Mis-Selling Capitalism

By Paul Warner, 7 February, 2012

Ever since the unfolding of the financial crisis in 2008, people have questioned the future of capitalism, and these questions have evolved. In October 2008 there was the outright statement that capitalism was dead. In recent months the question is more about why capitalism failed and allowed the financial crisis to occur. There is also the added question, politically driven and helped by the 'Occupy' demonstrations around the world, as to how capitalism has led to inequality?

The first question to ask is what does one actually mean by the term 'capitalism'. The Oxford dictionary states: "an economic and political system in which a country's trade and industry are controlled by private owners for profit, rather than by the state". If you dig deeper you find that there is really no precise view on what capitalism actually is. Others broaden the definition to include free competition and profit-making. The word is derived from the word capital, which is the amount of money invested in a business to create a return. The –ism was placed after this word in the 19th century when capitalism was the new system encompassing the Industrial Revolution, and competing with socialism and communism.

It is probably true to say that most people talk about capitalism as free markets in line with the thoughts of Adam Smith and Friedrich Hayek. Unfortunately, a perfect equilibrium within capitalism rarely exists. Total success could end in a monopoly. On the other hand the workings of capitalism, left to its own devices, could end in harm for big chunks of society. In previous financial crises when capitalism had free rein, banks that failed did just that, and anyone who had their money on deposit with them lost the lot. If the whole banking system failed then a depression would follow, thus affecting the whole of society. To guard against these extremes of capitalism, society developed regulatory systems to act as a protection.

So, despite what many have seen as a failure of capitalism, what we effectively witnessed was the failure of regulation. If capitalism had been free then the banks would have been allowed to fall. It is quite likely that due to the all-encompassing nature of the banking failure this would have led to a 1930s style depression. Ironically, in the UK the regulatory system had been changing away from micro-managing regulation towards a more principle-based form of regulation. If this had been implemented correctly it would have been more effective than the micro-manage style regulation, where the likes of banks spend a fortune on accountants and lawyers to find loopholes. This is because, as in the days of the stock exchange principal of 'dictum meum pactum' (my word is my bond), the regulated think about what they should be doing for the benefit of their shareholders, rather than thinking about how to get round the regulations. It is as if because the regulator says no, it must mean it must be good to do it. Effectively, the system promoted the child rather than the adult. With all the new changes to regulation around the world, it shook us when we read that Martin Wheatley, CEO designate of the FCA, had said that mass mis-selling was not possible under the new regulator. However, we found out that this was not Martin's Gordon Brown boom and bust moment, but a summary of what the journalist thought he said. In fact, he did say “we will get it wrong...”.