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The Next Century—Can the Free Market Panacea Survice?

ISSUE:  Winter 1995

On both the political and economic fronts American foreign policy has been on an uneven track of stumbles and reversals. On the political front the stumbles—Bosnia, Somalia, Haiti—have been the most visible but in many ways the most excusable. In each case the United States has been locked into commitments to the United Nations and its allies to consult first and abstain from unilateral action. The problems in Bosnia and Somalia have been just as intractable for the Europeans.

On the economic front the blunders have been largely of our own making. The belated and half-hearted adoption of NAFTA, the nearly fatal misstep over Most Favored Nation (MFN) status for China, the incessant wrangling with Japan over market access, the hypocritical whining over European aircraft and agricultural subsidies, and the tasteless attempts to force Hollywood trash down the throats of older cultures, are continuing examples of parochial adherence to a narrow, outdated economic ideology.

At precisely the time when Marxism is discredited, the United States is being afflicted with another brand of determinism—doctrinaire faith in deregulation and free market economics. During the Reagan and Bush administrations— and the Thatcher years in Great Britain—a belief that unbridled capitalism was the talisman for job creation and economic growth became official orthodoxy. The free market was sold to the public as inseparably linked to political freedom and the American way. The abysmal failure of this policy in the Great Depression and the subsequent rescue of the economy by the New Deal and the industrial mobilization of the Second World War were swept under the rug.

Equally ignored was the fact that in this century even the most business-oriented Republican administrations have engaged in one sort of government intervention or another— control of the money supply, tariffs, import quotas, agricultural subsidies. The difference today is that instead of being justified in old-fashioned practical terms, the nostrum of fundamentalist free market capitalism has been converted into an ideology preached by a priesthood of Chicago-school economists housed in universities and think-tanks and directly or indirectly subsidized by the corporate and political interests they serve. The right-wing idealogues of the Reagan and Bush administrations have mostly left the political stage, but the philosophy lingers on.

The result is that instead of growing closer to its principal trading partners, the United States is now in a state of continental drift away from them. If it persists in this course, it will eventually be the only major economic power dogmatically committed to free market economics with the rest of the world jogging comfortably along with mixed state and free market economies and pragmatically managed trading relationships. The United States will then find itself in recurring confrontations with these trading partners, including a unified Europe of even greater economic power. The consequences will certainly spill over into the political arena and affect relationships across the board.

To examine this divergence in detail, and with modeling as the academic fashion, let us call the United States the market economy model and the advanced industrial states of Japan and Western Europe the mixed economy model. The distinction is a crude one since both models share many common features, but one difference stands out—the doctrinaire ideology and inflated rhetoric of the first sharply distinguishes it from the second. There is a deep gulf between “libertarian” ideologues who preach that only the free market and minimal government are the keys to economic survival, and concerned citizens with a sense of history who recognize that while market forces have their place, it is the moral and constitutional duty of government to provide for the general welfare.

Underlying the market economy model, and illustrating its essentially artificial character, is the premise that the economy exists in a self-contained bubble. Broader considerations of the needs of society as a whole, including public services, health coverage, an unemployment safety net, environmental safety, and protection of critical sectors, are excluded or kept on the periphery as unquantifiable and injurious to the model’s efficiency. The mixed economy model excludes nothing, allows a place for market forces at the consumer level, and embraces society as a whole.

If we break down the market economy and mixed economy models into their components, the differences are striking.

In the market economy model profitability and the “bottom line” are the sole criteria by which market efficiency is judged. The model assumes, indeed requires, a competitive environment in which the free play of market forces makes continuing adjustments to provide incentives for technological innovation and greater management efficiency. The model makes no value judgments as between short-term and long-term profitability—indeed, favors the former since share price determines capitalization and the financial markets valuate share price by quarterly results. In this model, political, institutional, and societal factors play almost no role except a negative one. Heavy investment in R & D at the expense of immediate profits weighs in on the plus side only when the results pay off in new products and the “bottom line.”

At the international level, the market economy model in theory purports to replicate the competitive, free market environment of the national bubble by emphatically rejecting state support mechanisms like import quotas, tariffs, tax exemptions, and subsidies, not to mention societal and cultural factors. In practice of course it makes all kinds of exceptions for its own advantage.

The mixed economy model is nowhere near as dogmatic. Japan and Western Europe allow plenty of room for competition and the free market but virtually every country protects critical sectors of society by some form of government intervention. An unemployment safety net at the lower income levels and career security at the upper are prime considerations. Protection of the national culture in France and rice farming in Japan are typical examples.

Especially in Japan and Germany, the long-term competitive health of key industries is an important factor modifying the free play of market forces, and in some cases requiring heavy investment in R & D at the expense of short-term profit and stock valuation. Germany, Switzerland, and other continental countries have apprenticeship and vocational training programs paid for by the employer—another long-term investment at the expense of the immediate bottom line.

In the American market economy model, there is no such thing as job security, which is considered an impediment to the efficient functioning of the marketplace. During downturns in the business cycle, or after mergers and consolidations, firings, and layoffs are an acceptable part of the system regardless of human cost. Correspondingly, the social security safety-net and employer-paid health coverage, not to mention paid vacations and pregnancy or child-care leaves-of-absence, are considered an intolerable burden and threat to profitability. Vocational training is the responsibility of the individual; the apprentice system has been blocked both by profit concerns and minimum wage standards.

In the Japan-Western Europe mixed economy model, societal pressures require companies to keep layoffs to the absolute minimum. European industrial custom not only provides a great deal of job security for the skilled work force, but in addition to other benefits gives its members four to six weeks of paid vacation a year. In contrast to the United States, the social welfare-safety net—among other things paying the unemployed up to 80 percent of their last wage—is considered a positive benefit to the economy by keeping up purchasing power and preserving social stability. The costs of these programs do, however, affect competitiveness at the international level, making some form of government support inevitable.


The ethos of the market economy model is materialism pure and simple. Executive motivation is presumed to be driven exclusively by personal monetary reward, in other words greed: concern for the long-term health of the enterprise, let alone the work force, does not enter into it. Executive compensation in the United States—astronomical from the standpoint of any one individual’s contribution to company earnings—is fixed by top management and subservient boards of directors. Salaries, stock options, bonuses, and other “perks” are supposed to be keyed to performance, but this is pure fiction. Staggering losses and scandalous mismanagement are always excused by the business cycle, blaming foreign competition, labor problems, or government regulation; self-serving management contracts reward dismissal with a golden handshake. In the financial markets the obscene profits of speculators and buyout middlemen are viewed as an acceptable trade-off for market liquidity.

One of the most striking differences between the market and mixed economy models is in the attitude toward the role of government. Only a small part of the hostility to government controls by American business can be attributed to the size and diversity of the country and the difficulty of imposing uniformity from Washington. A much greater cause of hostility is the presumed threat of government regulation and increased taxes to profits. In the past even the most elementary safety regulations aimed at protecting the work force and public from hazardous working conditions and harmful drugs have drawn down the wrath of conservative business interests. During the Reagan-Bush administrations, deregulation and tax reduction were given priority over the poor and the inner city; the financial excesses of the eighties, including unprecedented budget deficits, were deemed an acceptable price for economic expansion. This was the boom-and-bust philosophy of the 1890’s and 1920’s all over again. Enrichis-sez-vous was the watchword and big government the enemy.

Nevertheless, even die-hard apostles of the free market have recognized its limitations. Thanks in large part to the New Deal some forms of government intervention are now too deeply embedded to dismantle. The open-market operations of the Federal Reserve, anti-trust legislation, regulation of the securities industry, requirements for financial disclosure, and pure food and drug legislation, are now unshake-able components of the capitalist system and indeed prevent it from breaking down.

There is, however, one feature of government intervention that differentiates the two models and that is how it is managed. Separation of powers and the maxim—drawn from the early constitution of Massachusetts—that “this shall be a government of laws and not men” has in the American market economy model led to reliance on tightly drawn legislation and detailed implementing regulations. Their application to individual situations, and the resolution of disputes over their interpretation, are left to the courts and a vast army of private and government lawyers. Additional employment for judges and lawyers is provided by the national habit of criminalizing infractions of economic laws, thereby covering them with the protective mantle of the Bill of Rights and the tangled web of American criminal law procedure.

By contrast, the Japanese-European mixed economy model treats government controls and economic regulation primarily as an administrative matter to be handled and even adjudicated by civil servants. Laws are couched in broad language emphasizing purpose; all but basic changes are made by decree—not a significant difference since under the parliamentary system the government in power can enact any legislation it wants. The right of citizens and business firms to challenge administrative rulings is protected on the continent by a separate channel of judicial appeal, in France the Conseil d’Etat. In most European countries (Great Britain excepted) the criminal law statutes are still mainly confined to traditional offenses like fraud and embezzlement. Infractions of economic laws, including most violations of the revenue code, carry civil penalties which in addition to monetary judgments may involve various forms of business disqualification. Only the most flagrant violations of law carry prison terms.

One result is that the financial burden of government regulation falls much more heavily on private business in relatively free-market United States than in supposedly state-controlled Europe. Once entangled in the regulatory net, an American firm faces staggering legal costs in addition to expensive delays in marketing its products while disputes work their way through successive layers of administrative hearings and appeals. The whole process is bedeviled by a minefield of fine print designed to ensure equality of treatment but in fact tying the hands of the regulator. The United States is the only country except for tiny Liechtenstein—a tax haven—that has more lawyers than farmers.

In Japan and Europe the discretion allowed to bureaucrats to interpret and administer economic and revenue laws may at first seem outrageously arbitrary. But the latitude foreign officials enjoy to negotiate practical arrangements that satisfy the intent of the rules more than compensates for timeconsuming recourse to legalistic haggling. In nearly all countries but the United States lawyers play a secondary role in commercial transactions, serving as advisers, not principals or negotiators.

The American free market model (and to a lesser extent the British) presents a curious paradox. On the surface it seems more resilient and propitious for long-term growth than the mixed economy models of Japan and Europe. As of the summer of 1994 the unemployment rate of the United States was only 6 percent as compared to 11 percent in France, 10 percent in Britain and 7 percent in Germany. In advanced technology innovation, though not necessarily application, the United States leads the world. In the latest annual “World Competitiveness Report” the United States also now leads other countries. The American capacity to shift its economic base from heavy industry and resource exploitation to hightech light industry and services has been extraordinary.

For free-market enthusiasts the Reagan-Bush policy of deregulation, drastic tax reduction, spending cuts in the public sector, and unrestrained speculation, mergers, and business expansion in the private sector, is an unimpeachable prescription for growth and job creation. Indeed, market economy zealots contend that the only reason the mixed economy models of other countries fare as well as they do is because they are following the U.S. lead in privatizing, deregulating, and cutting taxes.

But the seductive free market prescription has another and less appealing side. Much of its past efficacy can be attributed to the immense size of the American market; this advantage will diminish as other parts of the world unify. The standard of living in much of Western Europe is now higher, not lower, than the United States. To a large extent, the success of the American market economy model has been pure trickle-down, with the rich getting richer, the poor getting poorer, and the middle brackets barely staying even. The favorable “competitiveness” valuation turns out to be heavily based on a cheap dollar and earlier emergence from the recession cycle. The low unemployment figures conceal the fact of massive layoffs in the defense industry and less competitive companies; when laid-off workers reenter the work force, they do so in lower-paying service jobs or temporary employment. This is also the job route for inner city and other marginally educated youth and for immigrants from the third world.

The service sector is a deceptive yardstick for measuring job creation and economic growth. Only at the upper end of the service scale are jobs well-paid and comparatively secure. The middle and lower levels include large numbers of casual and intermittent labor whose wages are static and who are not on any kind of career track. With no safety net or union protection, this is a fundamentally volatile sector of the economy whose components are dependent on the spending power of the layers above. Any recession or business disruption will throw large numbers back on the street and shrink job prospects for new entrants.

It goes without saying that the recent expansion of the private sector has been at the expense of the public sector. The infrastructure of the country—roads, bridges, railbeds and transit systems, low-rent housing—is deteriorating. The airways are becoming choked with a transportation load that should be carried by rail. The automobile is clogging cities and freeways. An undereducated and potentially lawless underclass is making large urban areas unsafe and sometimes uninhabitable. Economic statistics alone fail to reflect the plight of the public sector and the degradation of the cities; the population in the lowest economic brackets, which is not politically organized and often does not vote, has no political weight in comparison to the vocal middle and upper brackets. Sooner or later, as the gap between rich and poor widens, and the public sector continues to deteriorate, the underlying social rot will undermine the whole economic structure.

It should be noted that while much of the deterioration has been caused by doctrinaire neglect, some of it was deliberate.

Policy decisions in Washington led to the abandonment and dismantling of the finest and most comprehensive railway system on earth, even while passenger traffic on major routes was still rising. Street railway systems, the pride of major cities in Europe, were allowed to fall into the rapacious hands of General Motors and other automobile companies, which promptly tore up the rails. Unrestrained real estate development was allowed to run riot and chew up the surrounding countryside, allowing urban residential areas to crumble.

After the 1929 crash, the American economy, then in the last phase of the 19th-century industrial age, came within an ace of collapsing into social revolution. It was rescued by Franklin D. Roosevelt’s New Deal, and given a new lease on life by the titanic industrial mobilization of the Second World War. The resultant prosperity lasted until undermined by the inflationary policies of the Vietnam war. Throughout this period unrestrained capitalism was held in check by the lessons of the Great Depression.

During the Nixon, Ford, and Carter administrations most of the New Deal programs remained in place. Lyndon Johnson’s New Society legislation added yet another dimension to the role of the federal government with Medicare, Medicaid, and Head Start. Thanks to a realistic level of taxation—income tax at more than 70 percent in the highest brackets—not only were these programs funded but food and energy costs remained low, public education improved and was racially integrated, cities continued to modernize, and there were large increases in public funding for space programs and scientific research. Not until the advent of the Reagan administration in 1981 was there a conscious and deliberate effort to cut taxes for the wealthy and sabotage the public sector. This was the era when free market fanatics emerged from the academic closet and joined up with right-wing libertarian pundits to clothe old-fashioned greed in a mantle of traditional American values.


In Japan and Europe the mixed economy model evolved under totally different conditions. Devastated both physically and economically by the Second World War and its after-effects, there was no way that the governments of Europe could indulge in the luxury of free market economics—in other words, the black market enlarged—while leaving their half-starved populations to sink or swim. For two decades it took rationing, import restrictions, currency controls, and massive, targeted Marshall Plan aid to set European industry on its feet and restore the dilapidated and wrecked infrastructure. The Coal and Steel Community and the gradual process of economic integration that led to the Treaty of Rome and the European Union, as well as the integration of East Germany into the Federal Republic, represent large-scale government intervention at its best on both a national and multi-national scale. Today, the European Commission in Brussels administers a wide range of trans-national regulatory measures aimed at gradually eliminating intra-European trade and financial barriers. Private enterprise has flourished and the fact that today Western Europe has a higher standard of living than the United States—ask any traveler—can be directly attributed to the supportive role of government.

In Europe the role of the state in the economy dates back to the Roman Empire and the Middle Ages. In more recent history, Socialist governments have come and gone, but the economic and social welfare programs that they and their conservative counterparts instituted have with minor fluctuations remained in place. Germany has had labor laws and universal health coverage since the last century, and Britain and the rest of Europe since the Second World War. Unemployment benefits are of long standing. European governments have continually extended and modernized their rail systems and urban transit networks. University education on the continent is free and a responsibility of the state; in

France even private schools get state subsidies. Major cities have trash collection daily—in Paris on Sundays as well.

In the mixed economy model, the national interest and the needs of society determine the balance between monopoly and competition, between free trade and managed trade. No mixed economy government in its senses would have allowed the most extensive railway network on earth to wither away because air transportation had become more competitive, or allowed black-robed legal mandarins to dismantle a national telephone system as efficient and innovative as AT&T. Given the unassailable reality that everywhere in the world, not least in the United States, critical sectors of the economy get some degree of support through government contracts, tax breaks, import quotas, and direct or indirect subsidies, and that the GATT rounds have been gradually reducing trade barriers, the mixed economy model necessarily views flexibility and compromise as the best route to a smoothly functioning global trading system.

On a global scale the problems of the American market economy model lie not so much in its internal deficiencies as in its doctrinaire character and propensity for confrontation. For better or worse, this is a mixed economy world. The market economy model seems unable to accept the fact that other cultures do not view the market-place as a sounding board for strident rhetoric and a testing ground of moral principles. They find the metaphor of level playing fields ridiculous and see little connection between political freedom and market economics.


The gulf between the American market economy model and the mixed economy models of the rest of the world cannot be understood, let alone bridged, at the purely economic level. At the heart of the problem are value systems, and these are rooted in the origins and cultures of the societies concerned.

The historical origins of the values underlying the American market economy model are too obvious to dwell on—the vast, empty territory and sparse native population; the successive waves of immigration with their ethnic diversity; the severance of ties with the homeland; the work ethic and necessity to start from scratch; the revolt against colonial status. But certain special features stand out as directly shaping market force ideology.

The empty land, waves of immigration, and necessity to start from scratch incorporated a vision of endless opportunity. But for most people this meant individual opportunity, not collective. Except for the original Pilgrim and Puritan settlements in New England, later religious communities like the Quakers, Mormons, and Mennonites, and the ethnic enclaves in the big cities, there was little support structure to sustain the individual and his family, especially in hard times. There was a strong fabric of property rights but almost no tradition of putting the community before the individual. From the beginning the cult of individual effort was built into the market economy model, and given theoretical justification by the textbook division of the economy into autonomous entities of land, labor, and capital.

Equally important was the nature of the mass immigration. Except for a handful of beneficiaries of land grants and the early religious separatists, nearly all the European immigrants were, in modern parlance, economic refugees in search of a better life. By and large they had no connection with the governing classes of their native countries, and no family tradition of service to the state. When the later waves arrived, they found on the Eastern seaboard an educated upper class and plantation aristocracy—the nucleus of the Founding Fathers and native governing class—but no careers in government, no military officer class, and only a small professional class of doctors and lawyers for those with educational qualifications. For most of the new arrivals, the only outlets of upward mobility, and even survival, were in farming, handicrafts, and commerce. Not until the 1929 depression was the national government an economic factor in most people’s lives. They were on their own and at all times at the mercy of market forces.

The supposed hostility of Americans to centralized government as originating in colonialism and the American War of Independence has only minor contemporary relevance and an even smaller basis in historical fact. By 20th-century standards, the degree of oppression suffered by the British colonists in North America was laughable. As Samuel Eliot Morison and other respected historians have never tired of pointing out, the stamp and tea taxes were negligible and soon revoked; the colonies had their own legislatures and local government; censorship and restrictions on assembly were minimal; and not until parliament made the mistake of trying to force the colonies to pay for their own defense and stationing small British garrisons in the cities did violence break out. The mercantilist trade policies of the mother country, which had helped American traders and shipowners grow rich, did finally become a straitjacket, but the grievances were primarily symbolic and political. It was Parliament’s clumsy efforts to establish control over its own self-governing offspring, from 3000 miles and two months sailing distance away, that led to separation.

For the market economy model in the United States, the significant legacies of the British colonial past and the American Revolution were a written constitution in a government of limited powers; separate legislative, executive and judicial arms; and, of equal importance, confirmation of English common law and the adversarial system of justice. Separation of the legislative branch from the executive branch, and designation of the President as executant of the laws passed by Congress, set the tone for a government of laws and not men. Limited government at the federal and state level speaks for itself. Adoption of English jurisprudence, less noticed by historians, requires elaboration.

The American legal system is different from that of other countries, even including the British, in its divorcement from the apparatus of executive government. The judiciary is not an integral part of the law enforcement structure but an autonomous and independent body for adjudicating the disputes of private parties and presiding over the prosecution of criminal defendants. It is also the final authority for interpreting legislation and applying the law to disputes brought before the courts. The American trial is not an instrument for discovering the truth—though this may emerge in one way or another—but for establishing a criminal defendant’s guilt or the validity of a claim for damages against a civil defendant. American legislation and regulations tend to be of unusual detail and complexity, requiring endless interpretation through judicial rulings based on precedent. The system is adversarial and based on aggressive pursuit of individual interests. Lawyers owe their allegiance not as elsewhere to the court or state, but to the client. Inherently contentious and disputatious, it is made to order for a competitive society obsessed with rights rather than duties.

Today the United States has evolved into a consumer-driven society of 260 million with a relatively high standard of living at the middle and upper levels but in which erosion of standards has debased the national culture and weakened family ties and obligations to the community. With a weakened support structure and vanishing tribal guideposts, the individual has felt so helpless that at every level, there is constant clamor for “leadership.” In no other Western society is there such adulation of the strong-jawed decisive CEO. Only in the United States are co-equal members of high-level government commissions like the Federal Reserve Board mere ciphers compared to the chairman, and boards of directors of publicly held companies nothing but rubber stamps for management. Unique to the land of the free is personal ownership of municipal ball clubs and domination of high school and university athletics by arrogant and foul-mouthed coaches who jerk players in and out of the game at will. It is the “fuhrer prinzip” of Nazi Germany all over again, ready to take over when market forces finally spin the economy out of control.

The mixed economy model, which includes most of the rest of the world, rests on quite different foundations. The traumatic events that have shaken Japan and Western Europe in this century—war, revolution, enemy occupation, economic and social chaos, the rise and fall of colonial empires—have for the time being cured their societies of any faith in panaceas and secular ideologies. The last theorist to invent a politico-economic doctrine with mass appeal was Karl Marx, and his blueprint for action—though not his analytical genius—has been largely discredited. In Japan and Europe, politicians and civil servants make policy—without the benefit of irresponsible advice from analysts and academics in universities and think-tanks.

The Japanese and European perception of the role of the state is utterly different from the American. The interconnections between the Japanese government and Japanese business are well-known and have been the subject of innumerable books and articles. Especially in relation to the outside world, Japanese society is an integrated whole with the lines between business and government often hard to separate. But the European perception is also different. Political upheaval, revolutions, and changes in the form of government have not altered the fact that since the Roman Empire the state has been the principal fount of rank, wealth, and privelege. Under the feudal system all landed property belonged to the monarch, with tenancies parcelled out in descending layers to the nobility and commons. Since the 19th century, capitalism has captured the private sector of the economy and land reform and taxes have broken up the big estates, but the social welfare net and extensive public services have kept the state’s paternalistic role alive.

Moreover, in Western Europe the state has always been a traditional field of employment for the upper classes and a prime source of upward mobility for the ambitious. The countries of Western Europe are political democracies, but elites run the government, the big banks, and the major corporations: the difference today is that the elites are a meritocracy and not hereditary. In Europe, democracy stops at the universal franchise—it does not imply leveling of cultural recruitment or educational standards.

Nor does European democracy include the concept of a powerful chief executive—they have been burnt too often by dictators and demagogues. Nearly all countries have a ceremonial chief of state, a king, or president, and collective cabinet leadership responsible to parliament—France alone has a stronger presidency. The prime minister is first among equals and can be displaced overnight by cabinet colleagues on an adverse vote of confidence by parliament or his own party—witness the fate of the redoubtable Margaret Thatcher.

On the continent of Europe, Latin America, and much of the Third World, the legal system derives from Roman Law and is incorporated in civil and criminal codes written in such terse and clear language that in Switzerland at least a one-volume edition is provided to every household. Criminal justice is non-adversarial and based on thorough judicial investigation in which the public trial is merely the final phase; guilt or innocence emerges in the course of the process itself.

What this adds up to is a collection of values that accords primacy to society rather than to the individual and which within a democratic framework entrusts the welfare of the nation to the state. Pursuit of wealth, private enterprise, competition, and—within limits—the free market are encouraged; but not at the expense of the social security network, public services, the infrastructure, critical sectors of the economy, the education system, and the national culture. In all these areas the state has a primary role. This gives the mixed economy model a set of priorities far different from the one-dimensional market economy model.

In a fragmented world, the Clinton administration has come to terms with the fact that military power no longer translates automatically into political power. But at the economic level the doctrinaire orthodoxies of the free market still have a strong grip. American politicians and trade negotiators seem unable to grasp that for the rest of the world these orthodoxies have a hollow ideological ring—that the national culture and vital economic interests weigh more heavily on the political scale than artificial free market dogma.

The outside world also knows that free market economics has only a marginal relationship to democracy and political freedom. Czarist Russia, the Porfirio Diaz dictatorship of Mexico, and Pinochet’s Chile each gave free rein to unbridled capitalism; the socialist governments of postwar Western Europe and present-day Spain and Scandinavia have been political democracies by any definition. For the United States to link market force economics to democracy and peddle the combination as a secular religion is to court derision and continuing rebuffs. Pax Americana reached its peak some time ago; we should beware the swing of the pendulum.


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