‘The Great Degeneration: How Institutions Decay and Economies Die’ by Niall Ferguson (Penguin Press; June 13, 2013)
Table of Contents:
i. Introduction/Synopsis
PART I: WHY NATIONS SUCCEED AND FAIL: THE GREAT RECONVERGENCE, THE GREAT DIVERGENCE & THE RECENT RISE OF ASIA
1. The Great Reconvergence
2. Explaining the Great Divergence, Part I: Examining the Theories
a. The Arguments from Geography and Imperialism
i. The Argument from Geography
ii. The Argument from Imperialism
b. The Arguments from Culture and Institutions
3. Explaining the Great Divergence, Part II: Successful and Unsuccessful Institutions (The Open Access Pattern Vs. The Limited Access Pattern)
4. Explaining the Great Divergence Part III: How the Open Access Pattern Led to Success, and the Limited Access Pattern Was Left Behind
5. The Recent Rise of Asia
PART II: THE DECLINE OF THE WEST
6. The Degeneration of Democracy
a. The Contract between the Generations
b. The Debt Problem
i. The Problem
ii. The Potential Solutions
iii. The Best Solution
7. The Degeneration of Capitalism, Part I: Laws and Regulations
a. Tax Laws & Business Regulations
b. File under Favoritism: Copyright Laws & the Lobbying Industry
8. The Degeneration of Capitalism, Part II: The Financial System (and the Financial Crash of 2008)
a. The Role of the Government and the Federal Reserve in the Latest Financial Crash
b. Financial Regulation
9. The Degeneration of the Rule of Law
10. The Degeneration of Civil Society
a. The Decline in Civic Participation
i. The Phenomenon
ii. The Causes and Consequences
b. Towards a Solution: Education Reform
11. Conclusion
i. Introduction/Synopsis
Over the past half-millennium the West has built up a substantial lead over other parts of the world when it comes to both economic power and material standard of living. Now, however, this lead is slipping away. Indeed, developing nations led by such powers as China and India are quickly closing the gap, as they are experiencing impressive economic growth, while the West is stagnating. Many argue that this is the natural result of globalization (and the fact that major corporations are taking advantage of cheaper labor in developing nations). For Harvard historian and writer Niall Ferguson, however, there is something deeper going on here. For Ferguson, the closing of the gap between the West and the Rest has less to do with the rise of the Rest, as the decline of the West.
Specifically, Ferguson argues that it is the West’s political, economic, legal and social institutions that have allowed it to gain the upper hand over the past 500 years or so, and that now these institutions are beginning to deteriorate (just as other nations increasingly copy what made the West successful in the first place). The result: Western stagnation, and the catching up of everyone else.
Ferguson identifies 4 primary institutions that account for the West’s success over the past half-millennium: 1. Democracy; 2. Capitalism; 3. The Rule of Law; and 4. Civil Society. Each of these, the author argues, has eroded in the recent past.
Beginning with democracy, Ferguson argues that the deterioration of democracy in our time has not so much to do with the break-down of the social contract between the individual and the state, as the break-down in the contract between the present generation and future generations. Specifically, by taking on the astronomical amount of public debt that many Western governments have taken on over the past half-century, we have undermined our own growth and unjustly put future generations in hock. We have lived well at the expense of our progeny, and have set them up for failure.
With respect to capitalism, where once Western institutions led the world in making it easy for businesses to start-up and operate efficiently, now heavy and overly-complex regulations stifle new businesses and send domestic corporations overseas. Western banks and financial institutions, the author argues, are not under-regulated, but poorly regulated. And what’s more, they are not made to pay for their transgressions when they do breach the law (as witnessed, most recently, in the financial crash of 2008), thus they are invited to behave irresponsibly.
When it comes to the rule of law, where once the West did well to protect contracts and property rights, now tort law has allowed civil suits to run amok and choke the legal system. Meanwhile, copyright law now deeply favors the established over the up-and-coming, which has stifled innovation and progress. The Rule of Law has become the Rule of Lawyers.
When it comes to civil society, where once most Western citizens freely donated their time and money to worthy causes and charities, and flocked to join associations, clubs and organizations that promoted both civic-feeling and the public good, now citizens largely hide behind their televisions and computer screens and wait for the government to take care of the less fortunate and any and all public goods.
For Ferguson, unless we reverse the current deterioration of our institutions, we can expect our stagnation to continue (and we also run the risk of having our societies crash outright).
*To check out the book at Amazon.com, or purchase it, please click here: The Great Degeneration: How Institutions Decay and Economies Die
What follows is a full executive summary of The Great Degeneration: How Institutions Decay and Economies Die by Niall Ferguson
PART I: WHY NATIONS SUCCEED AND FAIL: THE GREAT RECONVERGENCE, THE GREAT DIVERGENCE & THE RECENT RISE OF ASIA
1. The Great Reconvergence
It’s no secret that the economic gap between Western nations and the rest of the world is closing. There are two aspects to this phenomenon. One is that many developing nations are exploding economically; and two is that the West is stagnating. As evidence of this, consider that “in 2013 the World Bank expected the European economy to contract and the US to grow by just 2 per cent. China would grow four times faster than that, India three times faster” (loc. 48).
Nor is the explosion of the Rest and the stagnation of the West a recent and anomalous perturbation—or one that is tied entirely to the latest financial collapse of 2008. As the author explains, “those who invested in the West in 1989 have been punished (they have made nothing since 2000), while those who invested in the Rest have been richly rewarded” (loc. 48). Thus what has been termed the ‘great reconvergence’ (the closing of the gap between the West and the Rest) has been unfolding for roughly the past 20 to 25 years, or more.
As an indication of just how far the economic gap has closed, consider that, by 2017, the GDP of China (the champion of the Rest), is expected to overtake the GDP of the US (the champion of the West) (in terms of purchasing-power parity) (loc. 46 / loc. 2033).
The looming elimination of the economic gap between the US and China is particularly incredible when we consider just how far the US was ahead of China but a short while ago. As an indication of this, consider that in “1978, the average American was at least twenty-two times richer than the average Chinese” (loc. 274).
When it comes to the closing of the gap between the West and the Rest, the problem is not so much that the Rest is rising. Indeed, the fact that many parts of the developing world are exploding is without question an excellent thing. The problem is that the West is stagnating. So how can we make sense of this?
In order to truly resolve this question, we must explore just what it is that explains why nations succeed and fail. Fortunately, we have a grand body of historical evidence to draw from to help us out here. The most appropriate place to begin is way back when the West first began to pull away from the Rest (what has been termed the ‘great divergence’), and examine just how and why this occurred.
2. Explaining the Great Divergence, Part I: Examining the Theories
Unlike the great rconvergence (which has occurred entirely in the past half-century), the opening up of the gap between the West and the Rest—the great divergence—is something that unfolded over the past half-millennium—beginning around 1500 (loc. 274). What allowed for the great divergence? Many commentators have opened up with theories about this phenomenon—as well as the grander question of what explains the success and failure of nations. The leading candidates include geography (which comes down to agriculture and natural resources), imperialism, culture, and institutions. For Ferguson, only the last of these—institutions—can properly explain the great divergence. Let us see why.
a. The Arguments from Geography and Imperialism
i. The Argument from Geography
When it comes to the argument from geography (made famous by the scholar Jared Diamond), Ferguson has this to say: “with all due respect to Jared Diamond, geography and its agricultural consequences may explain why Eurasia did better than other parts of the world; but they can’t explain why the western end of Eurasia did so much better than the eastern end after 1500” (loc. 287). In other words, Eurasia’s agricultural advantages over other parts of the world may help explain why civilization advanced faster and further there than anywhere else, but since neither end of Eurasia can be said to hold a significant advantage over the other when it comes to agriculture, this argument cannot be used to explain why Europe exploded in the 16th century, whereas the eastern powers did not.
Staying on the topic of geographical advantages for a moment, it is true that Europe had more ready access to coal deposits than Asia did at the beginning of the great divergence, but this has more to do with the fact that Europeans were the first to overcome the technical challenges of extracting it, than any distinct advantage in terms of raw abundance of coal (loc. 294). Thus the geography argument falls flat here as well.
ii. The Argument from Imperialism
With respect to the argument from imperialism (as championed by the historian Kenneth Pomeranz—who in fact coined the term ‘the great divergence’ [loc. 289]), there are a few objections here. To begin with, as Ferguson points out, this argument is actually somewhat question begging, for we can always ask: Why was it that the European nations sought to colonize other parts of the world, while the Chinese did not? As Ferguson puts it, “this argument leaves unanswered the question[] of why the Chinese were not as assiduous as Europeans in the search for colonial ghost acres overseas” (loc. 295).
But even aside from this question begging, there is good reason to believe that imperialism on its own simply cannot explain the great divergence. For starters, Ferguson raises the following objection: “[we cannot] explain the great divergence in terms of imperialism; the other civilizations did plenty of that before Europeans began crossing oceans and conquering” (loc. 289). In other words, imperialism was nothing new to the 16th century. Civilizations had been doing their best to set up empires since civilization began, and the results of this empire building were scattered at best—and certainly not always successful.
In response to this it may be argued that the scale and circumstances of European imperialism were unique, and different than those former forays. However, even within the European expansion in modern times, there were significant divergences in just how successful these enterprises were. Take Spain, for example. The Spanish established a substantial early lead in empire building. And yet even with this significant advantage, in the end Spain’s empire ended up doing far worse than Britain’s (loc. 331). All in all, then, it must be granted that imperialism on its own is simply no sure recipe for success, and thus it cannot be used to explain the great divergence—much less why some nations succeed and others fail.
b. The Arguments from Culture and Institutions
This brings us to the final 2 candidates for explaining the great divergence: culture and institutions. Clearly, these 2 factors inform one another, for cultural norms (in conjunction with historical events) influence what institutions are developed, and institutions provide incentives and disincentives that influence cultural norms (Ferguson does not actually acknowledge this point in the book, but it is so manifestly obvious—and germane—that I cannot ignore it). Of the 2, though, Ferguson argues that we are warranted to place the greatest emphasis on the role of institutions (loc. 341).
To see why, we need only consider that when we place two groups of people from the same cultural background under different institutional regimes, we invariably get very different outcomes. Just think about the different outcomes that occurred in Germany following the separation of East and West, or the different outcomes in Korea following the separation of North and South (loc. 349). A ripe example can also be found from the time of the great divergence. As Ferguson explains, “Britons versed in much the same culture behaved very differently depending on whether they emigrated to New England or worked for the East India Company in Bengal” (loc. 341). Why? Because of their very different institutional set-ups (loc. 341).
3. Explaining the Great Divergence, Part II: Successful and Unsuccessful Institutions (The Open Access Pattern Vs. The Limited Access Pattern)
So, what are the institutional ingredients that lead to success or failure? Borrowing a line of thought from the team of Douglass North, John Wallis and Barry Weingast, Ferguson argues that societies can essentially be broken down into 2 basic institutional frameworks, or patterns: a ‘limited access pattern’ and an ‘open access pattern’ (loc. 297-307). In the limited access pattern we find “relatively few non-state organizations; a small and quite centralized government, operating without the consent of the governed; and social relationships organized along personal and dynastic lines” (loc. 301). In the open access pattern, by contrast, we find “a rich and vibrant civil society with lots of organizations; a bigger, more decentralized government; and social relationships governed by impersonal forces like the rule of law, involving secure property rights, fairness and (at least in theory) equality” (loc. 305). When it comes to the bottom line, the commentators add that the economies of the open access pattern tend to grow faster than those of the limited access pattern (loc. 297-301).
Essentially, the difference between the two institutional patterns comes down to equality (or the lack thereof). Where political and economic rights are arranged hierarchically, and dominated by an elite, this elite tends to exploit the lower classes. The result is a relatively inefficient (and, of course, unfair) system. Where political and economic rights are distributed more equally, on the other hand, the result is greater participation and greater efficiency (not to mention greater fairness).
Now, the limited access pattern may be thought of as more natural, in the sense that it was the first to develop among human communities (loc. 298, 311); however, as history has shown, societies are capable of making the transition from the limited access pattern to the open access one. For North, Wallis and Weingast, “West European states—led by England—were the first to make the transition from ‘limited access’ to ‘open access’” (loc. 308). And for them, it is this transition that explains the great divergence, and the success of the West (loc. 318)—a position that Ferguson agrees with.
4. Explaining the Great Divergence Part III: How the Open Access Pattern Led to Success, and the Limited Access Pattern Was Left Behind
In the case of England, the transition from a limited access pattern to an open access pattern happened slowly, over the course of many years. It began with the Magna Carta in 1215 (which established equality before the law, and curtailed the right of the Crown to levy taxes)(loc. 919), and culminated with the Glorious Revolution in 1688 (which gave full political power to the Parliament over the monarch) (loc. 924).
The specifics played out differently with respect to the other European powers that also made the transition, but the basics were always the same: the distinct power-hierarchy gave way to institutions that allowed for a more even distribution of power (both politically and economically) (loc. 305-11). The result was more economic activity, more innovation and, ultimately, a faster growing economy.
In the case of England, for instance, as Ferguson explains, “the ‘rights and liberties of the subject’ set out in the 1689 Bill of Rights were conceived at the time as ancient rather than novel. But the consequences of the Glorious Revolution really were new, not least in the way Parliaments after 1689 set about energetically legislating for economic development, protecting the infant textile industry, encouraging the enclosure of common land, promoting turnpike roads and canals. Even war became an increasingly profitable activity as the Whigs launched their bid for global commercial supremacy. The sequence is clear: first the Glorious Revolution, then agricultural improvement, then imperial expansion, then industrial revolution” (loc. 406). That is, the sequence proceeds directly from institutional reform to economic success.
By contrast, those parts of the world that did not undergo the transition from a limited access pattern to an open access pattern were left behind. As Ferguson explains, “none of the institutional changes I am talking about happened in Ming or Qing China, where the power of the Emperor and his officials remained unrestrained by semi-autonomous corporate bodies or representative assemblies. Asia had merchants; it did not have companies, much less parliaments. Institutions as they evolved in the Ottoman Empire were also significantly different in ways that hampered capital formation and economic development, as Timur Kuran has argued. This was because Islamic law took a fundamentally different approach to partnership, inheritance, questions of debt and corporate personalities from the legal systems that developed in Western Europe. Islam had waqfs, unincorporated trusts established by individuals, but not banks” (loc. 412).
The end result, again, is that the West exploded, while the Rest stagnated. Now, the situation has reversed itself. And once again, for Ferguson, institutions are at the heart of the story (loc. 412-17).
We shall get to the decline of the West in a moment. However, before we do so, let us first take a brief look at the rise of the Rest—and Asia in particular—for, according to the author, Asia’s recent success once again demonstrates how institutions are of central importance when it comes to the success and failure of nations.
5. The Recent Rise of Asia
As mentioned above, China’s GDP is expected to surpass that of the United States by 2017. However, China’s boom—and that of Asia more widely—has not been confined to economics. As Ferguson explains, “in a whole range of dimensions, the gap between the West and the Rest has narrowed dramatically. In terms of life expectancy and educational attainment, for example, some Asian countries are now ahead of most in the West. According to the 2009 OECD PISA study, the gap in mathematical attainment between the teenagers of the Shanghai district of China and those of the United States is now as big as the gap between American teenagers and Tunisians” (loc. 425).
What has allowed many Asian countries—most recently China—to advance so quickly? Here’s how Ferguson breaks down the phenomenon: “in some ways, it is easy to explain non-Western success. China has belatedly followed a number of other East Asian countries—the first was Japan—in downloading most (not all) of what I have called the ‘killer applications’ of Western civilization: economic competition, the scientific revolution, modern medicine, the consumer society and the work ethic. Copying the Western model of industrialization and urbanization tends to work if your entrepreneurs have the right incentives, your labour force is basically healthy, literate and numerate, and your bureaucracy is reasonably efficient” (loc. 431).
In other words, it is the mimicking of several of the institutions of the West that has allowed the Asian countries to rise so quickly. Of course, it is not the case that all of the Asian countries have moved entirely to the open access pattern of institutions. China, most glaringly, has opened up greatly, but still adheres to the limited access pattern in many ways (especially when it comes to political rights and the protection of the rule of law—but also significantly when it comes to economic rights). For Ferguson (and many other observers), China’s future growth will certainly be slowed unless these limitations are reformed (loc. 1202). And especially when it comes to the rule of law, for it is this institution which is the last line of defence against corruption and exploitation from above (loc. 1202-15, 1223).
Having said that, there are indications that officials in China are beginning to recognize the need for reform when it comes to the rule of law. For example, in 2012, “in a speech in Shenzhen in June… Zhang Yansheng, secretary general of the academic committee for National Development and Reform, argued that ‘we should shift towards reform based on rules and law,’ adding: ‘If such reform does not take off, China will run into big trouble, big problems.’” (loc. 1226). Still, it remains to be seen whether these reforms will indeed materialize, and if so, just how successful they will be (loc. 1226-32).
PART II: THE DECLINE OF THE WEST
To this point we have examined what is responsible for the success and failure of nations, and have seen that the answer lies in institutions. Specifically, we have seen that where nations have an institutional framework that provides equal rights to all (including political and economic rights)—and where these rights are protected by a healthy rule of law—you minimize exploitation and corruption, maximize opportunities and participation, and are rewarded with an efficient and growing economy. Conversely, where nations have an institutional framework that denies equal rights to all, and/or these rights are not protected by a healthy rule of law, you invite exploitation and corruption, choke-off opportunities and participation, and are rewarded with a relatively inefficient and handicapped economy.
Having seen how institutions drive success and failure, then, we are now prepared to see how institutional decay is responsible for the recent stagnation of the West. For Ferguson, the institutional decay of the West can be divided across 4 major institutions: 1. Democracy; 2. Capitalism; 3. The Rule of Law; and 4. Civil Society. We shall now proceed through each of these in turn.
6. The Degeneration of Democracy
a. The Contract between the Generations
Democracy is commonly understood as a contract between the individual and the state, where the state is obligated to actuate the general will of the people, and the people are obligated to adhere to the general will (by way of following the law, among other things) (this formulation of democracy was most famously stated by Jean-Jacques Rousseau under his ‘Social Contract’ [loc. 506]). There is a problem with this formulation of democracy, however; for, in practice, it leaves open the possibility that the majority may exploit the minority (in what is called the tyranny of the majority). In order to prevent this from happening, liberal democracies institute (often in their constitutions) inviolable rights and freedoms (such as the right to free speech), that even the general will cannot trump.
All of this is well and good, but nowadays Western democracies have found another way to exploit those of dimmer voice (or, rather, those with no voice at all). For they have decided to run-up their public debts in order that they may enjoy the fruits of public expenditures, while leaving the debt payments to future generations (more on this below). In other words, citizens today (and their governments) are using their power to exploit future generations.
For Ferguson, this is a significant breach of the institution of democracy (loc. 512-15). The great 18th century Irish statesman Edmund Burke echoes the argument. As Burke wrote, “‘one of the first and most leading principles on which the commonwealth and the laws are consecrated is, lest the temporary possessors and life-renters in it, unmindful of what they have received from their ancestors or of what is due to their posterity, should act as if they were the entire masters, that they should not think it among their rights to cut off the entail or commit waste on the inheritance by destroying at their pleasure the whole original fabric of their society, hazarding to leave to those who come after them a ruin instead of an habitation—and teaching these successors as little to respect their contrivances as they had themselves respected the institutions of their forefathers… Society is indeed a contract… the state… is… a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born’” (loc. 513).
b. The Debt Problem
i. The Problem
So, what evidence is there that the current generation in Western democracies has broken the partnership with generations to come? Consider the following: To begin with, the amount of debt that is currently piling up in many Western democracies is quite simply astronomical. As evidence of this, consider that “according to the International Monetary Fund, the gross government debt of Greece will reach 182 per cent of GDP in 2013. For Italy the figure is 128, for Ireland 119, for Portugal 124 and for the United States 112. Britain’s debt is approaching 93 per cent. Japan—a special case as the first non-Western country to adopt Western institutions—is the world leader, with a mountain of government debt approaching 245 per cent of GDP, more than triple what it was twenty years ago” (loc. 481).
And these numbers don’t even come close to capturing the true scale of the debt of these countries. For they include only federal government bonds (meaning they leave out “the often far larger unfunded liabilities of welfare schemes like—to give the biggest American programmes—Medicare, Medicaid and Social Security” [loc. 493]. And they also leave out the debt of states and municipalities [loc. 496]).
To get a handle on the real size of the debt problem—that includes all of the numbers—consider the American example: “the best available estimate for the difference between the net present value of federal government liabilities and the net present value of future federal revenues is $200 trillion, nearly thirteen times the debt as stated by the US Treasury. Notice that these figures, too, are incomplete, since they omit the unfunded liabilities of state and local governments, which are estimated to be around $38trillion” (loc. 496).
ii. The Potential Solutions
How will the US and other Western democracies climb out of their debts? One way to climb out of debt is through economic growth (loc. 89, 465, 1651). The problem, though, is that heavy debt in itself tends to stifle economic growth. As Ferguson explains, “in their study of twenty-six episodes of ‘debt overhang’—cases when public debt in advanced countries exceeded 90 per cent of GDP for at least five years—Carmen and Vincent Reinhart and Ken Rogoff show that debt overhangs were associated with lower growth (of 1.2 percentage points of GDP) over protracted periods (lasting an average of twenty-three years), lowering the level of output by nearly a quarter relative to the pre-overhang trend” (loc. 1661).
Of course, some massive technological breakthrough(s) may come along that will propel the economy forward enough that we may pay down the debt. But Ferguson is not optimistic that this will happen. As the author explains, “the harsh reality is that, from the vantage point of 2012, the next twenty-five years (2013-38) are highly unlikely to see more dramatic changes than science and technology produced in the last twenty-five (1987-2012) / My pessimism about the likelihood of a technological deus ex machine is supported by a simple historical observation. The achievements of the last twenty-five years were not especially impressive compared with what we did in the preceding twenty-five years, 1961-86 (for example, landing men on the moon). And the technological milestones of the twenty-five years before that, 1935-60, were even more remarkable (such as splitting the atom)” (loc. 1681). In the words, though technology continues to advance in impressive ways, there appears to be diminishing returns off the advances that are made.
Ultimately, then, what it looks like is that the debt will have to be paid-down by increasing taxation and/or reducing services (loc. 496). And, of course, given the size of the debt that has been run up, eliminating it by these means any time soon would require drastic measures. Indeed, as Ferguson reports, “the economist Laurence Kotlikoff calculates that to eliminate the federal government’s fiscal gap would require an immediate 64 per cent increase in all federal taxes or an immediate 40 per cent cut in all federal expenditures” (loc. 501). This is not going to happen. Rather, the increase in taxation and the reduction in spending (if it ever does happen) will be spread out over time (loc. 496). In other words, the debt will be left to future generations to pay down (loc. 496).
And this is where the breach in the contract between the generations enters the scene. As Ferguson explains (speaking of our enormous debt), “these mind-boggling numbers represent nothing less than a vast claim by the generation currently retired or about to retire on their children and grandchildren, who are obliged by current law to find the money in the future, by submitting to substantial increases in taxation or to drastic cuts in other forms of public expenditure. / In the enormous inter-generational transfers implied by current fiscal policies we see a shocking and perhaps unparalleled breach of [the partnership between the generations]” (loc. 497 / 514).
iii. The Best Solution
The best thing we can do now, Ferguson argues, is to limit the exploitation of future generations as much as possible. What the author suggests is that stringent laws be passed that curtail what governments are able to borrow and spend (loc. 540) (something that has, in fact, already occurred in “a number of American states as well as in Germany” [loc. 522]). The problem with this solution, though, is that people hate it (because they love their government programs), and so, as Ferguson points out, “experience suggests that any government that tries seriously to reduce its structural deficit ends up being drive from power” (loc. 529).
Still, if this does not happen, then we may well be doomed: “If we do not do these things—if we do not embark on a wholesale reform of government finance—then I am afraid we are going to end up with the bad, but more likely, second scenario. Western democracies are going to carry on in their current feckless fashion until, one after another, they follow Greece and other Mediterranean economies into the fiscal death spiral that begins with a loss of credibility, continues with a rise in borrowing costs, and ends as governments are forced to impose spending cuts and higher taxes at the worst possible moment. In this scenario, the endgame involves some combination of default and inflation. We all end up as Argentina” (loc. 552). In other words, what started out as a breach in the contract between the generations may ultimately end up undermining us all. Thanks, government programs.
And now onto the degeneration of capitalism…
7. The Degeneration of Capitalism, Part I: Laws and Regulations
a. Tax Laws & Business Regulations
The main idea at the heart of capitalism is economic rights. This includes the protection of private property, and, by extension, the right to earn a dollar from one’s efforts, ideas, innovations and assets. The government’s main responsibility in a capitalist economic system is to ensure private property is protected, and that there are no outstanding barriers in the way of starting a business, and running it efficiently.
Whereas Western governments used to do very well in this regard, now they are failing. Take the United States, for instance. As Ferguson reports, according to the International Finance Corporation, “in terms of the ease of paying taxes… the United States ranks seventy-second in the world. In terms of dealing with construction permits, it ranks seventeenth; registering a property sixteenth; resolving insolvency fifteenth; and starting a business thirteenth” (loc. 1160).
Why the poor report card? Because of overly-complex tax laws and overbearing business regulations (loc. 1105-10, 1137, 1146, 1159). This is reflected in the enormous cost to businesses of following these rules. Just what is this cost? Consider this price tag: “An estimated $1.75 trillion a year, according to a report commissioned by the US Small Business Administration, in additional business costs arising from compliance with regulations” (loc. 1118).
And what do businesses do when they face overly-complex tax laws and regulations? They take their businesses elsewhere. Which is precisely what they are doing. Consider the following: “In a 2011 survey, [Harvard Business School expert in economic competitiveness Michael] Porter and his colleagues asked HBS alumni about 607 instances of decisions on whether or not to offshore operations. The United States retained the business in just ninety-six cases (16 per cent) and lost it in all the rest. Asked why they favoured foreign locations, the respondents listed the areas where they saw the US falling further behind the rest of the world. The top ten reasons included: 1. The effectiveness of the political system; 2. The complexity of the tax code; 3. Regulation; 4. The efficiency of the legal framework; 5. Flexibility in hiring and firing” (loc. 1146). So the relative cost of labour in the developing world may be a significant factor in why work is disappearing in the United States, but the US is also doing much to shoot itself in the foot.
b. File under Favoritism: Copyright Laws & the Lobbying Industry
On the domestic front, the US is also doing much to hamper new businesses and innovations. Only this time, the threat is coming from over-reaching copyright law—a body of law that also adversely affects consumers. As the economists David Kennedy and Joseph Stiglitz have noted, in the United States “intellectual property laws are excessively restrictive. For example, ‘the “owner” of the patent on the gene that indicates a strong likelihood of breast cancer [could] insist on a large payment for every test performed. The resulting… fee puts the test out of the range of most without health insurance’” (loc. 1133). And, of course, the highly restrictive patent also prevents other businesses from building on the original idea. (Ferguson mentions copyright laws only in passing, and indirectly—via the comments of Kennedy and Stiglitz—but I felt it important to at least mention it here).
Excessively restrictive copyright laws, are, in effect, a form of corporate favoritism that limits business opportunities and economic growth. But copyright law is not the only area wherein the US can be accused of corporate favoritism. Just consider the enormous lobbying industry in the US; which, by design, is meant to skew legislation in favor of certain companies and whole industries over others (loc. 1114). In the US, this industry employs 13,000 people to the tune of $3.3 billion (loc. 1114). An enormous sum of money indeed, but small when compared to the economic damage that comes from the favoritism that it brings about (loc. 1114).
8. The Degeneration of Capitalism, Part II: The Financial System (and the Financial Crash of 2008)
And now to the financial system. These days, most criticism of the government regarding financial institutions is that the former is under-regulating the latter. Indeed, many have cited lack of regulation in the financial industry as the foremost cause of the latest financial crash of 2008. For Ferguson, though, the problem with the financial system in the West is not so much that it is under-regulated, as that it is poorly regulated—and the regulations themselves are poorly enforced.
a. The Role of the Government and the Federal Reserve in the Latest Financial Crash
To begin with, when discussing the financial crash of ‘08, even before we get into talk of regulation—poor or otherwise—we musn’t forget the role that both the federal government and the Federal Reserve played in inflating the housing bubble that preceded and precipitated the financial crash.
For one thing, let us not forget how the federal government passed legislation enabling lower-income households to qualify for mortgage loans. This immediately raised the risk of defaults, and skewed the entire market towards riskier mortgage loans. As Ferguson reminds us, “the US congress passed legislation designed to increase the percentage of lower-income families—especially minority families—that owned their own homes. The mortgage market was highly distorted by the ‘government-sponsored entities’ Fannie Mae and Freddie Mac. Both parties viewed this as desirable for social and political reasons. Neither considered that, from a financial viewpoint, they were encouraging low-income households to place large, leveraged, unhedged and unidirectional bets on the US housing market” (loc. 641).
In addition to this, when the housing bubble did inflate, the Federal Reserve did nothing to deflate the bubble (which it could have), but instead stood by and watched as it grew and grew. As the author explains, “central banks—led by the Federal Reserve—evolved a peculiarly lopsided doctrine of monetary policy, which taught that they should intervene by cutting interest rates if asset prices abruptly fell, but should not intervene if they rose rapidly, so long as the rise did not affect public expectations of something called ‘core’ inflation (which excludes changes in the prices of food and energy and wholly failed to capture the bubble in house prices). The colloquial term for this approach is the ‘Greenspan (later Bernanke) put’, which implied that the Fed would intervene to prop up the US equity market, but would not intervene to deflate an asset bubble” (loc. 636).
For Ferguson, then, one of the first things we could do to fix our financial problems is to overturn this absurd and reckless policy on the part of central banks. Specifically, the author suggests that we, “first, strengthen the central bank as the ultimate authority in both the monetary and supervisory systems. Second, ensure that those in charge at the central bank are ‘apprehensive’ as well as experienced, so that they will act when they see excessive credit growth and asset-price inflation. Third, give them considerable latitude in their use of the principal central banking tools of reserve requirements, interest rate changes and open-market securities purchases and sales. Fourth, teach them some financial history” (loc. 855).
b. Financial Regulation
Still, even with a competent and responsible central bank, financial institutions could yet find ways to behave irresponsibly, as they did on the run up to the crash of ’08. So, how to regulate them?
Let us begin with the banks-are-under-regulated argument. One of the most popular complaints here is that it was a great folly to repeal the Glass Steagall Act in the late 1990s. As Ferguson reminds us, “in the United States, the Glass-Steagall Act of 1933 separated the activities of commercial and investment banks until its supposedly fateful repeal in 1999” (loc. 569). Essentially, the argument is this: by allowing institutions to partake in both accepting savings and engage in highly speculative investments, it simultaneously put savings at risk and invited institutions to invest recklessly.
The problem with this argument, though, as Ferguson points out, is that many of the financial institutions that crashed in the fall of 2008—and indeed many of the worst offenders—did not partake of both activities. As the author explains, “it is hard to think of a major event in the US crisis—beginning with the failures of Bear Stearns and Lehman Brothers—that could not equally well have happened with Glass-Steagall still in force. Both were pure investment banks that could just as easily have been mismanaged to death before 1999. The same goes for Countywide, Washington Mutual and Wachovia, commercial lenders that blew up without dabbling in investment banking” (loc. 591).
The heart of the problem when it comes to the financial system, Ferguson argues, is overleveraging (in conjunction with bad investments and loans) on the part of financial institutions—and Glass-Steagall could never really have done much to stop this.
When it comes to overleveraging, a great difficulty here is that we have a lender of last resort (the central bank) that is there to bail financial institutions out after they’ve overleveraged themselves and crashed. In other words, there is a great moral hazard here that makes overleveraging an ever-present danger.
So, how do we remedy this? Some argue that the best approach here would be to break-up the big banks, and drastically reduce leverage ratios (loc. 841). All things being equal, Ferguson sees the appeal of this approach—but all things are not equal. We already have our big banks, and our central bank back-stopper, and revamping this system from the ground-up would be neither easy nor advisable. As Ferguson argues, “our task, like [Walter] Bagehot’s, is ‘to make the best of our banking system, and to work it in the best way that it is capable of. We can only use palliatives, and the point is to get the best palliative we can.’” (loc. 848).
For Ferguson, the best palliative is to ensure that we apply as many consequences as we can to address irresponsible behavior in the financial industry. To begin with, in times of crisis, the central bank should indeed act as the lender of last resort. However, rather than lending at the slimmest of rates—which it did following the crash of 2008, it should set these rates at a penalty (this is a solution that was first proposed by the British commentator Walter Bagehot, mentioned in the previous paragraph). This would not only incentivize financial institutions to behave more responsibly in their everyday activities, but would also ensure that only those institutions that truly need it would line-up for bailout packages. As Ferguson explains, “‘in a crisis the central bank should lend freely at a penalty rate. ‘Very large loans at very high rates are the best remedy…’ Nowadays we follow only the first half of [Bagehot’s] advice, in the belief that our system is so leveraged that high rates would kill it. Bagehot’s rationale was to ‘prevent the greatest number of applications by persons who do not require it’. Watching all banks, strong and weak alike, gorge themselves on today’s seemingly limitless supply of loans at near-zero rates, I see what he meant” (loc. 821).
In addition to this measure—and even more importantly—Ferguson insists that bankers must be prosecuted for their legal transgressions. Something that happens little these days—as highlighted in the aftermath of the crash of ’08. As the author explains, “we must ensure that those who fall foul of the regulatory authority pay dearly for their transgressions. Those who believe this crisis was caused by deregulation have misunderstood the problem in more than one way. Not only was misconceived regulation a large part of the cause. There was also the feeling of impunity that came not from deregulation but from non-punishment. There will always be greedy people in and around banks. After all, they are where the money is—or is supposed to be. But greedy people will commit fraud or negligence only if they feel that their misdemeanour is unlikely to be noticed or severely punished. The failure to apply regulation—to apply the law—is one of the most troubling aspects of the years since 2007. In the United States, the list of those who have been sent to jail for their part in the housing bubble, and all that followed from it, is risibly short” (loc. 861).
In connection with this, in those cases where financial executives were successfully prosecuted, the penalties were laughably inadequate. Ferguson leaves us with a single example to help prove his point: “In October 2010 Angelo Mozilo reached a settlement with the Securities Exchange Commission in which he agreed to pay $67.5 million in penalties and ‘disgorgements’ to settle civil fraud and insider-trading charges relating to his time as CEO of Countrywide, the failed mortgage lender. At least part of this fine was paid not by Mozilo himself but by Bank of America, which acquired Countrywide in the depths of the financial crisis, and by insurers. Between 2000 and 2008 Mozilo received nearly $522 million in total compensation, including sales of Countrywide stock: nearly ten times more than the fine. If there was nothing criminal in his conduct, it is surely only because the criminal law is defective in this area” (loc. 874).
9. The Degeneration of the Rule of Law
The degeneration of the rule of law in the West has already been touched upon above in connection with the degeneration of capitalism. There, the defects pertained primarily to statute law. Here, we will cover a separate aspect of the rule of law that has degenerated lately—this one pertaining to tort law.
Tort law, as Ferguson reminds us, has to do with “any ‘wrongful act, damage, or injury done wilfully, negligently, or in circumstances involving strict liability, but not involving breach of contract, for which a civil suit can be brought” (loc. 1121). At its best, tort law allows for civil protection and redress against acts of injustice not covered under any specific contractual stipulation. At its worst, tort law makes any harm done to any individual or business the legal responsibility of some other individual or business (for example, a restaurant’s being held responsible when someone spills its coffee and burns themselves).
In America today, tort law leans far more to the latter (tort law at its worst) than the former (tort law at its best). As evidence of this consider the following: “$865 billion in costs aris[e] from the US system of tort law, which gives litigants far greater opportunities than in England to seek damages… According to the Pacific Research Institute’s study Jackpot Justice, the tort system costs a sum ‘equivalent to an eight per cent tax on consumption [or] a thirteen per cent tax on wages’. The directs costs arising from a staggering 7,800 new cases a day were equivalent to more than 2.2 per cent of US GDP in 2003, double the equivalent figure for any other developed economy, with the exception of Italy” (loc. 1124).
As is clear, tort law in the US both clogs up the judicial system and costs an enormous amount of money in and of itself. Even over and above this, though, it also puts a huge burden on businesses—for they are obliged to take extensive, and often unreasonable measures to obviate law suits; and are also obliged to spend huge sums on frivolous cases (what’s more, the costs of complying with tort law not only handicaps existing businesses, but also acts as a barrier to entry for smaller players). Once again, then—as with the break-down in statute law mentioned above—this particular break down in the rule of law in the US ultimately hurts business, competition, and the economy more generally.
In creating overbearing and overly-complex tax laws and business regulations on the one hand, and allowing tort law to run amok on other, the US has allowed its once simple and efficient legal system to slide into an ugly and tangled mess that can only be negotiated by hordes upon hordes of lawyers. It is for this reason that Ferguson posits that the US has allowed its rule of law to degenerate into the rule of lawyers. The result, as we have seen, has only hurt business, and led to economic stagnation.
Fortunately, there is still hope that the system in the US may be reformed; but for the author, if this is to happen, it must begin with reform at a more grassroots level. As Ferguson explains, “how is the system to be reformed if, as I have argued, there is so much rotten within it: in the legislature, in the regulatory agencies, in the legal system itself? The answer, as I shall argue… is that reform… must come from outside the realm of public institutions. It must come from the associations of civil society. It must come, in short, from us: the citizens” (loc. 1251).
10. The Degeneration of Civil Society
a. The Decline in Civic Participation
i. The Phenomenon
Ultimately, the stability and strength of a democracy must come from the ground up. And the way this stability and strength is achieved is through the civic-mindedness and civic participation of the populace. Now, there was a time when the citizens of Western nations—and particularly Americans—led the world in this civic-mindedness and civic participation. This was reflected in a number of different ways—from widespread charitable donations, to the willingness to join civil associations and organizations. Over the past century, however, and particularly in the past half-century, these forms of civic-mindedness and civic participation have been on the wane in the Western world.
Take charitable donations, for starters. As Ferguson explains, in Britain “although the average donation has gone up, the percentage of households giving to charity has fallen since 1978 and more than a third of donations now come from over-sixty-fives, compared with less than a quarter some thirty years ago. (In the same period, the elderly have gone from 14 per cent to 17 per cent of the population)” (loc. 1364).
Or take voluntary associations. By this, Ferguson means “institutions established by citizens with an objective other than private profit. These can range from schools—although in modern times most educational institutions have been absorbed into the public sector—to clubs dedicated to the full range of human activities, from aeronautics to zoology” (loc. 212). When the French historian and theorist Alexis de Tocqueville visited the United States in the 19th century, he was struck by the ubiquity and popularity of these voluntary associations. In his Democracy in America, Tocqueville wrote that “America is, among the countries of the world, the one where they have taken most advantage of association and where they have applied that powerful mode of action to a greater diversity of objects. Independent of the permanent associations created by law under the names of townships, cities and counties, there is a multitude of others that owe their birth and development only to individual will. The inhabitant of the United States learns from birth that he must rely on himself to struggle against the evils and obstacles of life; he has only a defiant and restive regard for social authority and he appeals to its authority only when he cannot do without it… In the United States, they associate for the goals of public security, of commerce and industry, of morality and religion. There is nothing the human will despairs of attaining by the free action of the collective power of individuals… Americans use associations to give fetes, to found seminaries, to build inns, to raise churches, to distribute books, to send missionaries to the antipodes; in this manner they create hospitals, prisons, schools. Finally, if it is a question of bringing to light a truth or developing a sentiment with the support of a great example, they associate ” (loc. 1294).
While the British did not quite match this level of civic participation, they too, Ferguson explains, “experienced a golden age of associational life in the nineteenth century, ‘the age [in the historian G. M. Trevelyan’s words] of Trade Unions, Cooperative and Benefit Societies, Leagues, Boards, Commissions, Committees for every conceivable purpose of philanthropy and culture’” (loc. 1334).
In the 20th century, though, the civic participation that had so impressed de Tocqueville in America, and Trevelyan in the United Kingdom, began to deteriorate. Let us begin with the United States. As Ferguson reports, “in his best-selling book Bowling Alone, Robert Putnam detailed the drastic declines, between around 1960 or 1970 and the late 1990s, in a long list of indicators of ‘social capital’: attendance at a public meeting on town or school affairs: down 35 per cent; service as an officer of a club or organization: down 42 per cent; service on a committee for a local organization: down 39 per cent; membership of parent-teacher associations: down 61 per cent; the average membership rate for thirty-two national chapter-based associations: down almost 50 per cent” (loc. 1323).
When it comes to the UK, a similar story prevails. As Ferguson explains, “the reports of the Registrar of Friendly societies, which began in 1875 and continued until 2001, allow us to trace over the long run the number and membership of friendly societies (such as working men’s clubs), industrial and provident societies (such as co-operatives) and building societies (mutually owned saving and mortgage-lending associations). In absolute terms, the peak in the number of such societies was in 1914 (36,010) and the peak in membership in 1908 (33.8 million)—at a time when the population of the United Kingdom was just over 44 million. By contrast, there were just over 12,000 societies in 2001. Membership figures for that year are available only for the 9,000 industrial and provident societies and amount to 10.5 million, compared with a total population of 59.7 million… The most recent survey data indicates a further decline and indeed suggests that even more Britons than Americans are now ‘bowling alone’” (loc. 1349).
ii. The Causes and Consequences
So, just why has civic participation declined so much in the West? Some have argued that this has to do with the rise of distracting technologies such as television, and, more recently, the internet (loc. 1372). However, Ferguson questions just how much we can blame these new technologies. For Ferguson, a better explanation can be provided by the fact that, over the course of the 20th century, Western governments have increasingly taken over the role that was once played by civil organizations, thus rendering them more or less obsolete: “Not technology, but the state—with its seductive promise of ‘security from the cradle to the grave’—was the real enemy of civil society” (loc. 1401).
Now, in certain cases, the government’s stepping in and taking on public causes may have had positive results (such as in ensuring universal education [loc. 1424, 1496]). For Ferguson, though, the long term consequences of this movement have been predominantly negative. There are a couple of reasons for this. To begin with, on a practical level, small, civic-led initiatives tend to produce better results than large, government/bureaucratic-led ones (loc. 1402, 1496).
But even over and above this, the very act of taking part in civic associations, Ferguson argues, tends to have a civilizing and enobling effect on the participants. As the author explains, “I believe that spontaneous local activism by citizens is better than central state action not just in terms of its results, but more importantly in terms of its effect on us as citizens. For true citizenship is not just about voting, earning and staying on the right side of the law. It is also about participating in the ‘troop’—the wider group beyond our families—which is precisely where we learn how to develop and enforce rules of conduct: in short, to govern ourselves. To educate our children. To care for the helpless. To fight crime. To keep the streets clean” (loc. 1501).
It is the civilizing and enobling effect of civic participation that is sacrificed when the state takes over the role of arranging for social goods. And this is particularly damaging in democracies—where the health of the state is largely built on social capital.
To see the value of social capital—and the dangers of losing it—we need look no further than the enormous economic inequality between the classes that now exists in many Western nations. Take the US, for example. As Ferguson reports, “by most measures, American society is as unequal today as it was in the late 1920s. Another way of putting this is that a massive proportion of the benefits of the last thirty-five years of economic growth has gone to the super elite. That was not true in the period between the Great Depression of the 1930s and the Great Inflation of the 1970s. Between 1933 and 1973 the average real income of the 99 per cent rose (before tax) by a factor of four and a half. Yet from 1973 until 2010 it actually fell” (loc. 1551).
For Ferguson, much of this rising inequality can be explained in terms of the break-down in institutions mentioned above (loc. 72-77, 1550-56). But a certain share of it must also be assigned to the declining levels of civic engagement that now plagues the West (loc.72-77, 1327, 1550-56).
b. Towards a Solution: Education Reform
Now, for Ferguson, one area where private organizations are especially needed to re-enter the realm of public goods is in education. For while it may once have been choice-worthy for Western states to intervene and ensure that all would be guaranteed schooling, now the monopoly (or at least near-monopoly) that the state holds on education does more to compromise its quality than advance it. As the author explains, “we need to recognize the limits of public monopolies on education, especially for societies that have long ago achieved mass literacy. The problem is that the public monopoly providers of education suffer from the same problems that afflict monopoly providers of anything: quality declines because of lack of competition and the creeping power of vested ‘producer’ interests” (loc. 1430).
It is not that Ferguson wants to see the end of the state’s involvement in education entirely. On the contrary, as the author puts it: “I am not arguing for private schools against state schools. I am arguing for both, because ‘biodiversity’ is preferable to monopoly” (loc. 1431).
Nor is Ferguson’s position based merely on a theoretical flight of fancy. Indeed, several informal experiments in private education have shown that it does indeed produce better educational results (loc. 1433-41, 1449-68, 1482-84). What’s more, in those cases where both private and public schools co-exist, the increased presence of private institutions both raises educational standards across the board, and reduces costs. As Ferguson explains, “private education benefits more people than just the elite. In a 2010 article, Martin West and Ludger Woessmann demonstrated that ‘a 10 per cent increase in enrolment in private schools improves a country’s mathematics test scores… by almost half a year’s worth of learning. A 10 per cent increase in private school enrolment also reduces the total educational spending per student by over 5 per cent of the OECD average.’ In other words, more private education means higher-quality and more efficient education for everyone” (loc. 1490).
An improvement in the quality of education across the board would be good in itself, of course, but it would also certainly lead to better economic outcomes—including going some way towards narrowing the economic gap between the classes. So far all these reasons it should be a top priority.
11. Conclusion
We have seen how institutions are the single biggest factor in explaining the success and failure of nations. In the broadest possible terms, institutional frameworks that are skewed more towards a hierarchi
