Rethinking Capitalism


Edited by M. JACOB and M. MAZZUCATO

“A fine collection of chapters by leading progressives on what went wrong — low growth, flagging investment and innovation, too few jobs and too much carbon — and what might be done. May it close the door on the failed “mainstream” and open another, toward a fully-integrated, uncompromising, radical view of economics and economic policy.”                          James K. Galbraith


Table of Contents

1. Rethinking Capitalism: An Introduction
2. The Failure of Austerity: Rethinking Fiscal Policy
3. Understanding Money and Macroeconomic Policy
4. The Costs of Short-termism
5. Innovative Enterprise and the Theory of the Firm
6. Innovation, the State and Patient Capital
7. Investment-led Growth: A Solution to the European Crisis
8. Inequality and Economic Growth
9. The Paradoxes of Privatisation and Public Service Outsourcing
10. Decarbonisation: Innovation and the Economics of Climate Change
11. Capitalism, Technology and a Green Global Golden Age: The Role


  • Giovanni Cozzi
  • Colin Crouch
  • Stephany Griffith-Jones
  • Andrew G Haldane
  • Michael Jacobs
  • William Lazonick
  • Stephanie Kelton
  • Mariana Mazzucato
  • Yeva Nersisyan
  • Carlota Perez
  • Joseph E. Stiglitz
  • L. Randall Wray
  • Dimitri Zenghelis

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1 – Rethinking Capitalism – An Introduction

Page 12

One of the most contentious of those debates has concerned the role of fiscal and monetary policy in response to the financial crisis and the ensuing slow recovery . In their chapters , Stephanie Kelton , and Randall Wray and Yeva Nersisyan take issue with the orthodox prescription of fiscal austerity . Kelton’s argument is that austerity is based on a fundamental economic misunderstanding . The claim that high deficits caused the recession turns the facts on their head : it was the recession which caused deficits to balloon , as the downturn slashed the tax revenues earned by governments and the automatic stabilisers of social security benefits and public spending went into operation . Kelton shows that in fact the deficits prevented the recession becoming much worse , generating demand

Wray and Nersisyan go further . They argue that the orthodox view of macroeconomic policy stems from an incorrect understanding of the nature of money . Rather than being exogenously determined by the central authorities , as the orthodox view has it , money is effectively created whenever commercial banks lend , and thereby increase their borrowers ’ purchasing power . Money is endogenous to the real economy . Examining the operations of modern central banks , Wray and Nersisyan show that for a nation with its own currency , government spending is not constrained by the resources available from taxation or borrowing . 35 The euro zone in particular has suffered from its rules expressly designed to prevent weaker European economies from borrowing in the absence of their own currency . Quantitative easing meanwhile is a poor way of boosting aggregate demand . Fiscal policy , the authors argue , is a much more powerful and effective tool for stimulating growth .

Page 13

Perhaps unsurprisingly , austerity policies have not succeeded in reversing the low levels of investment

Haldane asks if short – termism in financial markets may have reduced the willingness of firms to invest .

Overall , he concludes that short – termism appears to be making a material difference to corporate investment behaviour .

Lazonick focuses on the orthodox economic theory of the firm . Neoclassical economists draw on a model of the firm as an optimising profit – maker constrained in its behaviour by the competitive markets in which it operates . But such a model cannot explain the phenomenon of innovation .

Lazonick argues that the key is not the nature of the market , but the structure and organisation of the firm .

He argues that only by studying real historical examples , rather than merely abstract theory , can economists properly understand how innovation and economic development occur . Mazzucato’s chapter picks up this theme . The orthodox economic view is that innovation is carried out by the private sector , and government policy should be restricted to basic scientific research . But Mazzucato shows that this is a misconception ; in fact the modern state , particularly in the US , has been a driver of innovation in a whole range of fields .

Page 14

Griffith – Jones and Cozzi then show what an investment programme based on these principles might achieve .

The chapters by Joseph Stiglitz and Colin Crouch look at two of the major gaps between orthodox economic theory and the reality of modern capitalism . Stiglitz addresses the growth of inequality over the past thirty years . He takes on the neoclassical view that wages and salaries reflect the marginal productivity of workers

Crouch looks at the experience of privatisation and outsourcing .

Page 15

The final two chapters of the book examine capitalism’s environmental consequences. Dimitri Zenghelis shows why climate change poses such a challenge , not just to the economic system , but also to economics .

Strong and consistent policy – making can help shift investment towards tipping points when innovation may be driven rapidly in a low – carbon direction . Carlota Perez notes that structural change of this kind has happened before .

Page 16

Nevertheless , their critiques have many elements in common . Each challenges an important aspect of orthodox economic theory and policy prescription .

By ‘orthodox’ we mean the view that dominates public debate about economic policy .

In individual markets , neoclassical theory ( on which the orthodox view is based ) holds that such competition drives economic efficiency , which in turn maximises welfare . Markets are assumed to tend towards equilibrium , while businesses are assumed to be fundamentally alike , analysed as ‘ representative agents ’ constrained to act in the same ways by the external pressures of the market . At the level of the economy as a whole , it is competition between firms which is believed to generate innovation , and therefore leads to long – run economic growth . … The orthodox model understands that markets do not always work well . It therefore uses the concept of ‘ market failure ’ to explain why suboptimal outcomes occur and how they can be improved .

Page 17

The orthodox model provides an attractively simple framework for thinking about economics and policy . It combines the mathematical elegance of neoclassical microeconomics with plausible claims about the macroeconomy . The fact that many of the policy prescriptions which follow from it favour those in positions of incumbent economic power has given it a powerful grip on public discourse . ./..

But it’s not an adequate model for understanding how capitalism works . For markets are not simple structures which behave in the ways set out in economics textbooks ; and ‘ market failure ’ is not a helpful concept for analysing capitalism’s major problems or how to address them . These idealised theories assume away many of capitalism’s key features , or treat them as ‘ imperfections ’ rather than structural , systemic characteristics . They ignore much of the evidence on how different economies actually function , and when and why they have performed well or badly . None of the key problems which Western capitalism has experienced over recent decades — weak growth and financial instability , declining investment and financialisation , the stagnation of living standards and rising inequality , dangerous environmental risk — are explained by them .

Capitalist economies are not theoretical abstractions but complex and dynamic systems , embedded in specific societies , as well as in natural environments governed by biophysical laws .

Page 18

For these characteristics of capitalist economies are hardly revelatory . They have been analysed in theory and documented in practice for more than a hundred years of economic scholarship . They underlie the work of some of the greatest economists of the past century — such as Karl Polanyi , Joseph Schumpeter and John Maynard Keynes — and of the more recent schools of evolutionary , institutional and post – Keynesian economics .

Markets are better understood as the outcomes of interactions between economic actors and institutions …. Markets are ‘ embedded ’ in these wider institutional structures and social , legal and cultural conditions . 38 In the modern world , as Polanyi pointed out , the concept of a ‘ free ’ market is a construct of economic theory , not an empirical observation . 39 Indeed , he observed that the national capitalist market was effectively forced into existence through public policy — there was nothing ‘ natural ’ or universal about it .

The orthodox notion of competition between firms is equally misleading .

Page 19

In fact , the evidence shows the particular importance of ownership and governance structures .

In short , markets are not idealised abstractions , but concrete and differentiated outcomes arising from different circumstances . Contrary to the claims of orthodox economists that ‘ the laws of economics are like the laws of engineering : one set of laws works everywhere ’ , 44 there are in fact many different kinds of market behaviour , and several varieties of capitalism . 45 The second key insight is that it is investments in technological and organisational innovation , both public and private , which are the driving force behind economic growth and development . The diffusion of such innovations across the economy affects not just patterns of production , but of distribution and consumption .

Page 20

Critically , as Mazzucato shows , innovation also needs well – funded public research and development institutions and strong industrial policies . These need to be directed across the entire innovation chain , not only in the classic ‘ public good ’ area of basic science . A crucial recognition is that innovation has not only a rate , but also a direction . By setting societal missions , and using their own resources to co – invest with long – term capital , governments can do far more than ‘ level the playing field ’ , as the orthodox view would allow . They can help tilt the playing field towards the achievement of publicly chosen goals .

Page 21

Recognition of the role of the public sector in the innovation process informs the third key insight . This is that the creation of economic value is a collective process .

Indeed , Keynes argued that the ‘ socialisation of investment ’ — which , as Mazzucato suggests , could include the public sector acting as investor and equity – holder — would provide more stability to the investment function and hence to growth .

So the size and functions of the state matter profoundly to the performance of capitalist economies . In orthodox economic commentary it is frequently asserted that the role of the public sector should be minimised in order to free private enterprise from the ‘ dead hand ’ of regulation and the perverse impact of ‘ crowding out ’ . In fact , successful economies have almost all had states actively committed to their development .

Page 22

We need to acknowledge , rather , the interdependence of private enterprise and the public sector ; of market and non – market activities . This has an important implication for the role of taxation . The orthodox economic view characterises taxation as an essentially negative activity in which the value generated by private firms is confiscated by the state . But understanding the role of the public sector in the co – production of economic output allows a more profound perspective . Taxation is the means by which economic actors pay the public sector for its contribution to the productive process .

This creates a powerful case for the rebalancing of the distribution of earnings between capital and labour .

Page 23

These three insights therefore have profound implications for how we think about economic policy – making . Public policies are not ‘ interventions ’ in the economy , as if markets existed independently of the public institutions and social and environmental conditions in which they are embedded . The role of policy is not one simply of ‘ correcting ’ the failures of otherwise free markets . It is rather to help create and shape markets to achieve the co – production , and the fair distribution , of economic value . Economic performance cannot be measured simply by the short – term growth of GDP , but requires better indicators of long – term value creation , social well – being , inequality and environment sustainability . 60

3 – Understanding Money and Macroeconomic Policy

Page 49

Many economics textbooks offer brief accounts of the origins and evolution of money . Some typically note how money reduced the inefficiencies of barter , thereby facilitating the exchange of goods and services , and then go on to describe the evolution of paper money as a promise ‘ to pay the bearer ’ a specified amount of a valuable commodity such as gold or silver in exchange . The available supply of the precious metal set limits on the amount of paper IOUs ( ‘ I – owe – yous ’ ) that could be issued . In turn , there was always a risk of default — failure to pay the valuable commodity if there was a sudden rush to redeem paper for gold .

Eventually , according to this basic account , governments issued ‘ fiat money ’ , that is , national currencies no longer backed by any commodity . But from an orthodox perspective , the problem with fiat money is that there are no natural limits to its supply once it is freed from a commodity backing such as gold . The growth of fiat money can outstrip the growth in the volume of output produced each year in the economy . This creates the danger that excess growth in the supply of fiat money would lead to inflation , with ‘ too much money chasing too few goods’ . This ‘ quantity theory of money ’ , subsequently developed by Milton Friedman , argued that if governments were allowed simply to ‘ print money ’ to finance spending , this would inevitably lead to higher inflation . 7 Consequently , orthodox economists believe that government spending should largely be constrained by tax revenue .

Page 50

From an orthodox perspective , the quantity of fiat money in existence appears to be ‘ exogenous ’ to the real economy . That is , the supply of money is determined by the central authorities independently and separately from the production of goods and services . This idea lies at the heart of the ‘ classical dichotomy ’ in macroeconomics , where monetary variables are seen as independent of real variables . In the orthodox view an excess growth of this exogenously determined money supply relative to the growth in real output causes a rise in the general price level ; for this reason , controlling the money supply is central to the control of inflation .

Page 50

But this view of money does not actually accord with the facts . As Hyman Minsky pointed out , money is not created simply by the central authorities . It is effectively created whenever commercial banks lend money , since such lending increases the purchasing power of those who borrow . It is therefore the demand for loans by businesses and households in the economy which determines the money supply . Money , in other words , is endogenous to the real economy , and is not independent of the production of goods and services at all .

Arguing that governments have a choice between debt financing ( which is regarded as unsustainable ) and money financing ( which is seen to be inflationary ) is based on a misunderstanding of how modern governments spend . In fact , both tax payments and bond sales logically come after the government has spent .

Page 53

So seen from the perspective of modern money theory , sovereign governments do not need to ‘ borrow ’ their own currency in order to spend . They offer bonds on which banks , households , businesses and foreigners can earn interest . They do this out of choice rather than necessity . Governments do not need to sell bonds before they spend ; indeed , they cannot sell them without reserves being in place . Reserves are provided either through government spending ( i.e . fiscal policy ) or through central bank operations ( i.e . lending or open market purchases ) .

Page 54

While governments do not face financial constraints , they do have to deal with real resource constraints .

Austerity efforts in the US and UK are now rarely done in the name of ‘ controlling inflation ’ . Rather , the case for fiscal consolidation is based on claims that these countries are ‘ running out of money ’ or spending in excess of ‘ hard – working taxpayers ’ money ’ such that governments need to ‘ tighten their belts ’ , as if the government budget were the same as a household budget .

With the collapse of Bretton Woods , for the first time in modern history , all the world’s currencies were de – linked from gold or any other commodity . The lack of any formal constraint on money creation contributed to nervousness about inflation . ’ 13 Orthodox economists , informed by the quantity theory of money , felt that monetary policy – makers should ensure that the quantity of money available in the economy did not contribute to inflation .

The push to mandate central banks to target inflation can be understood as a way to establish some anchor for the value of ‘ fiat money ’ .

Page 55  For proponents of modern money theory , however , this view of the process of bank credit creation , and the accompanying belief that the central bank can control the quantity of money available in the economy , is a fiction . Banks do not in fact lend from the deposits made by households and businesses .

Page 56

So if the central bank wants to secure its target rate , it will have to supply reserves . This is usually done through an open market purchase , where the central bank buys a security , paying for it with reserves . In the opposite situation , when banks have more reserves than they desire , the central bank needs to drain reserves through an open market sale to prevent the interest rate from dropping below its target .

In sum , while the orthodox view sees central banks as choosing between controlling reserves and controlling interest rates , endogenous money theory argues that interest rate control is in fact the only tool at the central bank’s disposal . The quantity of money in the economy in practice depends on many variables , with interest rates being only one of them . In any case , once one disposes of the quantity theory of money , the stock of money in the economy becomes a relatively unimportant variable . What is important for the economy is the total level of aggregate demand , and the quantity of money does not determine its level , but rather is mostly a consequence of the decision to lend to finance desired spending .

Page 58

As we saw in the previous section , bank lending is not constrained by reserves 

QE is no more inflationary than any central bank open market operation designed to increase reserves in the banking system .

7 – Investment-led Growth: A Solution to the European Crisis

Page 124

A well – designed pan – European public investment financing strategy would therefore have the potential to crowd in private investment and increase aggregate demand , with long – term positive effects on growth and employment .

The first is an expansion of lending by the EIB , based on an increase in its paid – in capital provided by EU members . The EIB’s ability to leverage its own financing to attract private co – investment enables a significant economic impact to be achieved from fairly limited public resources . Using the proven EIB would enable the programme to be implemented quickly and effectively .

Second , we propose that funds from the EU budget are used to mitigate investment risk for the private sector . Today many institutional investors such as pension funds and insurance companies do not fund large investment projects , particularly in infrastructure , due to a perception that the risks are too high .

Third, we suggest the creation of a new European Fund for Investment ( EFI )

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