant. Information technology elites are super-frontier firms. Identified problems include poor vocational training, high cost of college, productivity-suppressing entitlements, non-discretionary government spending, and growth of regulation (e.g., product-market regulation, burden on smaller companies, bureaucratization of capitalism, 30% of jobs require licensing. Entrepreneurs are the heroes ("seldom the easiest of heroes, or the nicest"). "Great companies can succeed only by delivering big benefits to consumers. ... Companies also succeed by riding roughshod over their competitors" (p. 422). "The costs of creative destruction are often more obvious than the benefits" (p. 423). "Entitlements crowd out productive investment. Creative destruction can sometimes be all destruction and no creation. ...  Capital is more fleet-footed and ruthless than any other factor of production" (p. 425). They point to the economic stagnation since 2009 (p. 438). Obama's 2% annual growth coming out of the Great Recession does not seem bad to me, especially since the boom continued (a case can be made that pressing for 4% or so growth may lead to recurring recessions).


They did comment on financial issues (remember Greenspan and the subprime meltdown, also that he was a regulator): "How do you guard against the destructive side of financial innovation without blunting the constructive side? One unhelpful solution has been to produce detailed regulations" (p. 444). They did address economic statistics from the Great Depression era, specifically Kuznets and the NBER plus Commerce Dept. statistics and others (p. 452). They missed the Securities Acts of the 1930's, a big deal to me and accountants in general.


Schumpeter argued that bureaucracy killed entrepreneurship. Entrepreneurs regained prominence in the 1980's-90's, plus financial innovation including Milken's junk bonds. Business forms included LLCs and limited liability partnerships. Jack Welsh was praised. Big companies became ruthless, Jensen and Meckling agency theory cited to think like owners. Enron mentioned for innovation, reminder that banks were over-regulated since the New Deal. New financials included money market funds, securitized loans into marketable securities. "Derivatives enabled investors to process a far wider range of risks" (p. 340). Private equity used LBOs with junk bonds. [The dark side of these innovations is covered in other books.]


America is great at bankruptcy ("world's most liberal bankruptcy laws"--p. 390), a relatively easy and common process in the US. One reason creative destruction works well is the ability to fail and try again. Many inventors and entrepreneurs failed and succeeded on the second or third attempt (Steve Jobs being a recent example). An interesting tail is the bankruptcy of the Northern Pacific from the panic of 1873, turning its vast land holdings into giant "factory farms" using mechanized combine harvesters and armies of workers broken into discrete operations (p. 114). The percent of land devoted to farming rose from 16% in 1850 to 39% in 1910 (about the same as today) despite fewer farmers. Plus animal slaughter houses consolidating and improving efficiency such as vertical integration and refrigerated rail cars; improved canning and packaging; food processing was 20% of manufactured output by 1910. Financing included futures markets--all of these integrated the West into the global economy.


Entitlements (mainly Social Security and Medicare/Medicaid) reduce dynamism, needing reform (like Sweden) according to the authors. In 2017, entitlement represented 14% of US GDP, up from 5% in 1965. The financial system needs reform, mainly by raising capital requirements of banks (not complicated regulations like Dodd-Frank). I agree with the need for more capital, but additional regulations still useful overall.


The use of creative destruction as the theoretical structure for American capitalism is a useful one, basically reconsidering the basic events in a different lens. It follows Smith's self interest and America's focus on making a buck while willing to abandon failing projects. Corruption also seems a core value of the country's dynamism; presumably, crooks (and the ethically challenged) can be as creative as inventors and entrepreneurs; James Fisk's "Never give a sucker an even break" seems to be an additional call for American exceptionalism, just another entrepreneurial genius. [Corruption levels seem to vary by culture and country; Scandinavia seems to be a corruption-free zone, while many third-world countries compete for the corruption-king title.]    


The authors overlay a libertarian free-market perspective on creative destruction. [Philip Tetlock would view this as a hedgehog perspective: presented as authoritative and occasionally right.] Given monopoly power in multiple industries and the tolerance (or even encouragement) of corruption, the idea that the market is the answer is foreign to me. I see a big government regulatory role to make markets work. Regulation needs to be effective and efficient and this is difficult, where industry capture and underfunding are big problems. I'm on the greater disclosure and transparency side of this discussion, plus greater funding and oversight. Having said that, this is a useful read for its libertarian/ creative destruction perspective.







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