"Understanding the Economic Basics & Modern Capitalism: Market Mechanisms and Administered Alternatives"
by Dan Blatt - Publisher of FUTURECASTS online magazine.

Smith: Wealth of Nations.   Ricardo: Principles.
Marx: Capital (Das Capital).   Keynes: General Theory.
Schumpeter: Capitalism, Socialism and Democracy.

Economics is the miracle science. Even imperfect capitalist markets routinely raise billions out of poverty.

Table of Contents & Chapter Introductions

Describing the elephant:

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  So, what is "capitalism," anyway? For two centuries, whole library shelves have been filled with efforts to answer that question. However, there is little confidence in the answers. There is always evidently so much left unexplained. Theorists resemble at best the blind men describing the elephant by the part they find themselves examining.
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The focus is too narrow. It inevitably leaves out much of the rest of the elephant.

Economic analysts must step back and open their eyes to view substantially more of the elephant.

Only with the broader interdisciplinary scope of political economy can valid explanations be developed for such vital phenomena as economic growth or decline, the business cycle, the underperformance of many social democratic economic systems, and the many failures of economic development policy.

Both political and economic systems must be robust enough to function with imperfect men and women achieving imperfect results at all levels. There are strong natural incentives that create constant threats to the proper functioning of both spheres and require constant effort at containment. At any moment, they must be a part of any valid economic analysis.

  In "The Concept of Capitalism," Bruce R. Scott of the Harvard Business School demonstrated conclusively one major shortcoming of most efforts. The focus is too narrow. It inevitably leaves out much of the rest of the elephant. This short - 75 page - monograph was the author's summary of a much larger work, "Capitalism: Its Origins and Evolution as a System of Governance," recently published.
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  These articles combine the two. They cover Scott's scholarly explanation of the inherent ineptness of narrowly focused modern economics and its mathematical versions. Only with the broader interdisciplinary scope of political economy can valid explanations be developed for such vital phenomena as economic growth or decline, the business cycle, the underperformance of many social democratic economic systems, and the many failures of economic development policy.
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  A sampling of other issues that cannot be adequately analyzed within the narrow focus of modern economics is addressed in this book and is summarized in the second of these two articles. See Scott, "Capitalism: Origins and Evolution as a System of Governance," Part II, "Oligarchs and Stakeholders and other Issues of Political Economy."  These issues include:

1. Market disciplinary mechanisms and administered alternatives;

2. Financial oligarchs;

3. Constitutional constraints on federal economic policy;

4. Stakeholder capitalism;

5. Tilting the markets;

6. Industrial policy;

7. Abuse of the economic commons;

8. Government enterprises;

9. Political market competition.

  As might be expected, the author and FUTURECASTS have some agreements and some disagreements on these issues.  FUTURECASTS readers are encouraged to add their input. E-mail comments to blat1@futurecasts.com.

  Scott's "Capitalism: Its Origins and Evolution as a System of Governance," is clearly the most important modern book FUTURECASTS has reviewed in its dozen year history. It is scholarship at its rigorous best. With impeccable logic, Scott raises interdisciplinary issues of fundamental importance that economists must address or risk irrelevance. 

  Adam Smith provided an elegant description of the functioning and capabilities of markets and the ways unwise government policies undermined those capabilities. See, Smith, "The Wealth of Nations," Part I, "Market Mechanisms," and Part II, "Economic Policy." That government plays vital roles in facilitating markets was clearly recognized by Smith, as was the need to consider the entire complex of pertinent government policies when analyzing any economic system. Much of the theoretical work that followed elaborated on Smith's work and continued his attack on government constraints on economic markets, especially with respect to international trade. See, Ricardo, "Principles of Political Economy," and Wolf, "Why Globalization  Works," Part I, "Globalization of Market Systems." and Part II, "Criticism of Market System Globalization."
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  Scott asserts convincingly that economic analysts must step back and open their eyes to view substantially more of the elephant. Government and private institutions and political policy facilitate market mechanisms and do much that is absolutely essential. While the author discusses the economic institutions and political spheres separately for analytical purposes, the book emphasizes the deep relationships.
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  The author avoids presenting idealized versions of markets, institutions or pertinent political activities. Both political and economic systems must be robust enough to function with imperfect men and women achieving imperfect results at all levels. There are strong natural incentives that create constant threats to the proper functioning of both economic and political spheres and require constant effort at containment. All of these factors must be a part of any economic analysis that hopes to reach valid conclusions.

  "[The] two basic systems of governance in the contemporary U.S. -- capitalism and democracy -- are inescapably interdependent, and neither can be transformed without affecting the other. Furthermore, capitalism cannot be transformed as a governance system except through the political process. Thus, the political authority of U.S. democracy is required not only for the shaping of democracy itself but also for the shaping of U.S. capitalism; the two systems share a single governing entity and depend on its ability to function both legitimately and effectively in both realms."

Indirect governance through regulated competition:

  The capitalist system is characterized by "indirect governance through regulated competition" both in economic and political markets.
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It is an economically, politically and legally empowered civil society working through the political markets and the courts that maintain limits on political excess.

"Only a political authority can correct these market frameworks, and this in itself should warn us that externalities will never be eliminated. Thus a market economy should be presumed to contain distortions that range from small to large, and even 'extra-large.'"

  The political and economic systems are interdependent, with each influencing the other. Competitive economic markets provide economic discipline and accountability through the trading process, and competitive political markets provide political discipline and accountability through the election process.
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  Strenuous efforts are always directed at tilting the political and economic markets in favor of narrow interests. However, in the U.S., both markets have robust procedures that have enabled them to perform often surprisingly well despite constant efforts to bias their outcomes. They have repeatedly recovered from periods of political or economic excess. Scott notes that the political markets are unbounded by natural constraints. However, the checks and balances wisely included in the Constitution do impose considerable obstacles to political excess. (Various ideologues often fret about the constraints of those checks and balances.)
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  Government authorities in the courts, administrative agencies and especially in the legislatures possess the power to shape economic markets as they wish. However, they don't have the economic resources or knowledge possessed by participants in the economic markets. They are always playing catch-up with developments in economic markets. Nor do they always make wise laws and regulations, but they will in most cases determine the ultimate shape of economic and political markets. It is an economically, politically and legally empowered civil society working through the political markets and the courts that maintain limits on political excess.

  "Imperfections, such as externalities, are the rule and not the exception; indeed they are to be expected of a system where imperfect political markets inevitably lead to imperfect legislative solutions that then impose imperfect institutional frameworks to underpin the economic markets. Only a political authority can correct these market frameworks, and this in itself should warn us that externalities will never be eliminated. Thus a market economy should be presumed to contain distortions that range from small to large, and even 'extra-large.' Furthermore these distortions can range far beyond asymmetries of information to include asymmetries of power and their routine abuse."

  Thus, the maintenance of competitive capitalist markets that meet the broad economic needs of the people and the nation depends on the political markets functioning properly to assure that both political and economic markets work for the people instead of just for the politically influential and economically powerful.
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Capitalism is as much a political phenomenon as an economic  one. It involves - and requires - not just Smith's "invisible hand" in economic markets, but the "visible hands" of political actors in political markets.

  Capitalism must be viewed as part of a system where economic markets are embedded in institutions designed and governed by political authority. Free markets alone do not constitute capitalism. Capitalism is as much a political phenomenon as an economic one. It involves - and requires - not just Smith's "invisible hand" in economic markets, but the "visible hands" of political actors in political markets. In democracies, political markets include elections, legislatures, and the activities of civil society and economic interests. "Visible hand" impacts of human agency also flow from government and private agencies and institutions that have economic authority.
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  That the nature of "democracy" is as poorly defined as that of capitalism is a major complication. Democracy, too, has a defining feature - democratic elections. However, democracy must be complemented by a broad panoply of supporting institutions. Elections alone do not constitute "democracy." One man, one vote, one time is not democracy. The defining feature of capitalism is indeed its free economic markets, but a free market alone may be nothing more than a Middle East bazaar or the town square on market day in a feudal or slave society.
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The huge concentrations of industrial power were ironically used by socialists and communists as a reason for establishing "a centrally planned, coercive state that would monopolize power even more" than either feudalism or the 19th century industrial giants.

  "Smith's conception of atomistic capitalism, where firms had little or no economic power," was already an inadequate framework for analyzing capitalist systems as they had developed by the last part of the 19th century. By that time, capitalist markets were dominated by vast industrial giants. Democracies were few in number at that time and governments had not launched any efforts to "embed markets in regulatory frameworks" to protect labor or other interests.
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  Scott points out that "capitalism" was being defined at that time by its adversaries, including most notoriously Karl Marx. (See the six articles on Marx, "Das Kapital," beginning with Part I: "Value Determined by an Abstract Labor Standard.") One of Marx' many great analytical weaknesses was his failure to recognize the possibilities for reform through the political process (a recognition that would have undermined his revolutionary aspirations). Capitalist proponents were more preoccupied with fending off utopians like Robert Owen. For this purpose they invoked the "laissez faire" propaganda myth that markets functioned best when governments intervened least.
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  Capitalism was just a very imperfect alternative to feudalism at that time. Huge concentrations of industrial power replaced concentrated feudal power. This imperfection was ironically used by socialists and communists as a reason for establishing "a centrally planned, coercive state that would monopolize power even more" than either feudalism or the 19th century industrial giants. The ongoing contest between a democratic capitalism and an oligarchic capitalism was just beginning.
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The narrow scope of modern economics:

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  Capitalism was actually viewed in a broader context at that time. The field was called "political economy" and it recognized the role of politics in economic markets. Since then, theoretical and analytical economists have persistently narrowed their focus first to just economic relationships and then "to economic relationships that can be mathematically modeled, as though economics were a science devoted to the discovery and exposition of a system of natural laws."
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Theoretical and analytical economists have persistently narrowed their focus first to just economic relationships and then "to economic relationships that can be mathematically modeled, as though economics were a science devoted to the discovery and exposition of a system of natural laws."

The massive role of government in facilitating and governing markets has been obvious throughout the two century history of capitalism.

  Today, modern economists and the prevailing conception of capitalism focus predominantly on largely self regulating markets assisted by such basic government services as property rights and rule of law and security for persons and property. (Smith specifically recognized defense, rule of law and infrastructure as important government roles.) This may have been adequate in Smith's time, Scott points out, but is certainly inadequate today. Today, "the study of economics requires a framework that encompasses political economy and not just economics."
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  The current narrow focus has been coming under increasing criticism. Scott notes that one critic, Michael Merrill, in a 1995 article directed at getting economics back to political economy, suggested a broadened definition of capitalism. Merrill asserted that capitalism is not just economic markets, but "a market economy ruled by, or in the interests of, capitalists." As Scott points out, Merrill's view is untenable. It "assumes that the interests of capitalists not only do prevail but should prevail." (emphasis in original)

  Adam Smith discusses "The Wealth of Nations," not the wealth of businessmen. Even Marx acknowledged that free markets imposed ruthless competitive pressures on capitalists that they were largely helpless to oppose.
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  For Smith, the free market system is justified by benefits to consumers, benefits to government, and benefits to society as a whole. Nor was atomistic competition the whole story. Joint stock companies were already legally empowered in Smith's time and were a part of his analysis. There were giant trading companies and other monopolies chartered by the Crown that dominated entire economic spheres and exercised considerable political influence.

  Merrill's view is also hopelessly simplistic. The massive role of government in facilitating and governing markets has been obvious throughout the two century history of capitalism. Human agents from the political sphere, Scott points out, must play substantial roles "if the market frameworks are to reflect public interest through proper recognition of true social costs and benefits."

  "[The] ultimate discipline of capitalist markets is dependent to a considerable degree upon the sense of responsibility of the political authorities who print currencies, subsidize saving or consumption, and set the rules for acceptable financial leverage."

Competition cannot be the only regulatory agency.

The need for a broader focus than mathematical economists can provide is obvious.

  Other critics, most prominently Milton Friedman, have also provided alternatives to the narrow focus of the modern economists, but Friedman's focus, too, has been too narrow. Scott criticizes Friedman for concentrating on the abuse of political power and ignoring the potential for abuse of economic power. (See, three articles beginning with Friedman & Schwartz, "A Monetary History of the U.S.(1867-1960)," Part I, "Greenbacks and Gold (1867-1921)") Competition may be a powerful disciplinary force in the economic markets, but its impact on market participants may vary greatly with size, geographical position, economic status and other factors. The interests of those with "meager resources, little education or human capital, and/or no financial capital with which to take advantage of market opportunities," will not be adequately protected by unfettered markets. Competition cannot be the only regulatory agency.

  Even Keynesian economists are increasingly criticizing the unrealistically narrow focus of modern economics and its mathematical version. See, Akerlof & Shiller, "Animal Spirits," criticizing mathematical economics for intentional ignorance of obviously outcome determinative psychological and social factors. Such factors as "confidence" and "trust" and "corruption" are ignored simply because they cannot be measured or estimated and expressed as an equation. Mathematical economics thus fails to even adequately cover the trading markets. The same criticism is raised by Baumol, Litan and Schramm, in "Good Capitalism, Bad Capitalism," This same criticism has been a persistent FUTURECASTS theme since its inception. See, "Capital as Purchasing Power."
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  See, also, Tavakoli, "Dear Mr. Buffett," explaining why the Credit Crunch cannot be explained or its problems adequately remedied without taking into account the regulatory failures and Congressional mismanagement involved. Cooper, "The Origin of Financial Crises," explains the massive role of  central banks, especially the Federal Reserve, and the mismanagement of monetary policy in generating financial crises, particularly including the Credit Crunch. See, also, Morgenson & Rosner, "Reckless Endangerment," emphasizing the role of the government sponsored privately owned entities Fannie Mae and Freddie Mac in corrupting government housing policy.

  The need for a broader focus than mathematical economists can provide is obvious. Economic influence can undermine political functions just as political influence can undermine economic functions, Scott points out. "Economic power can be a force for the subversion of equality among persons, and thus a force for the subversion of freedom and democracy."
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Neo-classical theory has proven inadequate as a basis for development policy. "It is concerned with the operation of markets, not with how the markets develop."

  The five decades of failure of development economics since WW-II proves the inadequacy of neo-classical theory as a basis for development policy. "It is concerned with the operation of markets, not with how the markets develop," Scott points out.
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  "Sociology [matters] as well as political science, law and economics." The traditional tools of economics "are not adequate to the task" of explaining how societies develop economically and why many fail.
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  The institutions in which markets are embedded must be a part of economic analysis and the definition of capitalist systems. It is institutions that create the incentives that promote economic growth or stagnation or decline. Those institutions must be analyzed as existing, evolving, thriving or declining entities in their own right. To what degree is economic development guided by human agency, natural forces, or both?
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Trajectories of economic development:

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  The differing trajectories of economic development in Latin America as compared with North America, and in the southern regions of the U.S. and Italy as compared with their northern regions, are covered in some detail by Scott. The author emphasizes the differences in governance, social customs, political and private sector institutions - the stuff of political economy.
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Path dependency phenomena played a major role in the underdeveloped regions as privileged elites fought the development of the political and private governance structures required for capitalist development.

  British colonists in Jamaica and the southern colonies of North America followed much the same development trajectory as the Spanish and Portuguese colonists in Latin America. These underdeveloped regions all responded to similar geographic comparative advantages. The common denominator was the presence of "rich factor endowments that could be exploited by forced labor." The operative "cultural factors" were clearly not ethnic. Political and ethnic culture factors come more into play in Argentina and French Canada, where centralized political regimes reinforced elite privileges and inhibited economic development.
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  In the 19th and 20th centuries, path dependency phenomena played a major role in the underdeveloped regions as privileged elites fought the development of the political and private governance structures required for capitalist development. Differing economic outcomes were clearly related to differences in the quality of political leadership in both the mother countries and their colonies and thereafter in the newly independent states.
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  The author extends his analysis to cover present conditions. All of these regions are cursed by rich factor endowments and continue to suffer to some considerable degree from historic conditions.
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The granting of title to property is clearly not enough to mobilize capital in the absence of the appropriate legal framework to enforce both property and creditor rights in a timely and cost-effective manner.

Remedies for the distorted factor markets and paucity of public goods must come through the "visible hand" of political policy.

  Clientelism, corrupt extra judicial relationships, and inadequate public goods and services such as infrastructure, education, legal protections for people and property, inadequate access to domestic financing and lack of technological development continue to plague most Latin American nations. Centralized political systems combine with impotent and corrupt local governance to retard development.

  "If profits and profitability are the incentives as well as the fuel that drive capitalism, credit that is scarce and very high in relative cost arguably remains a cause of underdevelopment with its roots in distorted and underdeveloped factor markets. Furthermore, exceedingly weak law enforcement throughout the region leaves the poor at the mercy of the rich. Oligarchic abuse is the norm, and the rich fortify their homes rather than trying to correct the manifest inequalities."

  Hernando de Soto in "The Mystery of Capital," provides an incomplete analysis of the credit problem, Scott points out. The problem is not a shortage of capital, but the absence of the appropriate governing institutions of capitalism. The granting of title to property is clearly not enough to mobilize capital in the absence of the appropriate legal framework to enforce both property and creditor rights in a timely and cost-effective manner. Bankruptcy laws and banking systems, and broad social acceptance of the pertinent legal processes - again, the stuff of political economy - are also essential.
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  The focus on free trade by libertarians and Milton Friedman is clearly too narrow. Scott points out that "free trade by itself has little capacity to induce" needed institutional reforms. Free trade may indeed be essential but by itself it is grossly insufficient under the circumstances of existing Latin American governance. "Only a political process can induce institutional reform." Remedies for the distorted factor markets and paucity of public goods must come through the "visible hand" of political policy.
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  Factor markets:

   Unlike product markets, factor markets for land, labor, finance and the natural resources of the commons cannot evolve naturally. They require the "visible hand of human agency," the author points out.

Capitalism is certainly more than a system for trading. It is the production paradigm that "is most susceptible to gross abuses of power," and is most subject to the influence of human agency within the capitalist system. If political actors do not develop and maintain property rights, contract rights, rule of law systems and the whole panoply of supporting and regulatory institutions, modern capitalism cannot exist.

  "[The] ultimate key to capitalism lies not in its product markets so much as in factor markets, and notably the willingness of a political authority to permit these factor markets to exist and to function in the first place. The existence of factor markets is - - - the sine qua non of capitalism, and factor markets cannot be established except by political decisions. Without political decisions to permit factor markets, and the additional willingness to develop regulatory frameworks to help govern such markets, there can be trade, but no organized commerce in the factor markets."

  Human agency - human political choices - play a major role in the development of the pertinent institutions, Scott emphasizes. The focus on the "trading paradigm" misses the aspect of capitalism which bears most directly on the "productive paradigm" involving the marshalling of resources for profitable development.
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  A summary of the corporate production paradigm clearly demonstrates the importance of institutional framework.

  "The production paradigm can be - - - characterized in terms of its primary actors and forces: Private parties are allowed to mobilize resources through various legal vehicles such as corporations to develop and exploit new technologies in search of profits, while corporations are permitted to lock in shareholder capital indefinitely at the discretion of the board of directors, and they are permitted the rights of self-governance through hierarchies; shareholders are shielded from losses through legislative grants of limited liability; managers are permitted to coordinate activities across functions and sectors through hierarchical organizations; employers are permitted to use implicit coercion, such as the loss of a job for employees who fail to carry out assigned roles; and competition for profits governs the allocation of resources and of internal rewards."

  As focus on the production paradigm demonstrates, capitalism is certainly more than a system for trading. It is the production paradigm that "is most susceptible to gross abuses of power," and is most subject to the influence of human agency within the capitalist system. If political actors do not develop and maintain property rights, contract rights, rule of law systems and the whole panoply of supporting and regulatory institutions, modern capitalism and its factor markets cannot exist.

  "Focusing on trade misses the importance of the production paradigm in developing the factor markets and thus in developing capitalism itself. Moreover, it misses the role of human agents, specifically political actors, in the emergence and ongoing evolution of capitalism."

  The essential elements of the capitalist economy thus include not just the product markets but also the factor markets and the supporting institutions and the political activities that develop and govern them. Politics includes political and societal institutions that are generally studied in the field of political science and remain outside the purview of economists. However, the contests for political influence have a direct impact on economic developments, and economic influence directly influences political developments.

  "Economic governance thus inevitably involves political institutions as well as political objectives, and capitalism cannot be reduced to the impersonal science of market forces alone."

The role of the "visible hand:"

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  Thus, Scott views capitalism as a particular system of governance. Since it is more than just markets, it must be analyzed as part of the broader field of political economy. It must include the political authority that governs how institutions, incentives and constraints are designed and shaped through political processes and the courts as well as how they are administered.
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The modern field of economics in general and mathematical economics in particular are currently focused narrowly just on market transactions. Without the broader scope of political economy, economic policy will continue to fail at development economics, and the field of modern economics will continue to fail to provide an understanding of the business cycle.

  In the political sphere, human agency "determines the rights, responsibilities, and resulting powers of individuals and institutions within the economic system over time." The modern fields of economics in general and mathematical economics in particular are currently focused narrowly just on market transactions. Without the broader scope of political economy, economic policy will continue to fail at development economics, and the field of modern economics will continue to fail to provide an understanding of prosperity or decline in developed nations. Major causes involved in the swings of the business cycle will remain beyond the understanding of modern economists.
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  The "visible hand" of human agents working through political and institutional processes establish and maintain the institutional structures that "shape the markets in which the invisible hand of the pricing mechanism operates." The emergence and development of capitalism is inexplicable without such "constant human intervention." It has not been a "natural" process. Capitalist systems have been "driven by human purposes from their very origins." Human agents remain involved in purposive adaptations. This implies a human strategy, "even if an imperfect or incoherent one," working through government. There exist varieties of economic governance and varieties of capitalism.

 "Markets will yield equilibrium, but the invisible hand of the pricing mechanism can only coordinate; it cannot govern."

Market participants act in the relatively free economic markets within the bounds of laws and rules that establish acceptable behavior.

Any economic system can have markets to trade products, but the lending of capital, the sale of land, and the contracting of labor require a particular social and legal system that permits and enforces freely negotiated contracts involving the factors of production.

The market system described by Friedman essentially describes informal gray or black market trade or the roadside fruit stand, not capitalism.

  Scott explains capitalism as a three level system of (1) economic markets, (2) private and public institutions, and (3) political authority accountable in political markets. It is an indirect system of governance, since market participants act in the relatively free economic markets within the bounds of laws and rules that establish acceptable behavior.  Informal customs among market participants are of course also very important. Any economic system can have markets to trade products, but the lending of capital, the sale of land, and the contracting of labor require a particular social and legal system that permits and enforces freely negotiated contracts involving the factors of production.
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  The author emphasizes that widely spread opportunity is a vital capitalist element. Feudal and slave labor societies lack such opportunity - as do societies where education is not widely available. To gain widespread opportunity, people in Europe have often had to violently overthrow feudal and slaveholder overlords. Slave and feudal systems are "statist" systems of direct governance through hierarchy using command and control systems, whereas capitalism as Scott envisions it is "an indirect system of governance where governance occurs not by political authority itself but rather through the rules and institutions it shapes." (emphasis in original)

  Many Latin American states are today suffering the consequences of their failure to offer education and other civil society benefits to their indigenous underclass. The result has been underclass support for demagogues, demagogic mismanagement of economic systems, and the failure yet once again of democratic experiments in these states. See, Chua, "World on Fire."

  Friedman's view, the author points out, is that most market constraints should be by the customs developed over time by market participants. Markets should be impersonal, apolitical, and unbiased, and government should play as minimal a role as possible. However, even Friedman accepts that government's role has to include doing what "the market cannot do for itself, namely to determine, arbitrate and enforce the rules of the game." But Scott asserts that the market system described by Friedman essentially describes informal gray or black market trade or the roadside fruit stand, not capitalism. It would be neither as efficient nor transparent as appropriately governed capitalist markets.
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The laws "are always created by political actors and therefore, to some extent, always contain a political agenda or tilt within them."

  The assertion that market capitalism "separates economic activities from political views" is a practical impossibility, the author points out in a further criticism of Milton Friedman. Political biases are inherent realities in these as in all political actions. The laws "are always created by political actors and therefore, to some extent, always contain a political agenda or tilt within them." Economic analysis must be broad enough to encompass this political fact of life.
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Laws and regulations designed to facilitate markets contrast with those designed to burden markets or constrain them in favor of political purposes and/or the politically influential.

In addition to the market price mechanism, capitalism requires an elaborate institutional framework including "the administrative apparatus through which the visible hand of government translates estimated societal costs and benefits into various rights, taxes, and subsidies in order to approximate true social costs for each particular society."

  Laws and regulations designed to facilitate markets contrast with those designed to burden markets or constrain them in favor of political purposes and/or the politically influential. As an example of a rule that facilitates a market, Scott refers to the credit card requirement that issuers assume responsibility for most charges on lost or stolen cards. The issuers can spread these costs widely and most effectively act to minimize them. This rule increases cardholder confidence in the use of the cards. (Title registration laws are another widely appreciated example.)
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  Thus, in addition to the market price mechanism, capitalism requires an elaborate institutional framework including "the administrative apparatus through which the visible hand of government translates estimated societal costs and benefits into various rights, taxes, and subsidies in order to approximate true social costs for each particular society." Modern capitalism also requires private institutions - including firms large and small with their hierarchical control apparatus and their strategies for competition.

  One of the key political questions concerning any particular economic policy is thus whether the government apparatus is facilitating market mechanisms and pursuing broad societal goals or directing benefits to politically influential entities or groups. There is also the ongoing problem of differentiating big firm abusive strategies from proper competitive strategies. Competition provides an essential disciplinary factor in all three spheres - economic market, political market and private firm - so all efforts to provide protection from competition are probably contrary to the public interest and should be viewed with intense skepticism. Protected economic entities should be heavily regulated in the public utility mode to prevent abuse of their protected status.
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  But, as Scott points out, even competition is hardly all-powerful. The incentives for rent seeking and claims for benefits from the public treasury are omnipresent, and most efforts at "reform" in Washington include thinly disguised efforts to promote particular interests and strengthen the advantages of incumbency. All extensions of government power serve to increase the advantages of incumbency; only economic decline seriously undermines incumbency.
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  The great strength of Scott's broadened concept of capitalist economics is that it brings into focus the Good, the Bad, and the Ugly of political sector economic activities. Without focus on the political sphere, the reasons for the failures and successes of economic development are inexplicable. The economic differences between the U.S. and Argentina, for example, are primarily found in the political sphere.
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  Paul Krugman, for example, in "Peddling Prosperity" (1995),  finds economic growth "magic" and both economic development and the business cycle a "mystery." The reasons for persistent high levels of unemployment in Europe during the 1980s is yet another "mystery." All of these economic mysteries can only be resolved by a critical examination of the mix of government policies and the characteristics of pertinent institutions.
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  Thus, Scott's broadened  focus is absolutely essential for understanding the business cycle and economic development. It brings into consideration all the many things that governments do well as well as everything they do to undermine economic prospects and stability.
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  We have, in fact, not had a free market business cycle at any time in the last 100 years. Government policies have played a substantial role in every economic contraction and period of chronic inflation since WW-I, and has been clearly the predominant factor in the most serious of these periods. See, "Government Directed Business Cycle."
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  Learned economists concentrating only on broad economic aggregates like "savings" and "GDP" and "effective demand" miss the essential causative elements in the economic, psychological, societal, political and institutional spheres. Largely because of the narrowness of their focus, Keynesian economists are forced to openly and candidly confess incompetence at the essential task of forecasting the business cycle. Yet it is precisely the mitigation of the business cycle that is the primary focus of Keynesian policies. The 45 year record of accurate published economic forecasts compiled by the publisher of FUTURECASTS was made possible precisely because of his broader focus. See the four articles setting forth his published forecasting record available through the links on the About the publisher page.
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  Of course, political leaders may not be welcoming towards this broader focus that shines a light on their policy misadventures. It will make harder the essential business of throwing blame on scapegoats - such as speculators, OPEC and the oil companies, the insurance companies, and even the markets. The response of the economists who serve the political leaders will be interesting - and important - since their government positions give them extraordinary status within the economics profession regardless of the inherent incompetence of their narrow analytical focus. Will they seriously respond to Scott's work, or ignore it?

Democratic governments thus have an unavoidable responsibility to protect the citizenry from the abuse of economic power. They must also provide a wide range of "public goods."  The study of economics and the analysis of economic markets thus must include both the political and economic spheres and all their interactions.

  As in professional sports, the institutional context shapes but does not control competitive behavior. In the formative years, the rules of a sport draw upon "custom, consensus and un-coerced conformity," evolving over time. However, modern professional games are governed by formal rule-making bodies. Modern capitalist markets are governed according to sometimes narrow majorities in legislatures and courts. For both professional sports and capitalism, formal rule-making bodies provide "indirect governance" that shapes the competitive playing fields but does not - or should not - determine competitive outcomes.
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  The fictional atomistic market is a propaganda ploy, Scott points out. It is invoked in efforts to change laws that impact the markets. It supports deregulation that opens the gates "to a free-for-all in the markets." It "becomes a form of political reasoning masquerading as economics."

  The "laissez faire" propaganda ploy is today more often used for the opposite purpose, as a pejorative to denigrate and silence opposition to political initiatives so that they need not be contested on their merits.
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  Laissez faire is an obvious myth. Government has always played major roles in capitalist systems - since well before there was a word for "capitalism" - as Scott repeatedly points out. Much of what the government does is clearly beneficial - even essential -  and much of it is clearly unwise. The Constitution - an 18th century document - has been interpreted as an economic document, with its provisions for due process, property rights, the uniform and non preferential regulation of interstate commerce, an independent judiciary, patent and copyright protection, the postal system, bankruptcy, and standardized weights and measures. Such basic rights as petition and press freedom also have commercial implications. The essential and beneficial aspects of government economic policies as well as those policies that are unwise have long been a major theme in FUTURECASTS articles. See, Future Economic Myths, at segment on "The  'Laissez Faire' Straw Man," and Government Futurecast at Part I, "Economic virtues of the U.S. political system," and Part II, "Government management."
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  At no time under the Constitution was the economy or its firms free from legal constraints and the government economic policies that initially favored producer, commercial and creditor interests and economic growth.
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  It is this system of governance that is the focus of Scott's book. Unfortunately, he is heavily invested in the misuse of the term "laissez faire" which he uses to describe not the lack of economic policy but the extensive government policy mix that does not include policies that he favors. "Capitalism was created more by political than economic actors," with "institutional innovations that were partly regulatory and partly political in nature," he accurately states in direct contradiction to his "laissez faire" assertions.
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  Indeed, he writes, in the 19th century, "one can speak of a deliberate transfer of power from product markets to factor markets and producers" and of the pertinent implications. It was "political actions" that shaped the capitalist system and the legal framework in which firms flourished," again contradicting his "laissez faire" assertions. Among the many facilitating political policies emphasized by the author was the granting of general purpose corporate charters of indefinite duration and the authorization of holding companies and other methods of concentrating economic power that came at the state level. U.S. Supreme Court decisions that blocked efforts to extend legislative control over producer interests constituted Court policy, not a lack of policy.

  Scott defines "laissez faire" policy as "self-regulatory markets with a weak state" concerned mainly with promoting producer interests. The system he characterizes as "laissez faire" involves "institutional arrangements [that] already embody a strategy, no matter how implicit or shortsighted that strategy might be." ( Used thus as a pejorative, the phrase obfuscates rather than illuminates.)
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Even those like Madison who favored federal chartering authority ultimately abandoned it as inconsistent with the desired limits to federal power.

  The fear of centralized power of the founding fathers and the ratifying public was the cause of the weakness of federal economic authority. This fear guided their actions both before and after the ratification of the Constitution. Scott points out that these views are evident in how Thomas Jefferson shaped the Northwest Ordinance just before the Constitutional Convention, and why Pres. Madison vetoed a bill that would have permitted federal funding of infrastructure, a task he thought Constitutionally left to the states.
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  Authority for federal chartering of corporations was excluded from the Constitution for fear it would derail ratification, the author acknowledges. Even those like Madison who favored federal chartering authority ultimately abandoned it as inconsistent with the desired limits to federal power. "By the mid-19th century, federal economic policies were rarely restrictive or regulatory in nature." Efforts to pass federal chartering statutes during the early years of the 20th century all failed.
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  Nevertheless, there is no question that the federal government can charter national corporations and it has in fact been periodically chartering national banks since its inception. It also has the power to require federal licenses to engage in interstate commerce. The precise terms of such charters and licenses for business corporations has never been agreed upon, however, and economic policy ultimately shifted to the regulatory route.

  The states today are increasingly active in imposing licensing requirements. As might be expected, the process is intensely politicized and used primarily to limit competition in favor of established providers. While there is obvious need to assure the quality of some professions, licensing requirements have spread far beyond such professions. Licensed services are generally underserved and overpriced.

Competition between states striving to attract economic resources led to the spread of laws favoring producers and commercial interests. No one was "looking out for the public interest."

Courts responded by viewing corporate charters under state corporation laws as simply "a convenient device for conducting business" rather than as a privilege subject to state purposes. Corporations had to comply with the laws of the land, including general regulatory provisions, but retained the same rights as individuals with respect to corporate purposes.

  State legislatures responded to their economic authority as might be expected - with widespread instances of corruption in favor of the politically influential. The public response was to amend state constitutions to limit the discretionary economic policy authority of state legislatures.
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  State constitutions thus limited legislative discretion in the granting of corporate charters. General incorporation laws "assured free entry into corporate status for all comers." The development of the holding company under New Jersey law facilitated industrial consolidation on a vast scale sufficient to dampen the fires of competition. Competition between states striving to attract economic resources led to the spread of laws favoring producers and commercial interests. No one was "looking out for the public interest."

  "Between 1895 and 1904, 157 holding companies consolidated more than 1,800 firms and controlled more than 40% of the capital invested in the entire industrial sector. Despite the relative success of all these consolidations, as the century came to a close, competitive pressures were ever-present and intensified as industry influence was increasingly concentrated in the hands of a few very large and very powerful firms."

  Yet again, the power of private parties was favored over that of the state. Courts responded by viewing corporate charters under state corporation laws as simply "a convenient device for conducting business" rather than as a privilege subject to state purposes. Corporations had to comply with the laws of the land, including general regulatory provisions, but retained the same rights as individuals with respect to corporate purposes. The author goes at some length into examples of abuse of private powers, corrupt private practices and massive miscalculation.

  "In this way, interstate competition and evolving legal doctrines created a context in which efforts to curb abuses by public actors ended up effectively opening opportunities for abuses by private actors, reducing their accountability to the interests of the state or the public."

  Scott emphasizes the railroads as the quintessential example of industrialization and economic power in this period. Textile firms and railroads led the way in the formation of modern, large-scale industrial organization. Their methods were adopted in the coal, iron and steel sectors. However, private competition led to periods of over-expansion followed inevitably by periods of economic contraction and enhanced creative destruction.
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Scott refers to the 19th century Robber Barons as "oligarchs," and uses the same term for the powerful financial sector leaders in the U.S. since 1980.

The courts were powerful actors, interpreting legal doctrine in favor of economic growth and thus in favor of producer and commercial interests.

Private economic actors were able to pursue their private economic interests "largely unaccountable to any public regulatory authority state or federal."

  The vast growth of power and political as well as economic influence of the 19th century industrial giants provides prominent examples of how unfettered market participants can destroy freedom in political as well as economic markets. Economic power can be, and has been, abused just like political power. The author emphasizes that markets can be shaped to work for the few rather than for the many. This has in fact been common in oligopolist nations from Russia and Central Asia to Latin America. (NOTE that these states all have highly centralized political systems such as the Constitution was designed to prevent.)
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  Scott refers to the 19th century Robber Barons as "oligarchs," and uses the same term for the powerful financial sector leaders in the U.S. since 1980. By the second half of the 19th century, the major -  sometimes "oligarchic" -  producers were able to dominate the weak local and state governments and exercise great influence over the federal government. The courts were powerful actors, interpreting legal doctrine in favor of economic growth and thus in favor of producer and commercial interests. Based on the lack of specific Constitutional empowerment for federal economic intervention, and the lack of any federal chartering or licensing statutes, legal doctrine was based upon common law property and contract rights and the policy of facilitating market mechanisms.
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  Thus, private economic actors were able to pursue their private economic interests "largely unaccountable to any public regulatory authority state or federal." There was no check on the power of the oligarchs. Scott sums up:

  "The power of these new firms was the joint product of the new technologies of the Industrial Revolution, a new form of organization that permitted management to coordinate vertically integrated flows of raw materials and semi-finished items within the firm through a managerial hierarchy, and the corporate autonomy established by a transformed legal system that granted them charters permitting them to reach any size in any number of businesses, thus allowing them to have the pricing powers of oligopolies. At the same time, this legal system also granted their shareholders limited liability and their entrepreneurs the right to create self-governing structures managed through self-appointed hierarchies without any corresponding accountability to society beyond the payment of taxes. Furthermore, these firms were permitted to lobby governments, state and local, to subvert the tax system in their own favor and to subvert competition to charge prices reflecting their market power. Ironically, then, these firms were permitted to develop within and eventually dominate the U.S. capitalist system, infiltrating even the democratic institutions of its three-level structure of governance."

The 1887 Interstate Commerce Commission Act and the 1890 Sherman Antitrust Act signaled the entry of the federal government as a significant regulatory power.

Initiative and referendum reforms at the state level, direct election of senators, and the 1913 Federal Reserve Act laid some groundwork for increased political opposition to the excesses of consolidated producer and commercial interests.

  Opposition supporting a political policy response developed towards the end of the 19th century. The 1887 Interstate Commerce Commission Act and the 1890 Sherman Antitrust Act signaled the entry of the federal government as a significant regulatory power. There were state regulatory efforts, also, but all these efforts were essentially beaten back by industry political influence and their success in legal proceedings.
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  Instead, J. P. Morgan stepped in to arrange industry consolidation and the control of policy to assure the profitable operation of businesses and to protect financial interests. Strikes by labor unions were declared illegal by the courts and met by military and police repression.
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  Populist and Progressive political influence grew in response. Initiative and referendum reforms at the state level, direct election of senators, and the 1913 Federal Reserve Act laid some groundwork for increased political opposition to the excesses of consolidated producer and commercial interests.

  Scott stumbles badly when he asserts that the 1913 Federal Reserve Act created a central bank. It did NOT create a central bank. Indeed, the Federal Reserve System was specifically designed so it could not be used as a central bank precisely because of fears that it would be politicized and used for purposes outside its limited remit. See, Meltzer, "The History of the Federal Reserve," Vol. 1 (1913-1951), Part I, "The Search for Monetary Stability." It did not become a central bank until the 1935 Banking Act, and it has indeed since been politicized with results that include several periods of extraordinary economic and financial turmoil.

The Supreme Court interpreted federal regulatory initiatives as efforts to facilitate market disciplinary mechanisms rather than to displace them with administered alternatives.

The Supreme Court shifted from recognizing Constitutional limits on the economic powers of Congress to accepting Congress as the authorized problem solver for the nation without Constitutional limits, at least in the economic sphere.

"The Framers and then the courts prioritized individual freedom over state power," and corporation law evolved to extend such freedoms to corporations.

  The change in judicial philosophy during the New Deal is emphasized by Scott. In short, with its New Deal appointments, the Supreme Court shifted from recognizing Constitutional limits on the economic powers of Congress to accepting Congress as the authorized problem solver for the nation without Constitutional limits, at least in the economic sphere. In academic circles, the shift is described as being from "Classical Legal Thought" that recognizes Constitutional constraints on the economic powers of Congress to "Legal Realism."
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  Free market, or Classical Legal Thought,  is based on the common law and the primacy of private property and contract rights, producer and commercial interests, the facilitation of market mechanisms and general reliance on those mechanisms. Classical Legal Thought "strictly upheld the classical notions that markets should be self-governing and that economic efficiency, as indicated by contracts, should take priority over policies that might try to redistribute incomes or wealth to correct a wrong." "The Framers and then the courts prioritized individual freedom over state power," and corporation law evolved to extend such freedoms to corporations.
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  The economic deregulation movement that began late in the 1970s was supported by the growing disrepute of government and the failure of its Keynesian economic policies. Scott accurately traces the recent Credit Crunch recession to government policies that he lumps together under the heading of "deregulation."

  Unfortunately, the removal of government regulations was accompanied by the dismantling of essential market regulatory mechanisms leaving only market anarchy. Yet the author claims that by these "deregulation" initiatives, the economy was left dependent on the "free market."

The removal of market interest rates by Fed Chairman Greenspan, the reduction of mortgage lending standards and the "too-big-to-fail" credit subsidies that transformed credit market vigilantes into credit market enablers, are acknowledged by ScottScott, as is the noxious impacts of the government's poorly conceived and disastrously implemented affordable housing policies.

  The noxious impacts of the removal of market interest rates by Fed Chairman Greenspan, the reduction of mortgage lending standards and the "too-big-to-fail" credit subsidies that transformed credit market vigilantes into credit market enablers, are acknowledged by Scott. He also notes the noxious impacts of the government's poorly conceived and disastrously implemented affordable housing policies.

  The noxious influences of the tax statute and the roles of Fannie Mae and Freddie Mac have yet to be candidly acknowledged within the government or eliminated as dominant factors in the pertinent "free" markets, 

    Where Scott is indubitably 100% correct is that any analysis and understanding of the Credit Crunch must involve the political, institutional and societal environment. (See, Understanding the Credit Crunch.) Narrowly focused economic analysis is inherently incompetent, and mathematical analysis an obvious farce. Only analysis into the broad realms of political economy can suffice.

  The mix of government policies involved are a good example of the scope of economic stupidity achievable by political actors, but by no stretch of logic could it be described as "laissez faire" - as a lack of policy. It demonstrates the dangers of centralized power. Indeed, Scott recognizes that centralized political systems play significant roles in the retardation of economic development in a variety of states with a variety of political systems. See, "Trajectories of economic development," above. The states can also make serious mistakes and suffer corruption, but only the federal government makes its mistakes from sea to shining sea - and with impacts that can stretch across the globe.
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  As the power and activities of the federal government have increased, so have incentives for influencing and corrupting it. Inevitably, many of these efforts succeed. Corrupt practices and political influence are not unique to state governments or the private sector, as Fannie Mae and Freddie Mac recently proved. See, Morgenson & Rosner, "Reckless Endangerment," For the "mega banks," see, 13 BAnkers: The Wall Street Takeover and the Next Financial Meltdown."

Social democratic system in Europe, by contrast, include social insurance for sickness, accidents, retirement and unemployment, collective bargaining rights and methods to increase the share of national income for labor. They also include the high levels of taxation required to finance the system.

  In Europe, government policy heavily influenced the course of economic development. Social democratic systems there have policies that protect "both labor and consumers from the full effects of lightly regulated competition, and notably in the markets for capital and labor." They include social insurance for sickness, accidents, retirement and unemployment, collective bargaining rights and methods to increase the share of national income for labor. They also include the high levels of taxation required to finance the system.

  Unintended consequences are widespread and adequately dealt with in only a few of the social democratic states. Youth unemployment is often chronically above double digit levels. In France, successful small firms refuse to expand beyond 49 employees to avoid expensive social democratic mandates. National insolvency is a spreading phenomenon as politicians prove incapable of constraining costs.
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  The U.S. and European models can both have degrees of success and severe problems. Those European nations that exercise a prudent degree of budgetary discipline can generally deal with their problems as they arise. As demonstrated by the U.S. during the Great Depression and at present, having the economic capacity to deal with problems doesn't mean that they will be dealt with - or even recognized. See, Blatt, "Understanding the Great Depression and the Modern Business Cycle," Table of Contents and Introduction. See also seven Great Depression Chronology articles beginning with "The Crash of '29." Government mismanagement on a colossal scale is possible under either system. The governing elites in the U.S. currently show no capacity for budget discipline.

Democratic governments thus have an unavoidable responsibility to protect the citizenry from the abuse of economic power. They must also provide a wide range of "public goods."

  Power inequality in both political and economic markets, how inequality grows to threatening levels, and the institutional mechanisms that might reduce and limit it, are vital issues stressed by Scott. He emphasizes that market failure can happen in both domains, but only the "visible hand" of political action can remedy market failure in either domain. Indeed, analysis of the political domain in general and the development and operations of democracy are of as much a concern of this book as analysis of the economic domain and the development and operations of capitalism.
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  Democratic governments thus have an unavoidable responsibility to protect the citizenry from the abuse of economic power. They must also provide a wide range of "public goods."  The study of economics and the analysis of economic markets thus must include both the political and economic spheres and all their interactions.

The growth of the entitlement welfare state must be a major factor in evaluation of the nation's economic prospects in the 21st century.

  What today are called "antitrust" problems were a major concern of Adam Smith as was the use of  political influence to obtain grants of monopoly franchises and legal advantage for guilds and local businesses. Corn law protectionism was a primary concern of David Ricardo in "Principles of Political Economy."
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  Governments in the U.S. have been increasingly active in efforts to shape economic markets. Disclosure requirements in investment and consumer markets, the recording of title to property, and limited levels of insurance for bank deposits are examples of political efforts during the first half of the 20th century to facilitate economic market participation and market disciplinary mechanisms. Administered alternatives to market mechanisms such as Federal Reserve monetary policy, the trade war protectionisms of the 1920s and 1930s, government sponsored enterprises like Fannie Mae and Freddie Mac, affordable housing policy, "too-big-to-fail" credit market subsidies, all played major noxious roles in the tumultuous business cycles of the previous hundred years. The growth of the entitlement welfare state must be a major factor in evaluation of the nation's economic prospects in the 21st century.

Institutions:

  The power relationships in capitalist systems are emphasized by Scott. He focuses on the scope and interplay of the linkages between economic and political power.
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Capitalism cannot be understood without the political inputs of "human agency." There is and always has been a "visible hand" involved in shaping free market capitalism through political processes.

Capitalist free markets are embedded in institutions of public administration and government.

It is the state that grants the power to enter, compete and exit from markets, and restrains participants from abuse of such power. Market participants are compelled to follow the rules.

  Economic analysis must cover "the basic institutional foundations, including physical and social infrastructure as well as the individuals and organizations operating them." Numerous alphabet soup institutions play governing and administrative roles in the U.S. The author mentions transportation and communications infrastructure as well as educational, public health and legal systems. These institutions define acceptable market behavior. They are agents of the state.

  They also include the private agencies that have public responsibilities, like securities and commodities exchanges and regional reserve banks. Credit rating agencies have been added to this list, with seriously flawed results.

  Above them all are the political institutions that govern political markets. In democracies, they include reasonably fair elections and the influence of a politically, legally and economically empowered civil society. "Laws do not make themselves or enforce themselves. Unless there is demand for enforcement, it will not normally happen." Capitalism cannot be understood without the political inputs of "human agency." There is and always has been a "visible hand" involved in shaping free market capitalism through political processes.

  "[The] invisible hand can only align individual and societal priorities if the institutional foundations of capitalism have shaped those markets so that individual costs and benefits reflect those of society rather than those of an unruly mob or powerful elites. The pricing mechanism cannot come close to achieving an optimal coordinating role absent the effective work of the visible hand of government." (emphasis in original)

  Indeed, a political authority is an essential ingredient for capitalism. The political authority must have "legitimacy to govern the economic system, the political power to reshape and/or modernize its institutions, and the coercive power to see that its decisions are implemented." Capitalism implies economic freedom, but "all such freedoms are conditional on obedience to the rules embedded in the system."
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  Thus, various forms of economic, administrative and political coercion are pervasive in free market capitalism. Coercion is employed "to create the freedoms of a capitalist system." It is the rule of law that creates and enforces contract rights. The proper functioning of the factor markets -  for land, capital, and labor and the natural resources of the commons - are particularly dependent on the visible hand of government. Capitalist free markets are embedded in institutions of public administration and government.
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  In developed capitalist systems, freedom is thus almost always "conditional" on the rules and regulations established and enforced by the state. It is the state that grants the power to enter, compete and exit from markets, and restrains participants from abuse of such power. Market participants are compelled to follow the rules.

  "Whereas the markets of capitalism are typically described as 'free markets,' the freedoms of economic actors in those markets are always conditioned upon their obedience to a set of laws and regulations." (emphasis in original)

Aside from nations suffering from the oil or other natural resources curse, it is from a prosperous market economy that governments draw their revenues and derive their power - political, economic, diplomatic and military.

Human political agency was involved "in the design of economic institutions to pursue societal objectives, actively directing the markets towards their desired equilibria."

  The state, in turn, has a powerful interest in the efficient functioning of its markets. Aside from nations suffering from the oil or other natural resources curse, it is from a prosperous market economy that governments draw their revenues and derive their power - political, economic, diplomatic and military. Historically, during times of military threat, free market nations like Great Britain and the Netherlands actively mobilized their economic resources for use in their conflicts. Even mercantilist policies could be justified as a means of mobilizing economic power for state purposes.
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  Wise or not, purposes other than consumer welfare were reflected in economic policy. Human political agency was involved "in the design of economic institutions to pursue societal objectives, actively directing the markets towards their desired equilibria."

  Like waves in the ocean, markets always seek their equilibrium levels but can never remain there due to the constant influence of economic and political winds, tides and currents.

  However, equilibrium alone is not enough. Equilibrium may be at a very low point due to distortions or inefficiencies affecting the market. Scott mentions the Great Depression and also the Credit Crunch with the prior expansion of the housing and mortgage debt bubbles. During the Credit Crunch, the markets struggled to maintain and regain equilibrium in supply and demand against major distorting influences. (See, "Moral Hazard and Conflicts of Interest in the Credit Crunch.")

  "But the invisible hand could not judge the adequacy of the design of the market frameworks in which transactions between [market participants] took place and, as is now clear, many and perhaps most of the economic actors and regulators proved equally inept at judging the adequacy of the system. Many were even arguably unwilling to engage in such judgment, believing instead that any outcome of a so-called free market system would be acceptable if not ideal. To ignore the fundamental import of the regulatory role of a political authority in such circumstances is to substitute ideology for analysis and to invite chaos, as the results of their inaction now demonstrates."

Political economy:

  Capitalism thus must be analyzed as a mix of sociology, administration, politics, economics and law.
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"The essential institutions of capitalism cannot develop along with the needs of society absent the informed and capable input of human agents, such as those empowered through a government."

Economic analysts thus have no choice but to cover the mix of political influences when analyzing market conditions. Political authorities must be held accountable for policies that adversely impact the markets.

  Capitalism must be viewed as including the "political level" where human agency impacts markets. Economic development is dependent on responsible governance as much as on free domestic and international markets.

  "[Capitalism is] a system of governance that requires first, the articulation of political vision to guide [and] design market frameworks that will work toward achievement of societal goals and, second, the mobilization of political power to implement those frameworks so as to shape the markets, to monitor the actions of human agents who ensure that the competitors follow the rules, and, crucially, to modify these institutional frameworks as needed to ensure that the markets yield results that are considered to be broadly in the interests of society. No invisible hand can create the frameworks in the first place, nor monitor them, nor - - - design and implement modifications to correct their unwanted side effects. The essential institutions of capitalism cannot develop along with the needs of society absent the informed and capable input of human agents, such as those empowered through a government."

  The political role may appear static in the short run. As the system operates according to its existing rules and regulations, government is involved only in an administrative capacity. However, government is not just a "given" factor. As time passes, changing conditions in the markets and changing societal objectives require adjustments to the laws and regulations that only political authority can provide. Thus, political markets are just as dynamic and vital as economic markets in understanding capitalism.
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  Political markets require the foresight to understand what is needed and the "entrepreneurial" political skills to mobilize the political power to effect the desired changes. This steps beyond the political role envisioned by Adam Smith, which extended to just "peace, easy taxation and a tolerable administration of justice." Changing market conditions and changing societal objectives are not accommodated by Smith's vision. Externalities, variances in power relationships, and the interests of an underclass will not be adequately addressed by market mechanisms. Patent laws and food and drug regulations are dependent on the political and institutional spheres and are essential facilitators of economic markets.
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  It is governance that shapes economic as well as political competition.

  "Life in capitalist democracies is shaped by two systems of governance: democracy and capitalism. These two systems influence each other and can be made to serve the public interest if their potential is understood and adapted accordingly and effectively. If society is to be democratic, this adaptation should be controlled through the political process, by the visible hand of government."

  Indeed, it is the political institutional framework that creates the capitalist markets, Scott emphasizes. Capitalist markets can facilitate the building of individual wealth and the economic power of the nation. Without their institutional framework and political governance, however, markets can be nothing more than town marketplaces or Middle East bazaars that facilitate little more than subsistence living.
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  Economic actors - whether individuals or firms - are not "free" actors in "free enterprise." They are free to act only "within the limits established by that system." The freedom of firms is "conditional upon a grant of authority from a political entity, typically a state." Thus, they in turn strive - with considerable but not invariable success - to influence the authority that the state exercises over their activities. The author's focus in this book is "less on how firms exercise their powers so as to grow and develop as profit-making entities than on how firms and political authorities interact with each other in the two systems of governance."
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  Scott is not naïve about the capabilities of the political decision making process. He recognizes that government policies can undermine the markets, and frequently have. Poor governance will undermine any economic policy. Loose credit and low interest rate policies played a significant role in the housing and mortgage bubbles of the Credit Crunch, and it was an obvious political mistake to leave it to the markets to deal with the results.  Economic analysts thus have no choice but to cover the mix of political influences when analyzing market conditions. Political authorities must be held accountable for policies that adversely impact the markets.
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Economic and political history:

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There was political consolidation and almost continuous warfare but, thanks to British balance of power policy, there was never a total takeover within Europe. There was thus a continuous intensely competitive environment.

Limited monarchy meant not modern democracy but the political empowerment of various elites. However, it was enough to permit the development of capitalist markets.

  Capitalism began to develop long before the industrial revolution. Its origins lie in the evolution of its systems of governance - political, economic and societal - the substance of political economy. Scott emphasizes that capitalism "is an emergent system of governance," "a human construct and not a natural system." He divides his analysis roughly into three parts covering the pertinent economic, administrative and political developments, knit together for his study of political economy.
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  Over a period of about four centuries, trade, travel and learning revived and nation-states replaced feudalism. There was political consolidation and almost continuous warfare but, thanks to British balance of power policy, there was never a total takeover within Europe. There was thus a continuous intensely competitive environment among European states.

  "The effect was to maintain pressure on all political entities to innovate, and thus stimulate social, political and economic change, in order to avoid hostile takeover."

  The winning strategy included the granting of extensive economic freedom so "private actors" could generate wealth through capitalist markets. Instead of direct control, it involved "indirect control" by regulation of economic market frameworks. Rules were enforceable by guilds or public officials and ultimately by courts. Ultimately, rule of law was extended to cover even the agents of the Crown. Limited monarchy meant not modern democracy but the political empowerment of various elites. However, it was enough to permit the development of capitalist markets.

  "In each case, it took regicide if not revolution to make this all-important transition to accountable governance. Even so, accountability was achieved only gradually, initially to an aristocracy and then, over a century or more, to a more broadly based electorate."

With oligarchy, there can be limited monarchy, council governance with the power of the purse, rule of law, incentives to facilitate commerce, and other factors of a capitalist system

The "visible hand" within governmental and private institutions was vital in the continuous modernization of the regulatory framework.

  It is thus oligarchy that is most compatible with capitalist development, as proven by about 1000 years of experience in Venice prior to 1800. With oligarchy, there can be limited monarchy, council governance with the power of the purse, rule of law, incentives to facilitate commerce, and other factors of a capitalist system. The view that it was inevitable is both simplistic and untenable. It "required institutional innovation that would disrupt the status quo and take power from vested interests." As capitalism builds and spreads wealth, the shift from oligarchy is also neither automatic nor inevitable. Strong broader political accountability came late in this process. Democracy may be favored by the spread of wealth, but it is the work of the "visible hand" of political actors in legislative bodies. These "are the political choices of political economy."
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  History clearly reveals that capitalism is more than just market pricing mechanisms for goods and services. Capitalist markets released human energies, but always in a regulated context. The "visible hand" within governmental and private institutions was vital in the continuous modernization of the regulatory framework.
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Cities could provide the ingredients for the generation of wealth, but capitalism is what actually generated it.

Much of this competition between political entities was unique to Europe.

  Early forms of European capitalism developed in city states like Venice, Florence and Genoa on Mediterranean trade routes or on river trade routes in central Europe far enough away from Spain or France, the dominant powers of that time, to enjoy some temporary period of autonomy. Capitalist elements that developed at that time included factor markets for manufactures, land and labor, double entry bookkeeping, bills of exchange, formal legal systems for disputes resolution, and various political authorities. Insurance for commercial ventures was developed in Genoa in the 14th century. Various forms of banking and the enforcement of contracts and property rights were also features of these early capitalist systems.
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  These cities provided freedom for merchants and entrepreneurs and invested in infrastructure and institutions. However, except for Venice, city government failed to develop a "monopoly of power." Cities could not maintain their independent status against internal coups, neighbors and the more powerful nation-states that developed around them. There were larger cities in China, India and the Ottoman Empire, but these were primarily political capitals that absorbed wealth instead of generating wealth. Cities could provide the ingredients for the generation of wealth, but capitalism is what actually generated it.
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  In the background were the opening of trade routes through Europe and to the Far East, the Renaissance, the Reformation and then the Enlightenment. There was also a European geographical and political environment that blocked the establishment of any dominant empire and fostered intense military and economic competition among European political entities. Soon, sovereigns were incurring major debts to finance themselves and their wars. Much of this competition between political entities was unique to Europe.
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  The development of the Atlantic trade routes radically changed this picture. Long trade routes required capital and the spreading of risk. European inheritance laws permitted the concentration of family wealth, and the development of the joint stock company in the 16th century overcame the limitations of partnership organization. Capital markets based on bank credit and state credit were developed. Interest rates for prime credit risks were already in sharp decline before this period, so credit availability played a major role in capitalist development.
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  Weaknesses of the city states include small scale, periodically unstable government, less secure political grip on power, and thus limited scope for further institutional development. Governance was a mixture of often informal legal arrangements and privately enforced customs. The expanding powers of Habsburg Spain, France and the Papacy, and later Prussia, gobbled up most of these cities.
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  Capitalist development thus shifted to the major cities of European states. These political capitals were different from the major imperial capitals of Asia. 

  "[They] were not merely a seat of power where an elite resided while exploiting its hinterland. For that European state to provide appropriate frameworks as technologies and societal priorities changed, it had to have both the power to govern and bring about change as well as the accountability to bring changes that continually related individual costs and benefits with those of society as a whole."

"Stable political governance providing market frameworks as modified by political authorities which were accountable to a rule of law" was a European political economy phenomenon.

Wars, revolutions and executions of sovereigns were part of the process. It took centuries, but the Reformation loosened the suffocating grip of the Church. The Enlightenment freed reason from ideological fetters.

  European states were responsible for providing market frameworks based upon a rule of law in return for taxes and loyalty. "Stable political governance providing market frameworks as modified by political authorities which were accountable to a rule of law" was a European political economy phenomenon.

  "[Capitalist] systems required the presence of a strong political authority to protect them from foreign takeover as well as to provide the political power for continuing domestic modernization. Any such concentration of power risked creation of a tyranny and the unleashing of arbitrary behavior that would inhibit economic development. Capitalism has been rooted in political economy since its origins, not in economics alone."

  Change in different places in different times undermined rigid feudal arrangements. However, change came through political decisions rather than impersonal market forces. These were not smooth impersonal processes of economic growth. Wars, revolutions and executions of sovereigns were part of the process. It took centuries, but the Reformation loosened the suffocating grip of the Church. The Enlightenment freed reason from ideological fetters. The rise of the nation state provided a single source for law and political authority. Clergy and nobility were disenfranchised in different ways and times in different nations. This opened the way for a broadening of political participation by the public and the establishment of modern professional administrative departments. Scott reviews the many different paths that this process followed in different nations and regions.
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The new ingredient was the acceptance of the notion that there should be a return on investment - a return on capital as well as labor - something religious authorities had frowned upon.

Rule of law and central banks in Venice, Netherlands and England provided credibility and a significant financial advantage for those states. Borrowing costs were about 1/3 that of the absolute monarchies in France and Spain.

It is governance that is the key to capitalist development, and as it turns out, capitalism is key to political modernization.

  The process was driven by competition between political entities and the realization that economic strength was the basis of military strength and the major source of funds for the ruling elites. The new ingredient was the acceptance of the notion that there should be a return on investment - a return on capital as well as labor - something religious authorities had frowned upon.
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  The author reviews the political history of Europe as states coalesced, fought numerous wars, but failed to form a dominant empire. They thus continued to compete with each other in ways beneficial to economic, societal and political development. Rule of law and central banks in Venice, Netherlands and England provided credibility and a significant financial advantage for those states. Borrowing costs were about 1/3 that of the absolute monarchies in France and Spain.
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  Britain, France, the Dutch Republic and Venice were the first "nation states" to develop broad popular acceptance of a "national interest." In various ways, rulers became accountable to a broadening circle of elites that could provide the funds needed for wars and administration, and that could engage in the commerce that generated wealth. Mercantilist strategies were used. Tariffs provided both funds for government and advantages for the politically influential.

  "Absent the hegemony of a single church or state, technology was diffused and secularized throughout Europe. - - - [Political] competition among states within Europe was a stimulus for continuing modernization, as it would be within the United States."

  Spain suffered the curse of natural resource wealth. It failed to develop politically or commercially, and declined with the decline of its American mines. Inflation and three bankruptcies in the 16th century undermined its great power status. Portugal similarly failed to modernize.

   "The state does not exist apart from its institutions and the agents who administer those institutions on its behalf. Seventeenth-century Portugal's law enforcement was stymied by the Inquisition supported by a rural aristocracy, much as Italian law enforcement in the Mezzogiorno since the early 19th century has been thwarted by the Mafia, supported by a patron-client culture."

  Outside Europe, wealthy, powerful empires stagnated and declined. "It was in the East that rulers were truly rich and their subjects miserably poor." Scott reviews the suffocating governance characteristics of India, Turkey, China, Japan, that persisted for centuries in the absence of political competition from external threats. Again, it is governance that is the key to capitalist development, and as it turns out, capitalism is key to political modernization.
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Disruptions of political arrangements due to changing conditions must be dealt with by the "visible hand" of political actors in competitive political markets and legislative markets. Political action is also required to facilitate economic development through appropriate infrastructure and institutional development.

Success required that those with political power relinquish some of it for the benefit of private actors who would put mostly private capital at risk and pay taxes for the privilege of trying and succeeding."

  Capitalism involves a constant process of change typically involving urbanization, industrialization, the development of services and financial sectors, the development of an educated civil society, and accelerated technological change. The resulting disruptions of political arrangements must be dealt with by the "visible hand" of political actors in competitive political markets and legislative markets. Political action is also required to facilitate economic development through appropriate infrastructure and institutional development.

  "In other words, government must be a successful entrepreneur in the modernization of the institutional context if the private sector and society itself are to have the opportunities for development that they deserve."

  Both government and private efforts can involve massive and costly mistakes. "But historically speaking, political actors have been key; success required that those with political power relinquish some of it for the benefit of private actors who would put mostly private capital at risk and pay taxes for the privilege of trying and succeeding."

    "To both emerge and then thrive over time, capitalism requires, first and foremost, political action to effect societal and consequently economic change; specifically, it requires government to provide the requisite institutional and physical infrastructure to support a capitalist economy, to guarantee sufficient freedoms and protections to economic actors, and to respect the rule of law, accepting accountability for all of the above."

  The roots of capitalism in the North American colonies can be traced to just before 1630 when Plymouth colonists reacted to the failures of communal farming by privatizing the land. This created private property wealth, with "stunning" agricultural success.
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  Scott emphasizes the role of the relatively egalitarian economy in the development of the political and economic institutions of the northern colonies. He goes into considerable detail about the economic and political development of the U.S. up to 1830, emphasizing the importance of property rights and civil liberties, including religious freedom, trial by jury, habeas corpus, representative government and public education. Charters were granted for limited liability corporations in the early 1800s.
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The egalitarian pattern of development is viewed by the author as a key element in this success.

Market liberalization by itself could not overcome privileged elite obstruction of economic and political development in the south. Thus, the southern states failed to prosper despite favorable factor endowments until reform was forced by federal government political and legal intervention.

In the south of Italy and in many Latin American states, market forces alone still cannot produce economic development. The elements of political economy are essential for understanding these developments.

  With limited factor endowments, the northern colonies offered no easy route to great wealth. Thus, state resources were dependent on the development of a prosperous populace. Governance was thus naturally directed towards the facilitation of the people's commerce. Investments in human resources and effective institutions ultimately proved more valuable than the gold and silver mines and the great plantations worked by forced labor.
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  The initial success of  predominantly market-driven economic governance in the 1630-1830 period was attributable to "local government and local firms in small, mostly local markets, a combination that would be rent asunder by the Industrial Revolution." The egalitarian pattern of development is viewed by the author as a key element in this success.

  "This egalitarian pattern of wealth distribution in turn permitted, encouraged, and benefited from the creation of institutions to provide public services such as education, law enforcement, and physical infrastructure for the bulk of the population. These institutional differences would ultimately provide the basis for northern incomes to surpass those of the more richly endowed south. They would also permit a poorly endowed New England to surpass the much more richly endowed areas of the Caribbean and elsewhere in Latin America."

  Market liberalization by itself could not overcome the privileged elites who obstructed economic and political development in the south. Thus, the southern states failed to prosper despite favorable factor endowments until reform was forced by federal government political and legal intervention. Cultural change in the north was a vital factor in ending segregation and providing political support for federal government civil rights enforcement in the south. In the south of Italy and in many Latin American states, market forces alone still cannot produce economic development. The elements of political economy are essential for understanding the economic failures.
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  Governance structures that worked so well for an initial "atomistic" economy would prove increasingly inadequate after the 1830s for a nationwide market increasingly stitched together by canals, railroads and steamboats, and then by steam powered factories. The industrial revolution was eagerly embraced by a free, entrepreneurial people in the northern U.S. while being inhibited by the "anti-development" institutions of the southern states and Latin America. "[A] lack of strong comparative advantages was itself a powerful advantage in that it required the population to learn how to govern and develop itself."
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The political markets of pseudo-democracy in Jamaica were more like the authoritarianism of feudalism around them than they were like the British model back home or indeed in North America. If there is a chance for a few to seize power to exploit the many, it is an almost irresistible temptation."

  French North America concentrated on exploiting the fur trade along the great waterways extending from the St. Lawrence to the Mississippi river. The author points out that property was communal and so no capitalist wealth developed even in the French settlements along the St. Lawrence. Governance was feudal and monarchic in the settlements and tribal elsewhere amongst the Indian tribes.
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  Scott emphasizes the example of English rule in Jamaica.

  "Markets and international trade do not trump dysfunctional institutions designed to permit elites to exploit their poorer neighbors. Stated more boldly, the political markets of pseudo-democracy in Jamaica were more like the authoritarianism of feudalism around them than they were like the British model back home or indeed in North America. If there is a chance for a few to seize power to exploit the many, it is an almost irresistible temptation."

Large initial land grants were made in both Argentina and Pennsylvania. All land was kept in centralized control in Argentina and doled out to favored elites. In Pennsylvania, the offer of egalitarian opportunities resulted in rapid economic development.

  Patron-client relationships played major roles in hindering economic development in Italian and U.S. southern regions. There were a variety of political weaknesses. Only the mobilization of political power can overcome entrenched privileged elites. Notoriously, for southern Italy, the picture includes exploitative patron-client social systems like the Mafia. The author provides some historic perspective.
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  In Italy, the state simply does not have a monopoly of coercive force. It cannot protect persons and property and adjudicate disputes in many of its southern provinces. Economic assistance from outside sources simply disappears without result into a black hole of corruption and ineptness.

  "[An] artificially high wage structure, subsidized state-owned enterprises, excess government employment, and generous transfer payments all contributed to a culture of dependency, limiting incentives for those in the Mezzogiorno to take advantage of Northern growth and dynamism."

  In the southern states of the U.S., the explanation for an economic trajectory that differs from that in the northern states both before and after the Civil War, and the failure of convergence until 1940, is to be found in the factors of political economy - social, institutional and political - rather than in economic factors alone. After the Civil War, plantation landholdings remained in the hands of white elites. The system of sharecropping functioned in a manner similar to the patron-client systems in southern Italy. Sharecroppers were economically dependent on the owners of the lands they worked because of the limited scope for black labor mobility until WW-I. Antebellum values tilted the economic markets in ways that favored the elites and prevented the economic convergence that could be expected under economic theory.  Scott goes into considerable detail on this point. 

  "As in the case of the Mezzogiorno, the lesson is that liberalization, by itself, will not necessarily unify markets or equalize factor incomes; nor will economic growth necessarily result in broadly shared societal gains. Economic inequalities, and the political arrangements that underpin them, need to be taken into account."

  The overall theory favored by the author again depends on factor endowment - an agricultural version of the "natural resources curse."

  "[Rich] factor endowments were an attractive target for capture and exploitation, typically by some form of forced labor, which could be achieved either by oppressing a weak and disorganized native population or by importing slaves. Then, once established, a rich elite had strong incentives to entrench and extend the distorted institutions that benefited the few at the expense of the many."

  Public goods such as law enforcement, education and infrastructure were typical casualties of all of these systems. The exceptions included Argentina, Chile, Uruguay and southern Brazil, where the factor endowments were similar to those in the northern colonies. However, these regions still wound up with vastly unequal land holdings and wealth and the political and social institutions typical of such conditions. Governance was centralized from the beginning so land holdings and wealth were concentrated in elite hands in the Iberian style.

  "[Rich] concentrated factor endowments were not necessary for the emergence of the oligarchic model; an Iberian heritage, or even French, in lower Canada, would lead towards this path, and thus depart from the British model in the U.S. North."

  Large initial land grants were made in both Argentina and Pennsylvania. All land was kept in centralized control in Argentina and doled out to favored elites. In Pennsylvania, the offer of egalitarian opportunities resulted in rapid economic development.
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Economic strategies:

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  The Northwest Ordinance just before the Constitutional Convention extended the preference for small landholdings into the frontier regions. It abolished primogeniture and entails and provided land surveys and boundary markers that facilitated private property rights in fee simple. It reserved lands to support public education.

  "State and local governments were thus endowed with incomes based on public property. They were not dependent on higher levels of government for their funds as in South America, and these differences have endured to the present time."

  The Constitution displays the "visible hand" of political decisions affecting the economy in many ways. It established judicial supremacy and state power in the economic realm over intrastate commerce. The courts became instruments of economic development by interpreting the laws to favor producers over consumers. "Markets still reached equilibrium, but playing fields were tilted toward producers almost from independence ."
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"Institutional innovations were initiated through the ad hoc decisions of legislatures, regulators, and courts of a governance system that had little capacity to coordinate among the various levels and subsystems of government. Indeed, competition among states to attract business investment undermined standards of public accountability for private actors."

  Scott sums up:

  "The changes in U.S. capitalist institutions reflected the often uncoordinated initiatives of states in responding to extraordinary development opportunities and evolving societal priorities as well as the new technologies in a context where there was a continuing mistrust of the role of federal power. Americans, hurrying to settle and develop their lightly populated country, turned to the private sector because it promised more rapid action than government entities; in addition they had continuing reservations about the role of state power in the economy. U.S. acceptance of a predominant role for the private sector rendered it quite distinct from any European or South American variety of capitalism in the same period. Institutional innovations were initiated through the ad hoc decisions of legislatures, regulators, and courts of a governance system that had little capacity to coordinate among the various levels and subsystems of government. Indeed, competition among states to attract business investment undermined standards of public accountability for private actors."

  This all changed in 1936 when Franklin D. Roosevelt appointed two new Supreme Court justices who were more accepting of legislative powers, especially at the federal level. Congress would thereafter be the "deciding voice in the U.S. capitalist framework."
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  Scott, "Capitalism: Origins and Evolution as a System of Governance," addresses a variety of modern political economy issues. See, Part II, "Oligarchs and Stakeholders and other Issues of Political Economy."  These issues include:

1. Market disciplinary mechanisms and administered alternatives;

2. Financial oligarchs;

3. Constitutional constraints on federal economic policy;

4. Stakeholder capitalism;

5. Tilting the markets;

6. Industrial policy;

7. Abuse of the economic commons;

8. Government enterprises;

9. Political market competition.

  As might be expected, the author and FUTURECASTS have some agreements and some disagreements on these issues.  FUTURECASTS readers are encouraged to add their input. E-mail comments to blat1@futurecasts.com.