The Bear’s Lair: Good policy favors the small property-owner

The Financial Times and the Economist have recently taken to issuing fatwas against the Trump Administration’s economic policy, indulging in repeated bouts of “Two Minutes Hate” against the man himself, combined with denunciations of “populism.” Yet “populism” is a term that covers a multitude of sins. In pandering to the prejudices of their journalists and readership, both publications have lost sight of the bedrock of sound economics: strengthening and furthering the interests of the small property-owner.

As I discussed a few months ago, the meaning of “liberalism” as defined and lauded in the FT and the Economist, has shifted in the last quarter-century. Immediately after the fall of Communism, when it appeared that history had indeed ended, a “Washington Consensus” grew up that relatively unfettered free markets worked best, and that policies should be set to give such markets as much play as possible.

The Washington Consensus was not truly liberal in the 19th Century sense; it failed in two respects. First, it was silent on the size of government, although it suggested that deregulation was optimal – hence the reforming governments of Central and Eastern Europe were not sufficiently slimmed down (except in a few countries like Estonia that went beyond the Consensus). Second, the Consensus paid insufficient attention to private property rights and the well-being of small property-owners, the bedrock of any capitalist system. Being determined by governments, international institutions and Establishment opinion-formers, the Washington Consensus was always too kind to the big battalions and the special interests, as well as to government itself.

After 2000, the Washington Consensus was attacked from two sides. From the emerging markets themselves, it was denounced as “neo-liberalism” as statists like Venezuela’s Hugo Chavez rejected its market orientation. In this respect, it was unfortunate that the Consensus had been imposed during a period of low commodity prices, so that commodity-based emerging markets in Latin America derived little benefit from it, their populations growing even more impoverished. Conversely, when commodity prices rose after 2000, the benefit of the rise was received and wasted by thoroughly unpleasant statist regimes in Venezuela, Argentina and Brazil.

The attack from emerging market leftists was perhaps to be expected. What was less forgivable was a movement in the world’s rich countries away from even the Washington Consensus version of free markets, beginning with the 2000-02 downturn and becoming more intense with the 2008 financial crisis. Balanced budgets were abandoned in favor of permanent Keynesian “stimulus,” while monetary policy prohibitions against central banks buying government bonds and against negative real interest rates were abandoned in an orgy of money printing.

Extraordinarily, the international institutions, the FT and the Economist, which would rightly have condemned such economic apostasy as recently as 1995, fell in completely with the new consensus and urged on the money-printers and budget-busters. What is more, instead of the mild support for free markets they had previously given, they instead favored an orgy of regulation, especially in finance and environmental areas, where they were seduced by the chimaera of global warming. Against all the evidence, they claimed that lack of regulation rather than misguided monetary policy and uncalled-for social engineering in the housing sector had been responsible for the 2008 financial crisis. Against all the evidence, they claimed that the planet was warming uncontrollably, so that infinite numbers of wasteful regulations and boondoggles must be imposed on the global economy to stop it.

Now the rise of Donald Trump and the British vote to leave the EU have led the usual suspects to condemn “populism” and to call for a return to the degraded leftist policy consensus they have been pushing since 2008. This is a clever piece of mis-labeling. Intellectually, one is inclined to reject anything called “populism,” remembering the half-baked socialism of the 1890s populists and the populist impulses behind such genuinely dangerous movements as Nazism. Yet when the new movement is examined closely, it bears only a modest resemblance to historic populism. Instead, it is mostly a long-overdue corrective to the follies of the Washington Consensus and its loathsome offspring, pushing us back much closer to true free-market capitalism.

Classical economics, as propounded by Adam Smith in 1776, depended on the individual, operating on a limited scale. By matching small-scale providers of goods with individual buyers, the market optimized the performance of the economy. By matching individual savings and resources with small-scale needs for capital, the resources of the economy were directed in an optimal direction. Smith was deeply suspicious, not only of government, but also of large scale enterprises like the East India Company; he regarded them as cesspits of corruption and resource misallocation.

Smith would also have been deeply suspicious of large investment institutions, had there been any in his time (even the Bank of England was tiny in the context of the overall economy.) He would have seen them as vulnerable to subornation of their officers by those seeking funding, and as very unlikely to allocate their capital optimally.

For Smith, therefore, the keys to a successful market economy were the small business and the small property owner. Capitalism could only work properly if their property rights were protected, and if they were given a fully equal chance against larger competitors on the playing field of the economy. Government’s principal function was to protect the rights of small investors and small businessmen against the politically well-connected.

The genesis of the Industrial Revolution showed the Adam Smith version of capitalism at its finest. Jean-Baptiste Say, visiting Britain in late 1814, was astonished at the prevalence of steam engines in the economy, each of them replacing the hard manual labor of a dozen or more workers. These new machines were mostly owned by businesses that were tiny in a modern context, with capital in the low thousands of pounds and under 100 employees.

Economic growth was further boosted after Say wrote by the profits to small savers, about 70% of GDP, from the rise in British government “Consols” in the decade after 1813, as peacetime capital market conditions were restored. (During the war, 3% Consols had been issued at a big discount, rather than issuing higher-interest bonds at par, so savers got a big capital gain when peace returned.) In real terms, given the deflation surrounding the 1819 return to the Gold Standard, savers who held on and reinvested income quadrupled their money in the decade 1813-23. This flood of new capital combined with technological innovation to produce a step-up in economic growth rates to levels never before seen, forming the self-sustaining “take-off” of the Industrial Revolution.

After Smith, technological progress seemed to make some of his prescriptions obsolete. While factories in Britain remained relatively small in the nineteenth century, in the United States over 1850-1950 giant corporate behemoths grew up. In the first three quarters of the twentieth century, giant investment institutions also increasingly came to dominate capital markets. When I went through business school in the 1970s, we were taught that the giant multi-divisional corporation was the most efficient form of capitalism and that funded final-salary pension schemes were becoming by far the most important players in the capital markets, dominating corporate governance.

Since 1990, undetected by the Washington Consensus believers, we have returned to a more Smithian economy. The behemoth corporations increasingly seem like dinosaurs, as their size and bureaucratic spread stifle innovation. Instead, new technology is produced in much younger and smaller companies, akin to the innovators of 1800-50. The big pension funds never came to dominate the capital markets, as final-salary pensions disappeared; instead, capital is provided mostly by wealthy individuals, often through small hedge funds and private equity funds, with institutional capital increasingly sidelined.

In such an environment. Adam Smith’s version of capitalism is again the model we should follow. The nexus of cozy arrangements between Wall Street, the corporate behemoths and the government must be broken up, to clear the way for new and more innovative companies and to restore Smith’s desired “level playing field.” Above all the private savers must be nurtured, not punished, which requires a revolution in both monetary and fiscal policy.

In monetary policy, interest rates must be raised well above the inflation rate, to provide decent real returns for savers and small capitalists. In fiscal policy, the government deficit, both visible and invisible through entitlements must be eliminated, to reduce the government’s drain on the economy. Taxes on capital must be slashed, in particular the death tax, which prevents the accumulation of wealth over multiple generations. Conversely the corporate tax, reducing which favors corporate behemoths over new and innovative businesses, can remain as it is, and must be applied on a worldwide basis so that the behemoths cannot simply evade tax by parking money offshore.

President Trump has not proposed an Adam Smithian capitalist economic program; his current proposals are an amalgam between his populism and traditional corporatist Republicanism. However, the focus of his policy, on the individual saver and small businessman, ignored by previous post-Reagan administrations both Republican and Democratic, is highly salutary. The pro-government pro-regulation quasi-Socialism of the Financial Times and the Economist is no longer a viable economic policy, and should be swept away in favor of a brighter populist future.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)