It's economists who have failed, not capitalism

ROBERT SAMUELSON, one of America's most respected economist-journalists, sees in recent share-price falls "a large, though muffled message: global capitalism . . . is now in full retreat". Anatole Kaletsky, writing in The Times, seizes on the same metaphor: "The global dominance of free-market fundamentalism . . . is now in full retreat." Business Week agrees. The magazine says we are now living in "a world where countries are opting out of a free-market system everyone took for granted . . . The American model is under attack everywhere".

How can an economic system that until a short time ago was seen as the model for all nations, fall into disrepute so quickly? For one thing, the decline in the stock market has shocked those who naively believed that up is the only direction in which share prices ever travel. For another, several countries have run into economic difficulties that they blame on free markets and on the free movement of goods, services and capital that has come to be known as "globalisation". In response, they are introducing restraints on the market forces that they say have brought their countries to ruin.

Thus Russia has abandoned what it has been calling "reforms" in favour of a reversion to Soviet-style economics. Prime Minister Yevgeny Primakov has installed old-line central planners and economists who confuse the creation of paper money with the creation of wealth. But speeding up the printing presses will inevitably lead to wage and price controls as well as restrictions on imports of goods and the export of capital.

Then there is Malaysia, where Prime Minister Mahathir bin Mohamed has decided his economy can be saved by cutting it loose from the rest of the world. Capital will no longer be allowed to flee his country - a policy that will ensure none enters it either.

Free-market advocates can easily explain these rejections of their creed. Russia never really engaged in serious reform. Instead, when communism collapsed the authorities allowed a small group of oligarchs to steal the nation's assets. Corruption, not capitalism, was communism's successor.

As for Mahathir's Malaysia, it, too, never joined the list of capitalist nations. Cronyism best describes a system in which the allocation of capital and other resources was determined by politicians and bureaucrats rather than by demand as reflected in market prices. As with Russia, so with Malaysia: never having adopted market capitalism, it cannot be said to have abandoned it.

But the controls instituted by Taiwan on capital movements and the intervention of free-market idol Hong Kong in its stock market are another matter. These nations have always been seen as the Asian outposts of free-market capitalism, and their extension of government power is a genuine retreat from reliance on market mechanisms.

But who can blame those who are having second thoughts about the American model when they are being offered confusing advice by the economists who are its advocates? Some economists say the solution to the troubled nations' ills is austerity: raise taxes, cut government spending, raise interest rates and all will be well - unless the treatment starves the patient before he has a chance to recover. Others say reflate: cut taxes, increase spending, print money, cut interest rates, and let the exchange rate go to, er, a low level. The patient will then leap from his sickbed, his pockets stuffed with newly printed money, and feel fine - until he tries to buy something.

In short, what we are seeing is not the failure of capitalism, but the failure of economists. The fact is that economists who specialise in macroeconomics - the study of entire national and global economies - don't have a clue as to how a modern economy works. High interest rates, say some, stifle investment; others say that high rates stimulate investment by encouraging saving, which makes capital available for investment. Balanced budgets, say some, are the key to prosperity because they give businessmen confidence and stimulate investment by reducing government borrowing and thereby interest rates. Deficit spending, say others with equal assurance, is the real key to prosperity because it stimulates consumer demand and, therefore, business investment.

Little wonder that politicians, faced with rampant unemployment and hunger, are inclined to assume they know better than the consultants, academics and IMF officials who descend on them like locusts in times of trouble. The problem is that they assume they have the power to order prices, interest rates and exchange rates to behave as obediently as the subordinates with whom they surround themselves. They don't.

But they can set the framework within which those factors will behave in a way that will produce prosperity - not immediately, and not without cyclical glitches, but in the long term. For what economists do know is that certain institutional arrangements produce prosperity, and others don't. Private property, the rule of law, a stable currency that encourages saving, a tax system that doesn't create disincentives to work, and a government that sees its economic role as umpire, rather than player, are the guarantors of prosperity. In short, the American model.