Capitalism vs. Skepticism

Perhaps the free market works best with skeptics restraining its excesses rather than with true believers writing the rules

As each new day brings word of another Wall Street bailout even more colossal than the last, one question presents itself with ever-increasing force: why does America’s economy perform so badly under Republican presidents?

The facts are hard to dispute; indeed, the historical record is now so stark that diehard Republicans are probably starting to wonder if there is a curse. Over the period for which modern statistics are readily available, Democrats have outperformed Republicans by almost every traditional measure of economic performance (per capita GDP growth, unemployment, inflation, budget deficits).

Democrats have even managed to beat the Republicans on their own turf. Thanks to the profligacy of the current Bush administration (and the prudence of the Clinton administration), average Federal spending as a proportion of GDP under Republican presidents now exceeds that under Democrats during the measured period.

The pattern of Republican deficiency holds up when the span of historical analysis is extended by using stock returns to measure economic performance. On average, since the inception of the Standard and Poor’s composite stock index in 1926, the reward for putting your money in the market has been about 16 percentage points lower per presidential term under Republicans than under Democrats. Republican underperformance remains a stubborn fact even when the Great Depression and World War II are left out of the analysis (in the fond hope that they will prove to have been unique experiences).

With the current presidential term lurching to such a calamitous close that the incumbent is probably worried about being remembered as George Herbert Hoover Walker Bush, the correlation between presidential party and economic outcome demands some kind of explanation.

The answer can’t be found in the specific policy proposals of Republicans or Democrats, which have evolved so much over the years that they defy meaningful generalization. Nor are there clearly identifiable differences in doctrine that should translate into a reasonable expectation of better economic performance under one party than the other.

Perhaps the best explanation has to do with attitudes, not ideology. Maybe capitalism works better when skeptics restrain its excesses than when true believers are writing, interpreting, judging, and executing the rules of the game. The Democrats are surely the more skeptical of America’s two parties.

Some evidence can be found in those features of the American economy that we believe others should emulate. There is now an overwhelming consensus that open, transparent, and accountable mechanisms of shareholder control are essential for the efficient functioning of public corporations. Virtue is defined by good accounting rules.

But it is instructive to recall that many of those now-universally-admired rules were fiercely resisted when first proposed. The options backdating scandal that recently caught Apple’s chairman, Steve Jobs, is a microcosm of innovation, prosecution, and reform; now that a rule has been written to prohibit backdating, this particular scam will not happen again. Thus do accounting rules approach perfection.

What do we learn from this example? It’s hard to say. Maybe that capitalism works better when it is being held accountable to some external standard than when left to its own devices.

As the twentieth century recedes in the rear-view mirror, it increasingly seems that, for better or worse, our era’s defining manifesto has been Milton Friedman’s book Capitalism and Freedom . But that book’s potency originally derived from its fierce independence from contemporary orthodoxies. Friedman’s voice was a skeptical breath of fresh air at a time when the reigning viewpoint was a kind of smug pseudo-socialism that did not recognize the astounding power of markets to accomplish desirable aims.

Today, however, the reigning Republican orthodoxy is a kind of smug pseudo-Friedmanism that believes that markets left to themselves can do no wrong. Perhaps it is time for another breath of fresh air.

The book for the new epoch has yet to be written, but I have a proposed title: Capitalism and Skepticism. Skepticism might not be as bracing as freedom, but it’s something we could have used a bit more of in the past few years.


Christopher Carroll is Professor of Economics at Johns Hopkins University.


Copyright: Project Syndicate, 2008.

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