Tonight, I would like to bury, not capitalism, as the Soviet leader Khrushchev foolishly claimed he would do, but the word capitalism.  It is a misleading phrase which gives rise to general misapprehensions.

       One is that economic power derives from the possession of capital.  One can see how people might have thought that when they went to work in a place that was labelled Arkwright’s Mill, and in which Mr – soon to be Sir Richard – Arkwright was the tyrannical figure who owned the mill and the machines in it and brooked no insubordination.

       But modern business is not like that.  The people who command economic power today are people such as Jamie Dimon of JP Morgan, central bankers like Ben Bernanke and Mario Draghi, business leaders like Steve Jobs and his successor Tim Cook, or Jeff Immelt, CEO of General Electric.  In no case does their economic power have anything to do with their ownership of capital:  it arises, as power almost always has, from the position they hold within a hierarchy, and none of them are able, as has always been true in the past, to use these positions to obtain capital for themselves.  The world’s richest men – Carlos Slim, Bill Gates, Warren Buffett – are not especially powerful.  The one with greatest political influence – Carlos Slim, the Latin American telecoms tycoon, is rich because of his political influence, not the other way round. 

       Another misconception is the importance of ownership of the means of production.  I have found it unhelpful to have any concept of ownership in mind in talking about modern business.  If you asked Martians visiting JP Morgan or Apple who was the owner they would unhesitatingly point to Jamie Dimon and Steve Jobs.   It makes little sense even to say that shareholders own their shares.  When you look at the structure of shareholding in the UK, as I have recently done, you discover that the questions ‘whose name is on the share register?’ ‘who decides to buy or sell a share?’, ‘who decides how a share should be voted?’ and ’who has the economic interest in a share?’ are questions that typically have four different answers.  Many people enjoy one of the attributes of ownership, and no one has very many.   As Charles Handy said many years ago, the concept of ownership simply gets in the way.  Gets in the way of clear thinking, and obscures the economic analysis of the modern corporation as a social institution and a political entity.

       Another misconception is that securities markets are capital markets, in the sense that they are an important influence on the direction of funds for investment.  Large companies today are overwhelmingly self-financing:  they generate more than sufficient funds from their operations to meet their investment needs.  Small and medium size enterprises do not have meaningful access to capital markets:  the idea that an IPO – a stock exchange quotation – is a normal stage of development of a successful new business is a feature of a past age.   Modern companies typically become cash generators at an early stage of their growth, and if they do seek to list it is generally to provide an opportunity for realisations by employees and early stage investors.  Securities markets are not a means of putting money into companies, but a vehicle for getting money out.  We ludicrously overstate their economic significance, though not the damage their frequent malfunctioning does to the non-financial economy.

       So tonight I want to talk not about capitalism, but about the market economy.  I believe it is clear that the market economy is the only game in town in the sense that no one has so far enjoyed any sustained economic success with any system that is not, in a broad sense, a market economy.

       The triumph of the market system over the planned economy was probably the defining economic event of our lifetime, its symbol the collapse of the Berlin Wall in 1989. In the advanced economies of the West, increased government intervention in the economy, more or less unchecked through the twentieth century, was halted in 1980 by the ideologically conservative governments of Reagan and Thatcher, with policy innovations that were widely if often reluctantly imitated elsewhere. In Asia, China and India followed some of their smaller neighbours into the market economy and the global trading system.

       These developments provoked the hubris famously framed as The End of History by Francis Fukuyama, who argued that a combination of liberal democracy and lightly regulated capitalism was now an inevitable form of political and economic organisation. If one country was the standard bearer for that new vision of the twenty-first century, it was the United States: if one industry was the standard bearer for that new view, it was the financial services industry.

       Today, that assertion lacks conviction. If there were defining events in that revisionism, analogous to the breaching of the Berlin Wall, they would be – for politics – the collapse of the Twin Towers and its bungled consequences, and for economics the bankruptcy of Lehman seven years later. There is, evidently, no end of history – as, indeed, Fukuyama today readily acknowledges.

       What I want to do tonight is to provide a more nuanced view of the nature of markets and the merits of the market economy. The critique of the market economy today is, as it has been since the end of socialism, largely incoherent – an incoherence nicely captured in the demonstrator’s slogan ‘capitalism should be replaced by something nicer’.

       I am going to argue that there are three elements to the triumph of the market economy. The first I will describe under the heading of ‘prices as signals’: the price mechanism is generally a better guide to resource allocation than central planning. The second element is ‘markets as a process of discovery’: a chaotic process of experimentation is the means through which a market economy adapts to change. The third heading is ‘diffusion of political and economic power’. The economic point here is that prosperity and growth require that entrepreneurial energy should be focussed on the creation of wealth, rather than the appropriation of the wealth of other people.

       In what we teach, in what we say, in our economic research and most importantly in the policies we adopt – we put too much emphasis on the first of these elements – prices as signals to guide resource allocation – at the expense of the, possibly more important, second and third elements – markets as process of discovery, markets as mechanism for the diffusion of political and economic power.

       The result is that both supporters and critics of the market economy have often confused policies that are pro-business with policies that are pro-market. That confusion has both undermined the social and political legitimacy of the market economy, and led to serious policy errors that follow from a mistaken, or at least incomplete, understanding of how a market economy works. I will illustrate that proposition by reference to three areas of policy – financial services, inevitably; digital media, and competition policy. These sectors are only a topical selection from what could be a much longer list.

       There is one central theme that runs through all three strands in the success of the market economy. The essential characteristic of a market economy as what I call disciplined pluralism:  on the one hand, there is a good deal of freedom to experiment with the provision of new and differentiated goods and services, methods of production, and business organisation:  on the other hand, there is also a reasonably rigorous process of discontinuing unsuccessful production or organisation, and the decentralised decisions of businesses and consumers play a large role in both facilitating pluralism and imposing discipline. 

       If the essence of markets is their pluralist character, then there is an inevitable association between the successful market economy and other components of an open society – freedom of expression, and democratic institutions. While it is evident that authoritarian regimes have operated market economies, at least for a bit, the combination is probably not sustainable in the long run. There is an important corollary: political freedom is jeopardised by excessive concentrations of economic power. Even if Fukuyama was wrong in his assertion of inevitability, the identification of an elective affinity between liberal democracy and lightly regulated capitalism was entirely appropriate.

       The world is uncertain: not just risky, but uncertain, in the sense used by Keynes and Knight. Not only do we not know which future outcomes will happen: we are unable to specify at all fully what these possible outcomes will be. If we could predict or anticipate the invention of the wheel, we would have already invented it. Market economies do not predict the future, they explore it. That is a fundamental – perhaps the fundamental – difference between a planned and a market economy.

       Hayek continues to be the most eloquent exposition of the concept of the market as a process of discovery. His argument was a priori , but vindicated by the failures of the eastern bloc in the post-war era. These planned economies failed in the development, not just of consumer products, but of business methods. Their technological development was disappointing in almost all not related to military hardware. Centralised systems experiment too little. They find reasons why new proposals will fail – and mostly they are right in finding reasons why they will fail because most experiments do fail. Market economies thrive on a continued supply of unreasonable optimism. And when, occasionally, the experiments of entrepreneurs succeed, they are quickly imitated. It is a sad fact of the market economy that even for innovations that are commercially successful, few are commercially successful for the innovator.

       If market economies are better than planned societies at the origination and diffusion of new ideas, they are also better at disposing of failed ideas. Honest feedback is not welcome in large bureaucracies. In authoritarian regimes, such feedback can be fatal to the person who delivers it. In less draconian contexts, unwanted messages can be fatal to careers. And when I talk about large bureaucracies here, I am talking just as much about large private bureaucracies as large public ones. Disruptive innovations most often come to market through new entrants – from Google, EasyJet, Amazon. Incumbents have good reasons to be suspicious of novelty and protective of their established markets and activities.

       The health of the market economy depends, therefore, on constant replenishment of the business sector by new entry. If, as planner or sponsoring department, you had been planning the future of the computer industry in the 1970s, would you have asked Bill Gates and Paul Allen?, If, as planner or sponsoring department, you had been planning the future of aviation in the 1980s, would you have asked Stelios Haji-Ioannou? If, as planner or sponsoring department, you had been planning the future of retailing in the 1990s would you have asked Jeff Bezos? Of course not: whether you were the politburo or permanent secretary you would have asked men in suits like yourself.

       Watching the impact of electronics and the internet on children and grandchildren, makers of business and public policy have at least understood these issues. Committees of the middle-aged Twitter about technology like embarrassing adults trying to have fun at the teenagers’ disco. But, like those adults at the party, we are not really serious. Whether planners or governments of a market economy, we see industries through the eyes of established firms in the industry. And in doing so. miss the pluralism that is the market economy’s central dynamic.

        ‘The market economy’ in the sense in which I have just described it is not the same as a concept of ‘free markets’ which might seem to imply encouraging people to be extremely greedy and imposing minimal restrictions on what they do.  This is also not a model which seems to have been successful anywhere it has been tried, and the countries which persist in it, like Nigeria and Haiti, suffer from endemic opportunism and rent-seeking and are some of the poorest on the planet.   Successful market economies – and there are many different ones, with the US, Sweden, Japan and now perhaps thus succeeding in different ways are governed by elaborate regulatory codes based on both law and social institutions, which is why these models are not easily transferable or irreproducible, although such transfer and reproduction is by no means impossible.

       Successful market economies are socially embedded.  They accommodate the complex and multi-faceted goals of individuals who mostly do not conform to stereotypes of rational economic man.   They exist in an environment characterised by radical uncertainty;  the property rights they protect are social constrictions, not endowments fixed by nature:  they require far more cooperation than individualism and contractual relationships would allow:  they produce complex goods and services which can only be safely traded in the context of reputation and trust relationships:  they require that most of the risks of everyday life must be managed through social institutions, not market ones.

       It is in some ways surprising that these things need to be said, but evident that they do:  it is a great paradox that the success of market economies is accompanied by a facile account of how they work that is simultaneously repulsive and false.

       But with that in mind, I want to turn to my central theme for the evening:  the difficulty the European centre-left has encountered, since the collapse of socialise regimes and socialism as an intellectual doctrine, reconciling its progressive instincts with the pervasive realities of market economies.  I can identify two principle strands of thought:  one I call redistributive market liberalism, the other homeopathic socialism.

       Redistributive market liberalism broadly accepts the market fundamentalist account of how market economies function, based on endemic greed and unrestricted business activity, but seeks to temper it in two directions – by an emphasis on using tax and benefits to undo malign distributive consequences, and a concern for a strictly limited class of problems described as ‘market failures’.   Redistributive market liberalism has a strong following among economists and those with some training in economics – it is the dominant economic philosophy in the UK Treasury and the European Commission, although I have not encountered much enthusiasm for redistributive market liberalism anywhere else.

       It should already be clear that I consider that redistributive market liberalism gives far too much away to market fundamentalists.  It posits a separation between the economic, on the one hand, and the political and social, on the other, that quickly becomes untenable when one recognises the economic role of trust, cooperation and solidarity, the properly contested nature of property rights, the limitations imposed by radical uncertainty.  And the very term market failure is a strong one.  Perhaps only economists would be arrogant enough to characterise the failure of a model to describe the world as a failure of the world rather than a failure of the model.

       What I term homeopathic socialism is state control of industry watered down to the point at which the control, or at least the effect of the control, is barely detectable.  When ownership of the means of production and exchange proved largely unattainable and inefficient in the industries in which it was tried, national planning was offered as a substitute:  planning agreements came next, then regulation, then light touch regulation.  This progressive watering down of an unpopular and unsuccessful doctrine satisfies neither those who advocate it or the voters to whom it is addressed.  It seems to be saying that since the medicine is unpleasant and useless, you need not like very much of it.  Homeopathic socialism is fatally undermined by its liability to offer a coherent critique either of the failures of capitalism or the failures of socialism.

       So when the banking system collapsed in 2008, the political left, bereft of ideas or analytic framework, readily acquiesced in the process by which the governments provided much of the capital and underwrote all the liabilities of major banks. Frightened of the word “nationalisation”, far less its reality, a Labour government in Britain would not countenance discussion of the issue: although the moment was one at which many people on the political right would have been easily convinced that such measures provided the best means of reorganising banks and securing continuation of their essential functions during the necessary and inevitable restructuring process. But simply writing large cheques saved thought, and averted a confrontation for which politicians were, and continue to be, completely unprepared.

      The statement “there should be more regulation” is a hopelessly inadequate response to the problems the modern financial sector poses for the real economy. There is no point in saying there should be regulation unless there is clarity about objectives and the questions that such regulation might address. Despite the plain evidence not so much of the past failure of regulation, but of its continuing irrelevance, ludicrously exaggerated expectations of what regulation might achieve remain widespread. If the CEOs and boards of large financial institutions had difficulty in both understanding and controlling what was happening within them, that was a fortiori true of external regulators. The issue was not, and never has been, that regulators lacked powers. The capacity to apprehend Bernie Madoff, to block the acquisition of ABN-Amro by RBS, or to prohibit the establishment of off-balance sheet vehicles with huge liabilities that banks would be expected to underwrite, has always been there. The issue is that regulators lacked political authority and technical competence to intervene. They still do.

      At present, the principal objective of regulation appears to be to stabilise the existing structure of financial institutions.  The declared purposes of the new regulatory institutions in Britain are to promote stability and maintain confidence.   This approach is not surprising, since the institutions of financial services regulation are mostly captured by the industry.  In some cases they are directly controlled by it; more often, they are manned by people who see the industry through its own eyes because they have no other perspective. The regulatory goal is the health of the industry, which is in turn interpreted as the health of the particular firms from which it is today composed. The purpose is the achievement, not of financial stability, but of industry stability, as if these were the same thing: but since the sources of instability are to be found in the structure of the industry, accomplishment of this goal is in fact a guarantee of further, and potentially more damaging, crises.

      Although poorly organised to manage their own affairs, large financial institutions were, and are, well organised to manage their external relations. Investment bankers are generally politically adroit if not managerially skilled. Policy makers recognised the intelligence and the range of contacts of investment bankers, overestimated their importance in business and the economy, and had little appreciation of what they did, beyond the fact that it was very difficult to understand.

      In the United States, the regulatory process has been corrupted by the mechanisms of political funding. In Europe, policies and politicians cannot be bought in the same crude way. But the instinctive corporatism of much of continental Europe leads to a natural equation between the interests of Germany and the interests of Deutsche Bank. Britain has neither American corruption, nor the extremes of German or French industrial policy. And yet political and regulatory capture is equally powerful here. There is an element of awe, almost intimidation, of politics by finance: the global leadership of the City of London is seen as a valuable asset, its activities complex, and the assertion that any action might damage City interests perceived as a powerful objection to any proposed course of action. Few politicians or officials have the knowledge, or inclination, to challenge such assertions or to examine the precise nature of the alleged damage or its consequences for the economy as a whole.

      And so financial institutions in general, and investment banks in particular, became the most powerful industrial lobbies in the western world. Simon Johnson has drawn the analogy between Wall Street and the Russian oligarchs—or mediaeval barons—who operated in a self-reinforcing style in which political power enhanced economic power and vice versa. It is, he suggests, a cycle capable of being broken only by revolution or external intervention.

       There is a strong tendency for private concentration of economic power to be self-reinforcing. This problem was widely recognised in America’s ‘gilded age’ at the end of the nineteenth century. The well-founded fear was that the new mega-rich – the Rockefellers, the Carnegies, the Vanderbilts – would use their wealth to enhance their political influence and hence enhance their economic power still further, subverting both the market economy and the democratic process. These concerns were the origin of anti-trust legislation, a point today often forgotten.

         Rent seeking is the process by which the ambitious find it more rewarding to batten on the wealth created by other people than to create it themselves. Rent seeking takes, and has taken, many forms – castles on the Rhine, the Wars of the Roses; ten per cent on arms sales, or seven per cent on new issues: awarding yourself control over former state assets, stealing the revenues from your country’s resources deposits, seeking protection from foreign competition, blocking market access by new entrants; winning sinecures or overpaid positions by ingratiating oneself with public servants or corporate employees. The mechanisms of rent-seeking range from the application of armed force to victory in democratic election; the methods pursued range from lobbying on Capitol Hill and in the restaurants of Brussels, through access to the King or the Chief Executive.

       But while rent seeking is ineradicable, we can have more of it, or less. Politics everywhere used to be dominated by rent seeking; factions would battle for control of the state and when they won such control would use it to steal as much as they could get their hands on. In much of the world, it is like that still. ‘It’s Our Turn to Eat’ is the stomach churning title of one fascinating recent book about the corrupt – and moderately – democratic politics of modern Kenya. We have come to recognise the resource curse – wealth from national resources does more harm than good in many countries because of the rent-seeking it attracts – and foreign aid may have some of the same characteristics. But in Western Europe, at least, corrupt politics has ceased to be an avenue for rent-seeking.

       The ability of a political/economic system to resist rent seeking depends on the degree of economic decentralisation. If there are concentrations of economic power. Individuals will try to get their hands on the rents concentrations of power attract whether they are found in the public sector, in private businesses, or in groups of private business. The wider the extent of the opportunities this created, the greater the tendency for individuals to gain wealth and influence for themselves by attaching themselves to power rather than exploiting their own individual talents and by developing distinctive capabilities in their own economic activities.

            When 10 years ago I published the truth about markets is often asked so where are you coming from? Are you for markets or against them? That is, of course, an absurd question we need to come to markets in a pragmatic frame of mind. A market system in the loose Sense is the best form of economic organisation we have. but that doesn’t mean that it’s particularly good form of economic organisation. Nor does it imply that we can have any confidence that regulation will improve it. That’s hard for people who want simple fundamentalist descriptions or a simple checklist of rationale is for government intervention that is provided by the market failure doctrine. Pragmatic intervention is based less on general principles than on an understanding of particular issues and the functioning of individual markets.

         It’s important to recognise that in the face of radical uncertainty and imperfect information the capacity of any centralised agency to issue standardised templates for decision-making is very limited. That is, in the end, one of the principal reasons why Soviet planning failed. Basel 12 and three, the endless iterations of complex procedures for risk weighting the assets of banks to determine their appropriate capital requirements, will fail for essentially the same reasons. Every target is gamed by people with superior local knowledge. The centre responds with a more complex set of targets which elicit the same response. The process continues indefinitely with multiplying complexity. Decentralise decision-making processes strike a balance between central objectives and local knowledge.

         Most of all decentralise decision-making processes provide opportunities for experiment and business models and products. The personal computer revolution happened because no one was in charge of it. The vast majority of new products launched in the course of that revolution failed.       

         A similar revolution did not happen in the Soviet Union because someone was in charge of it. The story of how the personal computer revolution did not happen in IBM, with one vital exception, in which a completely off-site operation free of the IBM bureaucracy was established to operate with bought in components, and created the machine which became known as the PC, neatly rounds out the picture.

         Finally, our policies need to be pro-market not pro-business. In financial services we confuse the health of the industry with the health of individual large firms in the industry. In pharmaceuticals, we protect a business model which worked well for two decades but no longer serves our change needs. I moved to a digital economy is slowed I need to protect the vested interests of large firms which no longer have a role to play. It is a theme which I could develop for many hours, and you will be relieved to hear that I’m not going to.

         If capitalism is about the role of capital, then we should understand that capital no longer plays a central role in modern economic development in rich countries. The legacy of an era in which it did is one in which the role of financial markets is greatly exaggerated. I want to insist on talking about the market economy rather than capitalism, and by the market economy I mean an economy which is based on markets in goods and services, not markets in securities and derivatives.

         The strength of markets and the market economy lies in disciplined pluralism, which is every bit as important in economics as it is in politics and intellectual life. Markets are not well oiled physical machine, but a constantly changing adaptive biological system. Pluralism is their motive force, their essence is chaotic, their development is inherently uncertain. If we could predict the future of markets, we would not need markets in the first place.