‘Mrs	Lintott:	Now.	How	do	you	define	history,	Mr	Rudge?
Rudge:	Can	I	speak	freely,	Miss?	Without	being	hit?
Mrs	Lintott:	I	will	protect	you.
Rudge:	How	do	I	define	history?	It’s	just	one	fucking	thing	after	another.’
ALAN	BENNETT,	THE	HISTORY	BOYS
One	Fucking	Thing	after	Another:	What	Use	Is	History?
Many	readers	probably	feel	the	same	way	about	history	as	young	Rudge	in	The	History	Boys	–	Alan
Bennett’s	hit	play	and	2006	film	about	a	bunch	of	bright	but	underprivileged	Sheffield	boys	trying	to	gain
admission	to	Oxford	to	study	history.
Many	people	consider	economic	history,	or	the	history	of	how	our	economies	have	evolved,
especially	pointless.	Do	we	really	need	to	know	what	happened	two,	three	centuries	ago	in	order	to	know
that	free	trade	promotes	economic	growth,	that	high	taxes	discourage	wealth	creation	or	that	cutting	red
tape	encourages	business	activities?	Aren’t	these	and	other	economic	wisdoms	of	our	time	all
propositions	derived	from	logically	airtight	theories	and	checked	against	a	vast	amount	of	contemporary
statistical	evidence?
The	majority	of	economists	agree.	Economic	history	used	to	be	a	compulsory	subject	in	graduate
economics	training	in	most	American	universities	until	the	1980s,	but	many	of	them	don’t	even	offer
courses	in	economic	history	any	more.	Among	the	more	theoretically	oriented	economists,	there	is	even	a
tendency	to	consider	economic	history	at	best	as	a	harmless	distraction,	like	trainspotting,	and	at	worst	as
a	refuge	for	the	intellectually	challenged	who	cannot	handle	‘hard’	stuff	like	mathematics	and	statistics.
However,	I	present	my	readers	with	a	brief	(well,	not	so	brief)	history	of	capitalism	because	having
some	knowledge	of	that	history	is	vital	to	fully	understanding	contemporary	economic	phenomena.
Life	is	stranger	than	fiction:	why	history	matters
History	affects	the	present	–	not	simply	because	it	is	what	came	before	the	present	but	also	because	it
(or,	rather,	what	people	think	they	know	about	it)	informs	people’s	decisions.	A	lot	of	policy
recommendations	are	backed	up	by	historical	examples	because	nothing	is	as	effective	as	spectacular
real-life	cases	–	successful	or	otherwise	–	in	persuading	people.	For	example,	those	who	promote	free
trade	always	point	out	that	Britain	and	then	the	US	became	the	world’s	economic	superpowers	through
free	trade.	If	they	realized	that	their	version	of	history	is	incorrect	(as	I	will	show	below),	they	might	not
have	such	conviction	in	their	policy	recommendations.	They	would	also	find	it	harder	to	persuade	others.
History	also	forces	us	to	question	some	assumptions	that	are	taken	for	granted.	Once	you	know	that	lots
of	things	that	cannot	be	bought	and	sold	today	–	human	beings	(slaves),	child	labour,	government	offices	–
used	to	be	perfectly	marketable,	you	will	stop	thinking	that	the	boundary	of	the	‘free	market’	is	drawn	by
some	timeless	law	of	science	and	begin	to	see	that	it	can	be	redrawn.	When	you	learn	that	the	advanced
capitalist	economies	grew	the	fastest	in	history	between	the	1950s	and	the	1970s,	when	there	were	a	lot
of	regulations	and	high	taxes,	you	will	immediately	become	sceptical	of	the	view	that	promoting	growth
requires	cuts	in	taxes	and	red	tape.
History	is	useful	in	highlighting	the	limits	of	economic	theory.	Life	is	often	stranger	than	fiction,	and
history	provides	many	successful	economic	experiences	(at	all	levels	–	nations,	companies,	individuals)
that	cannot	be	tidily	explained	by	any	single	economic	theory.	For	example,	if	you	only	read	things	like
The	Economist	or	the	Wall	Street	Journal,	you	would	only	hear	about	Singapore’s	free	trade	policy	and
its	welcoming	attitudes	towards	foreign	investment.	This	may	make	you	conclude	that	Singapore’s
economic	success	proves	that	free	trade	and	the	free	market	are	the	best	for	economic	development	–	until
you	also	learn	that	almost	all	the	land	in	Singapore	is	owned	by	the	government,	85	per	cent	of	housing	is
supplied	by	the	government-owned	housing	agency	(the	Housing	Development	Board)	and	22	per	cent	of
national	output	is	produced	by	state-owned	enterprises	(the	international	average	is	around	10	per	cent).
There	is	no	single	type	of	economic	theory	–	Neoclassical,	Marxist,	Keynesian,	you	name	it	–	that	can
explain	the	success	of	this	combination	of	free	market	and	socialism.	Examples	like	this	should	make	you
both	more	sceptical	about	the	power	of	economic	theory	and	more	cautious	in	drawing	policy	conclusions
from	it.
Last	but	not	least,	we	need	to	look	at	history	because	we	have	the	moral	duty	to	avoid	‘live
experiments’	with	people	as	much	as	possible.	From	the	central	planning	in	the	former	socialist	bloc	(and
their	‘Big	Bang’	transition	back	to	capitalism),	through	to	the	disasters	of	‘austerity’	policies	in	most
European	countries	following	the	Great	Depression,	down	to	the	failures	of	‘trickle-down	economics’	in
the	US	and	the	UK	during	the	1980s	and	the	1990s,	history	is	littered	with	radical	policy	experiments	that
have	destroyed	the	lives	of	millions,	or	even	tens	of	millions,	of	people.	Studying	history	won’t	allow	us
to	completely	avoid	mistakes	in	the	present,	but	we	should	do	our	best	to	extract	lessons	from	history
before	we	formulate	a	policy	that	will	affect	lives.
If	you	have	been	persuaded	by	any	of	the	above	points,	please	read	through	the	rest	of	the	chapter,	in
which	a	lot	of	the	historical	‘facts’	that	you	thought	you	knew	may	be	challenged	and	thus	the	way	you
understand	capitalism	hopefully	transformed	at	least	a	little	bit.
Tortoise	vs.	Snails:	the	World	Economy	before	Capitalism
Western	Europe	grew	really	slowly	…
Capitalism	started	in	Western	Europe,	especially	in	Britain	and	the	Low	Countries	(what	are	Belgium
and	the	Netherlands	today)	around	the	sixteenth	and	the	seventeenth	centuries.	Why	it	started	there	–	rather
than,	say,	China	or	India,	which	had	been	comparable	to	Western	Europe	in	their	levels	of	economic
development	until	then	–	is	a	subject	of	intense	and	long-running	debate.	Everything	from	the	Chinese
elite’s	disdain	for	practical	pursuits	(like	commerce	and	industry),	the	discovery	of	the	Americas	and	the
pattern	of	Britain’s	coal	deposits	has	been	identified	as	the	explanation.	This	debate	need	not	detain	us
here.	The	fact	is	that	capitalism	developed	first	in	Western	Europe.
Before	the	rise	of	capitalism,	the	Western	European	societies,	like	all	the	other	pre-capitalist	societies,
changed	very	slowly.	The	society	was	basically	organized	around	farming,	which	used	virtually	the	same
technologies	for	centuries,	with	a	limited	degree	of	commerce	and	handicraft	industries.
Between	1000	and	1500,	the	medieval	era,	income	per	capita,	namely,	income	per	person,	in	Western
Europe	grew	at	0.12	per	cent	per	year.1	This	means	that	income	in	1500	was	only	82	per	cent	higher	than
that	in	1000.	To	put	it	into	perspective,	this	is	a	growth	that	China,	growing	at	11	per	cent	a	year,
experienced	in	just	six	years	between	2002	and	2008.	This	means	that,	in	terms	of	material	progress,	one
year	in	China	today	is	equivalent	to	eighty-three	years	in	medieval	Western	Europe	(which	were
equivalent	to	three-and-a-half	medieval	lifetimes,	as	the	average	life	expectancy	at	the	time	was	only
twenty-four	years).
…	but	its	growth	was	still	faster	than	elsewhere	in	the	world
Having	said	all	this,	growth	in	Western	Europe	was	still	a	sprint	compared	to	those	in	Asia	and	Eastern
Europe	(including	Russia),	which	are	estimated	to	have	grown	at	one-third	the	rate	(0.04	per	cent).	This
means	that	their	incomes	were	only	22	per	cent	higher	after	half	a	millennium.	Western	Europe	may	have
been	moving	like	a	tortoise,	but	other	parts	of	the	world	were	like	snails.
The	Dawn	of	Capitalism:	1500–1820
Capitalism	is	born	–	in	slow	motion
In	the	sixteenth	century,	capitalism	was	born.	But	its	birth	was	so	slow	that	we	cannot	easily	detect	it
from	the	numbers.	During	1500–1820,	the	growth	rate	of	per	capita	income	in	Western	Europe	was	still
only	0.14	per	cent	–	basically	the	same	to	all	intents	and	purposes	as	the	one	for	1000–1500	(0.12	per
cent).
In	Britain	and	the	Netherlands,	there	was	visible	growth	acceleration	by	the	late	eighteenth	century,
especially	in	sectors	such	as	cotton	textiles	and	iron.2	As	a	result,	during	1500–1820,	Britain	and	the
Netherlands	achieved	per	capita	economic	growth	rates	of	0.27	per	cent	and	0.28	per	cent	per	year,
respectively.	These	are	very	low	by	modern	standards,	but	they	were	still	double	the	Western	European
average.	Behind	this	lay	a	number	of	changes.
Emergence	of	new	sciences,	technologies	and	institutions
First	came	the	cultural	shift	towards	more	‘rational’	approaches	to	understanding	the	world,	which
promoted	the	rise	of	modern	mathematics	and	sciences.	Many	of	these	ideas	were	initially	borrowed	from
the	Arab	world	and	Asia,3	but	in	the	sixteenth	and	seventeenth	centuries,	the	Western	Europeans	started
adding	their	own	innovations.	The	founding	fathers	of	modern	science	and	mathematics	–	such	as
Copernicus,	Galileo,	Fermat,	Newton	and	Leibniz	–	are	from	this	era.	This	development	of	science	did
not	immediately	affect	the	broader	economy,	but	it	later	enabled	the	systemization	of	knowledge	that	made
technological	innovations	less	dependent	on	individuals	and	thus	more	easily	transferable,	which
encouraged	the	diffusion	of	new	technologies	and	thus	economic	growth.
The	eighteenth	century	saw	the	emergence	of	several	new	technologies	that	heralded	the	advent	of	a
mechanized	production	system,	especially	in	textiles,	steel-making	and	chemicals.*	As	in	Adam	Smith’s
pin	factory,	a	finer	division	of	labour	was	developing,	with	the	use	of	continuous	assembly	lines
spreading	from	the	early	nineteenth	century.	In	the	emergence	of	these	new	production	technologies,	a	key
driver	was	the	desire	to	increase	output	in	order	to	be	able	to	sell	more	and	thus	make	more	profit	–	in
other	words,	the	spread	of	the	capitalist	mode	of	production.	As	Smith	argued	in	his	theory	of	division	of
labour,	the	increase	in	output	made	a	finer	division	of	labour	possible,	which	then	increased	productivity
and	consequently	output,	setting	off	a	‘virtuous	cycle’	between	output	growth	and	productivity	growth.
New	economic	institutions	emerged	to	accommodate	the	new	realities	of	capitalist	production.	With	the
spread	of	market	transactions,	banks	evolved	to	facilitate	them.	Emergence	of	investment	projects
requiring	capital	beyond	the	wealth	of	even	the	richest	individuals	prompted	the	invention	of	the
corporation,	or	limited	liability	company,	and	thus	the	stock	market.
Colonial	expansion	starts
The	Western	European	countries	started	to	expand	rapidly	outwards	from	the	early	fifteenth	century.
Euphemistically	known	as	the	‘Age	of	Discovery’,	this	expansion	involved	expropriating	land,	resources
and	people	for	labour	from	the	native	populations	through	colonialism.
Beginning	with	Portugal	in	Asia	and	Spain	in	the	Americas	from	the	late	fifteenth	century,	the	Western
European	nations	ruthlessly	moved	out.	By	the	middle	of	the	eighteenth	century,	North	America	was
divided	up	between	Britain,	France	and	Spain.	Most	Latin	American	countries	were	ruled	by	Spain	and
Portugal	until	the	1810s	and	the	1820s.	Parts	of	India	were	ruled	by	the	British	(mainly	Bengal	and
Bihar),	the	French	(the	south-eastern	coast)	and	the	Portuguese	(various	coastal	areas,	especially	Goa).
Australia	was	beginning	to	be	settled	around	this	time	(the	first	penal	colony	was	established	in	1788).
Not	much	of	Africa	was	affected	yet,	with	small	colonies	along	the	coasts	settled	by	the	Portuguese	(the
formerly	uninhabited	islands	of	Cape	Verde	and	Sao	Tome	and	Principe)	and	the	Dutch	(Cape	Town	in	the
seventeenth	century).
Colonialism	was	run	on	capitalist	principles.	Symbolically,	until	1858,	British	rule	in	India	was
actually	administered	by	a	corporation	(the	East	India	Company),	not	by	the	government.	These	colonies
brought	new	resources	to	Europe.	The	early	expansions	were	motivated	by	the	quest	for	precious	metals
to	use	as	money	(gold	and	silver)	and	spices	(especially	black	pepper).	Over	time,	plantations	using
slaves,	mostly	captives	from	Africa,	were	established	in	the	new	colonies	–	especially	the	US,	Brazil	and
the	Caribbean	–	to	grow	and	bring	back	to	Europe	new	crops	such	as	(cane)	sugar,	rubber,	cotton	and
tobacco.	Some	of	the	New	World	crops	were	grown	in	Europe	and	beyond	and	became	basic	food	items.
It	stretches	the	imagination	to	think	of	the	days	when	the	British	did	not	have	their	chips,	the	Italians
lacked	tomatoes	and	polenta	(made	with	maize,	or	sweetcorn)	and	the	Indians,	the	Thais	and	the	Koreans
did	not	eat	any	chillies.
Colonialism	leaves	big	scars
There	is	a	long-running	debate	on	whether	capitalism	could	have	developed	without	the	colonial
resources	of	the	sixteenth–eighteenth	centuries	–	precious	metal	to	be	used	as	money,	extra	food	sources
such	as	potato	and	sugar	and	industrial	inputs	such	as	cotton.4	While	there	is	no	question	that	the
colonizers	greatly	benefited	from	those	resources,	those	countries	would	probably	have	developed
capitalism	even	without	them.	There	is	no	question,	however,	that	colonialism	devastated	colonized
societies.
Native	populations	were	exterminated	or	driven	on	to	the	margins.	Their	land,	and	the	resources	over
and	under	it,	were	taken	away.	Marginalization	of	the	indigenous	population	has	been	so	extensive	that
Evo	Morales,	the	current	president	of	Bolivia,	elected	in	2006,	is	only	the	second	head	of	state	from	the
indigenous	population	in	the	Americas	since	the	Europeans	arrived	in	1492	(the	first	was	Benito	Juarez,
the	Mexican	president	between	1858	and	1872).
Millions	of	Africans	–	12	million	is	a	common	estimate	–	were	captured	and	shipped	out	as	slaves	by
both	the	Europeans	and	the	Arabs.	This	was	not	only	tragedy	for	those	who	became	slaves	(if	they
survived	the	atrocious	journey)	but	it	also	depleted	many	African	societies	of	workers	and	destroyed	their
social	fabric.	Countries	were	created	out	of	thin	air,	with	arbitrary	boundaries,	affecting	the	internal	and
the	international	politics	of	those	countries	to	this	day.	The	fact	that	so	many	borders	in	Africa	are	straight
is	a	testimony	to	that;	natural	borders	are	never	straight	because	they	are	usually	formed	along	rivers,
mountain	ranges	and	other	geographical	features.
Colonialism	often	meant	the	deliberate	destruction	of	existing	productive	activities	in	the	economically
more	advanced	regions.	Most	importantly,	in	1700,	Britain	banned	the	import	of	Indian	cotton	textiles
(‘calicoes’)	–	we	encountered	the	event	in	Chapter	2	–	in	order	to	promote	its	own	cotton	textile	industry,
dealing	a	heavy	blow	to	the	Indian	cotton	textile	industry.	The	industry	was	finished	off	in	the	mid-
nineteenth	century	by	the	influx	of	exports	from	the	then	mechanized	British	cotton	textile	industry.	As	a
colony,	India	could	not	use	tariffs	and	other	policy	measures	to	protect	its	own	producers	against	British
imports.	In	1835,	Lord	Bentinck,	the	Governor-General	of	the	East	India	Company,	famously	reported	that
‘the	bones	of	the	cotton	weavers	are	bleaching	the	plains	of	India’.5
1820–1870:	The	Industrial	Revolution
The	turbo-charged	drive:	the	Industrial	Revolution	starts
Capitalism	really	took	off	around	1820,	with	a	visible	acceleration	of	economic	growth	all	around
Western	Europe	and	then	in	the	‘Western	offshoots’	in	North	America	and	Oceania.	The	growth
acceleration	was	so	dramatic	that	the	half-century	following	1820	is	typically	referred	to	as	the	Industrial
Revolution.6
In	those	fifty	years,	per	capita	income	in	Western	Europe	grew	at	1	per	cent,	a	poor	growth	rate	these
days	(Japan	grew	at	that	rate	during	the	so-called	‘lost	decade’	of	the	1990s),	but	compared	to	the	0.14
per	cent	growth	rate	between	1500	and	1820,	it	was	a	turbo-charged	drive.
Expect	to	live	for	seventeen	years	and	work	eighty	hours	a	week:	misery	increases	for	some
This	acceleration	of	growth	in	per	capita	income,	however,	was	initially	accompanied	by	a	fall	in
living	standards	for	many.	Some	with	old	skills	–	such	as	textile	artisans	–	lost	their	jobs,	having	been
replaced	by	machines	operated	by	cheaper,	unskilled	workers,	including	many	children.	Some	machines
were	even	designed	with	the	small	sizes	of	children	in	mind.	Those	who	were	hired	to	work	in	factories,
or	in	the	small	workshops	that	supplied	inputs	for	them,	worked	long	hours	–	seventy	to	eighty	hours	per
week	was	the	norm,	and	some	worked	more	than	100	hours	a	week	with	usually	only	half	of	Sunday	free.
Working	conditions	were	extremely	hazardous.	Many	British	cotton	textile	workers	died	of	lung
diseases	from	the	dust	generated	in	the	production	process.	The	urban	working	class	lived	in	crowded
conditions,	sometimes	fifteen	to	twenty	people	in	a	room.	It	was	typical	that	hundreds	of	people	shared
one	toilet.	They	died	off	like	flies.	In	poor	areas	of	Manchester,	life	expectancy	was	seventeen	years7	–
30	per	cent	lower	than	what	it	had	been	for	the	whole	of	Britain	before	the	Norman	Conquest,	back	in
1000	(then	twenty-	four	years).
The	rise	of	anti-capitalist	movements
Given	the	misery	that	capitalism	was	creating,	it	is	no	wonder	that	various	forms	of	anti-capitalist
movements	arose.	Some	of	them	merely	tried	to	turn	the	clock	back.	The	Luddites	–	textile	artisans	of
England	who	lost	their	jobs	to	mechanized	production	in	the	1810s	–	turned	to	destroying	the	machines,
the	immediate	cause	of	their	unemployment	and	the	most	obvious	symbol	of	capitalist	progress.	Others
sought	to	build	a	better,	more	egalitarian	society	through	voluntary	associations.	Robert	Owen,	the	Welsh
businessman,	tried	to	build	a	society	based	on	communal	working	and	living	among	the	like-minded	–
rather	like	the	Israeli	kibbutz.
The	most	important	anti-capitalist	visionary	was,	however,	Karl	Marx	(1818–83),	the	German
economist	and	revolutionary,	who	spent	most	of	his	time	exiled	in	England	–	his	grave	is	in	Highgate
Cemetery	in	London.	Marx	labelled	Owen	and	others	like	him	as	‘utopian	socialists’	for	believing	that	a
post-capitalist	society	can	be	based	on	idyllic	communal	living.	Calling	his	own	approach	‘scientific
socialism’,	he	argued	that	the	new	society	should	build	on,	rather	than	reject,	the	achievements	of
capitalism.	A	socialist	society	should	abolish	private	ownership	in	the	means	of	production	but	it	should
preserve	the	large	production	units	created	by	capitalism	so	that	it	can	take	full	advantage	of	their	high
productivities.	Moreover,	Marx	proposed	that	a	socialist	society	should	be	run	like	a	capitalist	firm	in
one	important	respect	–	it	should	plan	its	economic	affairs	centrally,	in	the	same	way	in	which	a	capitalist
firm	plans	all	its	operations	centrally.	This	is	known	as	central	planning.
Marx	and	many	of	his	followers	–	including	Vladimir	Lenin,	the	leader	of	the	Russian	Revolution	–
believed	that	a	socialist	society	could	only	be	created	through	a	revolution,	led	by	workers,	given	that	the
capitalists	would	not	voluntarily	give	up	what	they	had.	However,	some	of	his	followers,	known	as	the
‘revisionists’	or	social	democrats,	such	as	Eduard	Bernstein	and	Karl	Kautsky,	thought	that	the	problems
of	capitalism	could	be	alleviated	through	the	reform,	rather	than	abolition,	of	capitalism	through
parliamentary	democracy.	They	advocated	measures	like	regulation	of	working	hours	and	working
conditions	as	well	as	the	development	of	the	welfare	state.
With	hindsight,	it	is	easy	to	see	that	those	reformists	read	the	historical	trend	the	best,	as	the	system	they
advocated	is	what	all	the	advanced	capitalist	economies	have	today.	At	the	time,	however,	it	was	not
obvious	that	workers	could	be	made	better	off	under	capitalism,	not	least	because	there	was	fierce
resistance	to	reform	from	most	capitalists.
From	around	1870,	there	were	palpable	improvements	in	the	conditions	of	the	working	class.	Wages
went	up.	At	least	in	Britain,	the	average	adult	wage	was	finally	high	enough	to	allow	the	workers	to	buy
more	than	the	bare	necessities,	and	some	workers	were	now	working	less	than	sixty	hours	a	week.	Life
expectancy	was	up	from	thirty-six	years	in	1800	to	forty-one	years	in	1860.8	At	the	end	of	this	period,
there	were	even	the	beginnings	of	the	welfare	state,	which	started	in	Germany	with	the	1871	industrial
accident	insurance	scheme,	introduced	by	Otto	von	Bismarck,	the	Chancellor	of	the	newly	united
Germany.
The	myth	of	free	market	and	free	trade:	How	capitalism	really	developed
The	advancement	of	capitalism	in	the	Western	European	countries	and	their	offshoots	in	the	nineteenth
century	is	often	attributed	to	the	spread	of	free	trade	and	free	market.	It	is	only	because	the	government
in	these	countries,	it	is	argued,	did	not	tax	or	restrict	international	trade	(free	trade)	and,	more	generally,
did	not	interfere	in	the	workings	of	the	market	(free	market)	that	these	countries	could	develop	capitalism.
Britain	and	the	US	are	said	to	have	forged	ahead	of	other	countries	because	they	were	the	first	ones	to
adopt	the	free	market	and,	especially,	free	trade.
This	could	not	be	further	from	the	truth.	The	government	played	a	leading	role	in	the	early	development
of	capitalism	both	in	Britain	and	the	US,	as	well	as	in	other	Western	European	countries.9
Britain	as	the	pioneer	of	protectionism
Starting	with	Henry	VII	(1485–1509),	the	Tudor	monarchs	promoted	the	woollen	textile	industry	–
Europe’s	then	hi-tech	industry,	led	by	the	Low	Countries,	especially	Flanders	–	through	government
intervention.	Tariffs	(taxes	on	imports)	protected	the	British	producers	from	the	superior	Low	Country
producers.	The	British	government	even	sponsored	the	poaching	of	skilled	textile	artisans,	mainly	from
Flanders,	to	gain	access	to	advanced	technologies.	British	or	American	people	with	names	like	Flanders,
Fleming	and	Flemyng	are	descendants	of	those	artisans:	without	those	policies,	there	wouldn’t	be	007
(Ian	Fleming)	or	penicillin	(Alexander	Fleming);	and	somehow	I	don’t	think	The	Simpsons	would	have
been	as	fun	as	it	is	if	Ned	Flanders	were	called	Ned	Lancashire.	These	policies	continued	after	the
Tudors,	and	by	the	eighteenth	century	woollen	textile	goods	accounted	for	around	half	of	Britain’s	export
revenue.	Without	those	export	revenues,	Britain	would	not	have	been	able	to	import	the	food	and	the	raw
materials	that	it	needed	for	the	Industrial	Revolution.
British	government	intervention	was	stepped	up	in	1721,	when	Robert	Walpole,	Britain’s	first	prime
minister,10	launched	an	ambitious	and	wide-ranging	industrial	development	programme.	It	provided	tariff
protection	and	subsidies	(especially	to	encourage	export)	to	‘strategic’	industries.	Partly	thanks	to
Walpole’s	programme,	Britain	started	to	forge	ahead	in	the	second	half	of	the	eighteenth	century.	By	the
1770s,	Britain	was	so	obviously	ahead	of	other	countries	that	Adam	Smith	saw	no	need	for	protectionism
and	other	forms	of	government	intervention	to	help	British	producers.	However,	it	was	only	nearly	a
century	after	Smith’s	TWON	–	in	1860	–	that	Britain	fully	switched	to	free	trade,	when	its	industrial
supremacy	was	unquestioned.	At	the	time,	Britain	accounted	for	20	per	cent	of	world	manufacturing
output	(as	of	1860)	and	46	per	cent	of	world	trade	in	manufactured	goods	(as	of	1870),	despite	having
only	2.5	per	cent	of	the	world	population;	these	numbers	can	be	put	into	perspective	by	noting	that	the
corresponding	figures	for	China	today	are	15	per	cent	and	14	per	cent,	despite	its	having	19	per	cent	of
the	world	population.
The	US	as	the	champion	of	protectionism
The	US	case	is	yet	more	interesting.	Under	British	colonial	rule,	its	development	of	manufacturing	was
deliberately	suppressed.	It	is	reported	that,	upon	hearing	about	the	first	attempts	by	the	American
colonists	to	engage	in	manufacturing,	William	Pitt	the	Elder,	the	British	prime	minister	(1766–8),	said	that
they	should	‘not	be	permitted	to	manufacture	so	much	as	a	horseshoe	nail’.
After	gaining	independence,	many	Americans	argued	that	their	country	should	industrialize	if	it	was	to
rub	shoulders	with	the	likes	of	Britain	and	France.	Leading	this	camp	was	no	less	than	the	first	ever
minister	in	charge	of	the	US	economy,	Alexander	Hamilton,	the	treasury	secretary	(that’s	the	one	you	see
on	the	$10	bill).	In	his	1791	report	to	the	Congress,	Report	on	the	Subject	of	Manufactures,	Hamilton
argued	that	the	government	of	an	economically	backward	nation,	such	as	the	US,	needs	to	protect	and
nurture	‘industries	in	their	infancy’	against	superior	foreign	competitors	until	they	grow	up;	this	is	known
as	the	infant	industry	argument.	Hamilton	proposed	the	use	of	tariffs	and	other	measures	to	help	the
infant	industries;	subsidies,	public	investments	in	infrastructure	(especially	canals),	a	patent	law	to
encourage	new	inventions	and	measures	to	develop	the	banking	system.
In	the	beginning,	the	slave-owning	landlords	from	the	South,	who	then	dominated	US	politics,	thwarted
Hamilton’s	plan;	they	didn’t	see	why	they	should	buy	inferior	‘Yankee’-manufactured	products	when	they
could	import	better	and	cheaper	things	from	Europe.	But,	following	the	Anglo-American	War	(1812–16)	–
the	first	and	so	far	the	only	time	that	the	US	mainland	was	invaded	–	many	Americans	came	around	to
Hamilton’s	view	that	a	strong	country	needed	a	strong	manufacturing	sector,	which	was	not	going	to
happen	without	tariffs	and	other	government	interventions.	The	only	pity	was	that	Hamilton	was	not
around	to	see	his	vision	realized.	He	had	been	shot	dead	in	a	pistol	duel	in	1804	by	a	certain	Aaron	Burr
–	the	serving	vice	president	of	the	country	at	the	time	(yes,	those	were	wild	days	–	a	serving	vice
president	shoots	a	former	finance	minister	dead,	and	no	one	goes	to	prison).
After	the	shift	of	direction	in	1816,	the	US	trade	policy	became	increasingly	protectionist.	By	the
1830s,	the	country	was	boasting	the	highest	average	industrial	tariff	in	the	world	–	a	status	that	it	would
keep	for	(almost	all	of)	the	next	hundred	years,	until	the	Second	World	War.	During	that	century,	tariffs
were	much	lower	in	states	such	as	Germany,	France	and	Japan	–	states	that	people	these	days	normally
associate	with	protectionism.
In	the	first	half	of	this	protectionist	century,	together	with	slavery	and	federalism,	protectionism
remained	a	constant	bone	of	contention	between	the	industrial	North	and	the	agrarian	South.	The	issue
was	finally	settled	by	the	Civil	War	(1861–5),	which	the	North	won.	The	victory	was	no	accident.	The
North	won	exactly	because	it	had	developed	manufacturing	industry	in	the	previous	half	a	century	behind
the	wall	of	protectionism.	In	Margaret	Mitchell’s	classic	novel	Gone	with	the	Wind,	Rhett	Butler,	the
leading	male	character,	tells	his	Southern	compatriots	that	the	Yankees	would	win	the	war	because	they
had	‘the	factories,	the	foundries,	the	shipyards,	the	iron	and	coal	mines	–	all	the	things	we	[the
Southerners]	haven’t	got’.
Free	trade	spreads	–	mostly	through	unfree	means
Free	trade	was	not	responsible	for	the	rise	of	capitalism,	but	it	did	spread	throughout	the	nineteenth
century.	Some	of	it	happened	in	the	heartland	of	capitalism	in	the	1860s	–	Britain’s	adoption	of	free	trade
and	the	signing	of	a	series	of	bilateral	free-trade	agreements	(or	FTAs),	in	which	two	countries	abolish
import	restrictions	and	tariffs	on	each	other’s	exports,	among	the	Western	European	countries.	But	much
of	the	spread	happened	on	the	periphery	of	capitalism,	in	Latin	America	and	Asia.
This	was	the	result	of	something	that	you	would	not	normally	associate	with	the	word	‘free’	–	that	is,
force,	or	at	least	the	threat	of	using	it.	Colonization	was	the	obvious	route	to	‘unfree	free	trade’,	but	even
many	countries	that	were	not	colonized	were	also	forced	to	adopt	free	trade.	Through	‘gunboat
diplomacy’,	they	were	forced	to	sign	unequal	treaties	that	deprived	them	of,	among	other	things,	tariff
autonomy	(the	right	to	set	their	own	tariffs).11	They	were	allowed	to	use	only	a	low	uniform	tariff	rate
(3–5	per	cent)	–	enough	to	raise	some	government	revenue	but	not	enough	for	infant	industry	protection.
The	most	infamous	unequal	treaty	is	the	Nanking	Treaty,	which	China	was	forced	to	sign	in	1842,
following	its	defeat	in	the	Opium	War.	But	the	unequal	treaties	had	started	with	the	Latin	American
countries,	upon	their	independence	in	the	1810s	and	the	1820s.	Between	the	1820s	and	the	1850s,	a	string
of	other	countries	were	forced	to	sign	them	–	the	Ottoman	Empire	(Turkey’s	predecessor),	Persia	(Iran
today)	and	Siam	(today’s	Thailand),	and	even	Japan.	The	Latin	American	unequal	treaties	expired	in	the
1870s	and	the	1880s,	but	the	Asian	ones	lasted	well	into	the	twentieth	century.
The	inability	to	protect	and	promote	their	infant	industries,	whether	due	to	direct	colonial	rule	or	to
unequal	treaties,	was	a	huge	contributing	factor	to	the	economic	retrogression	in	Asia	and	Latin	America
during	this	period,	when	they	saw	negative	per	capita	income	growths	(at	the	rates	of	-0.1	and	-0.04	per
cent	per	year,	respectively).
1870–1913:	High	Noon
Capitalism	gets	into	a	higher	gear:	the	rise	of	mass	production
The	development	of	capitalism	began	to	accelerate	around	1870.	Clusters	of	new	technological
innovations	emerged	between	the	1860s	and	the	1910s,	resulting	in	the	rise	of	the	so-called	heavy	and
chemical	industries:	electrical	machinery,	internal	combustion	engines,	synthetic	dyes,	artificial
fertilizers,	and	so	on.	Unlike	the	technologies	of	the	Industrial	Revolution,	which	had	been	invented	by
practical	men	with	good	intuition,	these	new	technologies	were	developed	through	the	systematic
application	of	scientific	and	engineering	principles.	This	meant	that,	once	something	was	invented,	it
could	be	replicated	and	improved	upon	very	quickly.
In	addition,	organization	of	the	production	process	was	revolutionized	in	many	industries	by	the
invention	of	the	mass	production	system.	The	use	of	a	moving	assembly	line	(conveyor	belt)	and
interchangeable	parts	dramatically	lowered	production	costs.	This	system	of	production	is	the	backbone
(if	not	the	entirety)	of	our	production	system	today,	despite	frequent	talks	of	its	demise	since	the	1980s.
New	economic	institutions	emerge	to	deal	with	growing	production	scale,	risk,	and	instability
During	its	‘high	noon’,	capitalism	acquired	the	basic	institutional	shape	that	it	has	today	–	the	limited
liability	company,	bankruptcy	law,	the	central	bank,	the	welfare	state,	labour	laws	and	so	on.	These
institutional	shifts	came	about	basically	because	of	the	changes	in	underlying	technologies	and	politics.
Recognizing	the	growing	need	for	large-scale	investments,	limited	liability,	hitherto	reserved	only	for
privileged	firms,	was	‘generalized’	–	that	is,	granted	to	any	firm	that	met	some	minimum	conditions.
Enabling	unprecedented	scales	of	investment,	the	limited	liability	company	became	the	most	powerful
vehicle	for	capitalist	development	–	Karl	Marx,	spotting	its	enormous	potential	before	any	self-appointed
cheerleader	of	capitalism,	called	it	‘capitalist	production	in	its	highest	development’.
Before	the	1849	British	reform,	the	bankruptcy	law	focused	on	punishing	the	bankrupt	businessman,
with	a	debtors’	prison	in	the	worst	case.	New	bankruptcy	laws,	introduced	in	the	second	half	of	the
nineteenth	century,	gave	failed	businessmen	a	second	chance	by	allowing	them	not	to	pay	interest	to
creditors	while	they	were	reorganizing	their	business	(as	in	Chapter	11	of	the	US	Federal	Bankruptcy	Act,
introduced	in	1898)	and	by	forcing	the	creditors	to	write	off	parts	of	their	debts.	Being	a	businessman
became	far	less	risky.
With	larger	companies	came	larger	banks.	The	risk	was	then	heightened	that	the	failure	of	one	bank
could	destabilisze	the	whole	financial	system,	so	central	banks	were	set	up	to	deal	with	such	problems	by
acting	as	the	lender	of	last	resort,	starting	with	the	Bank	of	England	in	1844.
With	increasing	socialist	agitation	and	reformist	pressures	in	relation	to	the	condition	of	the	working
class,	a	raft	of	welfare	and	labour	legislations	were	implemented	from	the	1870s:	industrial	accident
insurance,	health	insurance,	old	age	pensions	and	unemployment	insurance.	Many	countries	also	banned
the	employment	of	younger	children	(typically,	those	under	ten	to	twelve)	and	restricted	the	working	hours
of	older	children	(initially	only	to	twelve	hours!).	They	also	regulated	the	working	conditions	and	hours
of	women.	Unfortunately,	this	was	done	not	out	of	chivalry	but	out	of	contempt	for	women.	Unlike	men,	it
was	believed,	women	lacked	full	mental	faculties	and	therefore	could	sign	a	labour	contract	that	was
disadvantageous	to	them	–	they	needed	to	be	protected	from	themselves.	This	welfare	and	labour
legislation	took	the	roughest	edges	off	capitalism	and	made	a	lot	of	poor	people’s	lives	better	–	if	only
slightly	at	the	beginning.
These	institutional	changes	promoted	economic	growth.	Limited	liability	and	debtor-friendly
bankruptcy	laws	reduced	risk	involved	in	business	activities,	thereby	encouraging	wealth	creation.
Central	banking,	on	the	one	hand,	and	labour	and	welfare	legislations,	on	the	other,	also	helped	growth	by
enhancing,	respectively,	economic	and	political	stability,	which	increased	investment	and	thus	growth.
The	growth	rate	of	per	capita	income	in	Western	Europe	accelerated	during	this	‘high	noon’	from	1	per
cent	during	1820–70	to	1.3	per	cent	during	1870–1913.
How	the	‘liberal’	golden	age	was	not	so	liberal
The	‘high	noon’	of	capitalism	is	often	described	as	the	first	age	of	globalization,	that	is,	the	first	time	in
which	the	whole	world	economy	was	integrated	into	one	system	of	production	and	exchange.	Many
commentators	attribute	this	outcome	to	the	liberal	economic	policies	adopted	during	this	period,	when
there	were	few	policy	restrictions	on	cross-border	movements	of	goods,	capital	and	people.	This
liberalism	on	the	international	front	was	matched	by	the	laissez-faire	approach	to	domestic	economic
policy	(see	the	box	below	for	definitions	of	these	terms).	Allowance	of	maximum	freedom	for	business,
pursuit	of	a	balanced	budget	(that	is,	the	government	spending	exactly	as	much	as	it	collects	in	taxes)	and
the	adoption	of	the	Gold	Standard	were	the	key	ingredients,	they	say.	Things	were,	however,	far	more
complicated.
‘LIBERAL’:	THE	MOST	CONFUSING	TERM	IN	THE	WORLD?
Few	words	have	generated	more	confusion	than	the	word	‘liberal’.	Although	the	term	was	not	explicitly	used	until	the	nineteenth
century,	the	ideas	behind	liberalism	can	be	traced	back	to	at	least	the	seventeenth	century,	starting	with	thinkers	like	Thomas
Hobbes	and	John	Locke.	The	classical	meaning	of	the	term	describes	a	position	that	gives	priority	to	freedom	of	the	individual.	In
economic	terms,	this	means	protecting	the	right	of	the	individual	to	use	his	property	as	he	pleases,	especially	to	make	money.	In
this	view,	the	ideal	government	is	the	one	that	provides	only	the	minimum	conditions	that	are	conducive	to	the	exercise	of	such	a
right,	such	as	law	and	order.	Such	a	government	(state)	is	known	as	the	minimal	state.	The	famous	slogan	among	the	liberals	of
the	time	was	‘laissez	faire’	(let	things	be),	so	liberalism	is	also	known	as	the	laissez-faire	doctrine.
Today,	liberalism	is	usually	equated	with	the	advocacy	of	democracy,	given	its	emphasis	on	individual	political	rights,	including
the	freedom	of	speech.	However,	until	the	mid-twentieth	century,	most	liberals	were	not	democrats.	They	did	reject	the
conservative	view	that	tradition	and	social	hierarchy	should	have	priority	over	individual	rights.	But	they	also	believed	that	not
everyone	was	worthy	of	such	rights.	They	thought	women	lacked	full	mental	faculties	and	thus	did	not	deserve	the	right	to	vote.
They	also	insisted	that	poor	people	should	not	be	given	the	right	to	vote,	since	they	believed	the	poor	would	vote	in	politicians	who
would	confiscate	private	properties.	Adam	Smith	openly	admitted	that	the	government	‘is	in	reality	instituted	for	the	defence	of
the	rich	against	the	poor,	or	of	those	who	have	some	property	against	those	who	have	none	at	all’.12
What	makes	it	even	more	confusing	is	that,	in	the	US,	the	term	‘liberal’	is	used	to	describe	a	view	that	is	the	left-of-centre.
American	‘liberals’,	such	as	Ted	Kennedy	or	Paul	Krugman,	would	be	called	social	democrats	in	Europe.	In	Europe,	the	term	is
reserved	for	people	like	the	supporters	of	the	German	Free	Democratic	Party	(FDP),	who	would	be	called	libertarians	in	the
US.
Then	there	is	neo-liberalism,	which	has	been	the	dominant	economic	view	since	the	1980s	(see	below).	It	is	very	close	to,
but	not	quite	the	same	as,	classical	liberalism.	Economically,	it	advocates	the	classical	minimal	state	but	with	some	modifications
–	most	importantly,	it	accepts	the	central	bank	with	note	issue	monopoly,	while	the	classical	liberals	thought	that	there	should	be
competition	in	the	production	of	money	too.	In	political	terms,	neo-liberals	do	not	openly	oppose	democracy,	as	the	classical
liberals	did.	But	many	of	them	are	willing	to	sacrifice	democracy	for	the	sake	of	private	property	and	the	free	market.
Neo-liberalism	is	also	known,	especially	in	developing	countries,	as	the	Washington	Consensus	view,	referring	to	the	fact
that	it	is	strongly	advocated	by	the	three	most	powerful	economic	organizations	in	the	world,	all	based	in	Washington,	DC,
namely,	the	US	Treasury,	the	International	Monetary	Fund	(IMF)	and	the	World	Bank.
The	1870–1913	period	did	not	actually	see	universal	liberalism	on	the	international	front.	In	the
heartland	of	capitalism,	in	Western	Europe	and	the	US,	trade	protectionism	actually	increased,	not
decreased.
The	US	became	even	more	protectionist	than	before	following	the	conclusion	of	the	Civil	War	in	1865.
Most	Western	European	countries	that	had	signed	FTAs	in	the	1860s	and	the	1870s	did	not	renew	them
and	significantly	increased	tariffs	after	their	expiry	(they	usually	had	a	twenty-year	lifetime).	This	was
partly	to	protect	agriculture,	which	was	struggling	with	new	cheap	imports	from	the	New	World
(especially	the	US	and	Argentina)	and	Eastern	Europe	(Russia	and	Ukraine)	but	also	to	protect	and
promote	the	new	heavy	and	chemical	industries.	Germany	and	Sweden	were	the	best	examples	of	this
‘new	protectionism’	–	famously	called	the	‘marriage	of	iron	and	rye’	in	Germany.
When	the	unequal	treaties	they	had	signed	upon	independence	expired	in	the	1870s	and	the	1880s,	the
Latin	American	countries	introduced	rather	high	protective	tariffs	(30–40	per	cent).	However,	elsewhere
in	the	‘periphery’,	the	forced	free	trade	we	talked	about	earlier	spread	much	further.	European	powers
competed	for	parts	of	the	African	continent	in	the	‘scramble	for	Africa’,	while	many	Asian	countries	were
also	taken	as	colonies	(Malaysia,	Singapore	and	Myanmar	by	Britain;	Cambodia,	Vietnam	and	Laos	by
France).	The	British	Empire	expanded	enormously,	backed	up	by	its	industrial	might,	leading	to	the
famous	saying:	‘The	sun	never	sets	on	the	British	Empire.’	Countries	like	Germany,	Belgium,	the	US	and
Japan,	which	had	not	so	far	engaged	in	much	colonialism,	also	joined	in.13	Not	for	nothing	is	this	period
also	known	as	the	‘Age	of	Imperialism’.
The	domestic	front	also	saw	a	marked	increase,	not	a	decrease,	in	government	intervention	in	the	core
capitalist	countries.	There	was,	indeed,	a	strong	adherence	to	free-market	doctrines	in	relation	to	fiscal
policy	(the	balanced	budget	doctrine)	and	monetary	policy	(the	Gold	Standard).	However,	this	period
also	saw	an	enormous	increase	in	the	role	of	the	government:	labour	regulations,	social	welfare	schemes,
public	investments	in	infrastructure	(especially	railways	but	also	canals)	and	in	education	(especially	the
US	and	Germany).
The	liberal	golden	age	of	1870–1913	was	thus	not	as	liberal	as	we	think.	It	was	getting	less	liberal	in
the	core	capitalist	countries,	in	terms	of	both	domestic	and	international	policies.	Liberalization	happened
mostly	in	the	weaker	countries,	but	out	of	compulsion	rather	than	choice	–	through	colonialism	and
unequal	treaties.	In	the	only	peripheral	region	that	experienced	rapid	growth	during	this	period,	namely,
Latin	America,	there	was	a	vast	increase	in	protectionism	following	the	expiry	of	the	unequal	treaties.14
1914–45:	The	Turmoil
Capitalism	trips	up:	the	First	World	War	and	the	end	of	the	liberal	golden	age
The	outbreak	of	the	First	World	War	in	1914	signalled	the	end	of	an	era	for	capitalism.	Until	then,
despite	constant	threats	of	revolt	by	the	poor	(the	1848	revolutions	across	Europe,	the	1871	Paris
commune,	etc.)	and	economic	problems	(the	Long	Depression	of	1873–96),	the	only	way	for	capitalism
had	seemed	to	be	up	–	and	outwards.
This	view	was	rudely	shaken	by	the	First	World	War	(1914–18),	which	totally	discredited	the	then
popular	view	that	the	thickening	web	of	commerce,	which	capitalism	was	building	across	the	globe,
would	make	wars	between	nations	thus	intertwined	highly	unlikely,	if	not	totally	impossible.
At	one	level,	the	outbreak	of	the	First	World	War	should	not	have	been	surprising,	given	that	the
globalization	of	the	‘high	noon’	had	been	in	large	part	driven	by	imperialism,	rather	than	market	forces.
This	meant	that	the	international	rivalry	between	the	leading	capitalist	countries	had	a	high	chance	of
escalating	into	violent	conflicts.	Some	went	even	further	and	argued	that	capitalism	had	reached	a	stage	in
which	it	could	not	be	sustained	without	continuous	outward	expansion,	which	has	to	come	to	an	end
sooner	or	later,	marking	the	end	of	capitalism.
Capitalism	gets	a	rival:	the	Russian	Revolution	and	the	rise	of	socialism
This	was	the	view	most	famously	expounded	in	Imperialism:	The	Highest	Stage	of	Capitalism	by
Vladimir	Lenin,	the	leader	of	the	Russian	Revolution	in	1917.	The	Russian	Revolution	was	an	even
bigger	shock	to	the	defenders	of	capitalism	than	the	First	World	War,	as	it	led	to	the	creation	of	an
economic	system	that	claims	to	undermine	all	the	cornerstones	of	capitalism.
In	the	decade	following	the	Russian	Revolution,	private	property	in	the	means	of	production	(machines,
factory	building,	land,	etc.)	was	abolished.	The	big	break	came	with	the	agricultural	collectivization	in
1928,	in	which	the	lands	of	large	farmers,	or	kulaks,	were	confiscated	and	turned	into	state	farms
(sovkhoz)	and	small	farmers	were	forced	to	join	agricultural	cooperatives	(kolkhoz),	which	were	state
farms	in	all	but	name.	Markets	were	eventually	abolished	and	replaced	by	full-blown	central	planning	by
1928,	when	the	first	Five	Year	Plan	started.	By	1928,	the	Soviet	Union	had	an	economic	system	that	was
definitively	not	capitalist.	It	ran	without	private	ownership	of	means	of	production,	profit	motives	and
markets.
As	for	the	other	cornerstone	of	capitalism,	wage	labour,	the	picture	was	more	complicated.	Yes,	in
theory	the	Soviet	workers	were	not	wage	labourers	because	they	owned	all	the	means	of	production	–
through	state	ownership	or	cooperatives.	In	practice	they	were	indistinguishable	from	wage	labourers	in	a
capitalist	economy,	since	they	had	little	control	over	the	way	in	which	their	enterprises	and	the	wider
economy	operated,	and	their	daily	work	experience	was	still	subject	to	the	same	hierarchical	relationship.
Soviet	socialism	was	a	huge	economic	(and	social)	experiment.	Until	then,	no	economy	had	been
centrally	planned.	Karl	Marx	had	left	the	details	rather	vague,	and	the	Soviet	Union	had	to	make	things	up
as	it	went	along	this	untrodden	path.	Even	many	Marxists,	especially	Karl	Kautsky,	were	sceptical	about
its	prospects	–	socialism	was,	according	to	Marx	himself,	supposed	to	emerge	from	the	most	developed
capitalist	economies.	Those	economies	were	only	a	step	away	from	a	fully	planned	economy,	it	was
argued,	because	their	economic	activities	were	already	planned	to	a	high	degree	by	large	enterprises	and
cartels	of	those	enterprises.	The	Soviet	Union	–	even	its	more	developed	European	part	–	was	a	very
backward	economy	in	which	capitalism	had	been	hardly	developed,	where	socialism	really	had	no
business	emerging.
To	everyone’s	surprise,	the	early	Soviet	industrialization	was	a	big	success,	most	graphically	proven
by	its	ability	to	repel	the	Nazi	advance	on	the	Eastern	Front	during	the	Second	World	War.	Income	per
capita	is	estimated	to	have	grown	at	5	per	cent	per	year	between	1928	and	1938	–	an	astonishingly	rapid
rate	in	a	world	in	which	income	typically	grew	at	1–2	per	cent	per	year.15
This	growth	came	at	the	cost	of	millions	of	deaths	–	from	political	repression	and	the	1932	famine.*
However,	the	scale	of	the	famine	was	not	known	at	the	time,	and	many	were	impressed	by	Soviet
economic	performance,	especially	given	that	capitalism	was	then	on	its	knees,	following	the	Great
Depression	of	1929.
Capitalism	gets	depressed:	the	Great	Depression	of	1929
The	Great	Depression	was	an	even	more	traumatic	event	for	the	believers	in	capitalism	than	the	rise	of
socialism.	This	was	especially	the	case	in	the	US,	where	the	Depression	started	(with	the	infamous	1929
Wall	Street	crash)	and	which	was	the	hardest	hit	by	the	experience.	Between	1929	and	1932,	US	output
fell	by	30	per	cent	and	unemployment	increased	eightfold,	from	3	per	cent	to	24	per	cent.16	It	was	not	until
1937	that	US	output	regained	its	1929	level.	Germany	and	France	also	suffered	badly,	with	their	outputs
falling	by	16	per	cent	and	15	per	cent	respectively.
One	influential	view,	propagated	by	neo-liberal	economists,	is	that	this	large	but	totally	manageable
financial	crisis	was	turned	into	a	Great	Depression	because	of	the	collapse	in	world	trade	caused	by	the
‘trade	war’,	prompted	by	the	adoption	of	protectionism	by	the	US	through	the	1930	Smoot-Hawley
Tariffs.	This	story	does	not	stand	up	to	scrutiny.	The	tariff	increase	by	Smoot-Hawley	was	not	dramatic	–
it	raised	the	average	US	industrial	tariff	from	37	per	cent	to	48	per	cent.	Nor	did	it	cause	a	massive	tariff
war.	Except	for	a	few	economically	weak	countries	such	as	Italy	and	Spain,	trade	protectionism	did	not
increase	very	much	following	Smoot–Hawley.	Most	importantly,	studies	show	that	the	main	reason	for	the
collapse	in	international	trade	after	1929	was	not	tariff	increases	but	the	downward	spiral	in	international
demand,	caused	by	the	adherence	by	the	governments	of	the	core	capitalist	economies	to	the	doctrine	of
balanced	budget.17
After	a	big	financial	crisis	like	the	1929	Wall	Street	crash	or	the	2008	global	financial	crisis,	private-
sector	spending	falls.	Debts	go	unpaid,	which	forces	banks	to	reduce	their	lending.	Being	unable	to
borrow,	firms	and	individuals	cut	their	spending.	This,	in	turn,	reduces	demands	for	other	firms	and
individuals	that	used	to	sell	to	them	(e.g.,	firms	selling	to	consumers,	firms	selling	machinery	to	other
firms,	workers	selling	labour	services	to	firms).	The	demand	level	in	the	economy	spirals	down.
In	this	environment,	the	government	is	the	only	economic	actor	that	can	maintain	the	level	of	demand	in
the	economy	by	spending	more	than	it	earns,	that	is,	by	running	a	budget	deficit.	However,	in	the	days	of
the	Great	Depression,	the	strong	belief	in	the	doctrine	of	the	balanced	budget	prevented	such	a	course	of
action.	As	tax	revenues	were	falling	due	to	reduced	levels	of	economic	activity,	the	only	way	for	them	to
balance	their	budgets	was	to	cut	their	spending,	leaving	nothing	to	arrest	the	downward	demand	spiral.18
To	make	things	worse,	the	Gold	Standard	meant	that	their	central	banks	could	not	increase	the	supply	of
money	for	fear	of	compromising	the	value	of	their	currencies.	With	restricted	money	supply,	credit
became	scarce,	restricting	private-sector	activities	and	thus	reducing	demand	even	further.
Reform	begins:	the	US	and	Sweden	lead	the	way
The	Great	Depression	left	a	lasting	mark	on	capitalism.	With	it	came	widespread	rejection	of	the
laissez-faire	doctrine	and	serious	attempts	to	reform	capitalism.
The	reforms	were	particularly	widespread	and	far-reaching	in	the	US,	where	the	Depression	was	the
greatest	and	lasted	the	longest.	The	so-called	First	New	Deal	programme	(1933–4)	under	the	new
president,	Franklin	Delano	Roosevelt,	separated	the	commercial	and	investment	arms	of	banks	(the	1933
Glass-Steagall	Act),	set	up	the	bank	deposit	insurance	system	to	protect	small	savers	against	bank
failures,	tightened	stock	market	regulation	(the	1933	Federal	Securities	Act),	expanded	and	strengthened
the	farm	credit	system,	provided	a	minimum	farm	price	guarantee	and	developed	infrastructure	(such	as
the	Hoover	Dam	–	that’s	the	one	you	see	in	the	1978	Superman	movie,	starring	the	late	Christopher
Reeve),	and	so	on.	There	were	even	more	reforms	under	the	so-called	Second	New	Deal	(1935–8),
including	the	Social	Security	Act	(1935),	which	introduced	old	age	pensions	and	unemployment
insurance,	and	the	Wagner	Act	(1935),	which	strengthened	trade	unions.
Sweden	was	another	country	where	significant	reforms	were	introduced.	Riding	on	the	back	of	the
public	discontent	with	liberal	economic	policies,	which	left	unemployment	at	25	per	cent,	the	Social
Democratic	Party	came	to	power	in	1932.	Income	tax	was	introduced	–	surprisingly	belatedly	for	a
country	that	is	today	considered	the	bastion	of	income	tax	(Britain	introduced	income	tax	in	1842	and
even	the	famously	anti-tax	US	in	1913).	The	revenues	were	used	for	expanding	the	welfare	state
(unemployment	insurance	was	introduced	in	1934,	and	the	old-age	pension	was	raised)	and	for	helping
small	farmers	(farm	credits	were	expanded,	and	minimum	prices	were	guaranteed).	In	1938,	the
centralized	trade	union	and	the	centralized	employers’	association	signed	the	Saltsjöbaden	Agreement,
establishing	industrial	peace.
Other	countries	did	not	go	as	far	as	the	US	and	Sweden	in	reforming	capitalism,	but	their	reforms
presaged	the	shape	of	the	things	to	come	after	the	Second	World	War.
Capitalism	falters:	growth	slows	down	and	socialism	outperforms	capitalism
The	turmoil	of	the	1914–45	period	reached	its	peak	with	the	outbreak	of	the	Second	World	War,	which
killed	tens	of	millions	of	people,	both	soldiers	and	civilians	(higher	estimates	put	the	death	toll	at	60
million).	The	war	resulted	in	the	first	reversal	in	the	acceleration	in	economic	growth	since	the	early
nineteenth	century.19
1945–73:	The	Golden	Age	of	Capitalism
Capitalism	performs	well	on	all	fronts:	growth,	employment	and	stability
The	period	between	1945,	the	end	of	the	Second	World	War,	and	1973,	the	first	Oil	Shock,	is	often
called	the	‘Golden	Age	of	capitalism’.	The	period	really	deserves	the	name,	as	it	achieved	the	highest
growth	rate	ever.	Between	1950	and	1973,	per	capita	income	in	Western	Europe	grew	at	an	astonishing
rate	of	4.1	per	cent	per	year.	The	US	grew	more	slowly,	but	at	an	unprecedented	rate	of	2.5	per	cent.	West
Germany	grew	at	5.0	per	cent,	earning	the	title	of	the	‘Miracle	on	the	Rhine’,	while	Japan	grew	even
faster	at	8.1	per	cent,	starting	off	the	chain	of	‘economic	miracles’	in	East	Asia	in	the	next	half	a	century.
High	growth	was	not	the	only	economic	achievement	of	the	Golden	Age.	Unemployment,	the	bane	of	the
working	class,	was	virtually	eliminated	in	the	advanced	capitalist	countries	(henceforth	ACCs)	of
Western	Europe,	Japan	and	the	US	(see	Chapter	10).	These	economies	were	also	remarkably	stable	on	a
number	of	accounts	–	output	(and	thus	employment),	prices	and	finance.	Outputs	fluctuated	much	less	than
in	the	previous	periods,	not	least	thanks	to	Keynesian	fiscal	policy,	which	increased	government	spending
during	downturns	and	reduced	it	during	booms.20	The	rate	of	inflation,	that	is,	the	rate	at	which	the
general	price	level	rises,	was	relatively	low.21	And	there	was	a	very	high	degree	of	financial	stability.
During	the	Golden	Age,	virtually	no	country	was	in	banking	crisis.	In	contrast,	since	1975,	anything
between	5	and	35	per	cent	of	countries	in	any	given	year	have	been	in	banking	crisis,	except	for	a	few
years	in	the	mid-2000s.22
So	in	every	measure	the	Golden	Age	was	a	remarkable	period.	When	Harold	Macmillan,	the	British
prime	minister,	said,	‘You’ve	never	had	it	so	good,’	he	wasn’t	exaggerating.	Exactly	what	lay	behind	this
sterling	economic	performance,	which	was	unprecedented	and	has	since	been	unparalleled,	is	a	matter	of
an	ongoing	dispute.
Factors	behind	the	Golden	Age
Some	point	out	that,	after	the	Second	World	War,	there	was	an	unusually	large	pool	of	new	technologies
that	were	waiting	to	be	exploited,	which	gave	an	impetus	to	growth	in	the	Golden	Age.	Many	new
technologies	that	had	been	developed	during	the	war	for	military	purposes	had	civilian	uses	–	computers,
electronics,	radar,	jet	engines,	synthetic	rubber,	microwave	(applied	from	radar	technology)	and	much
more.	With	the	end	of	the	war,	a	lot	of	new	investments	that	use	these	technologies	were	made,	first	for
post-war	reconstruction	and	then	for	the	meeting	of	consumer	demands	pent	up	during	wartime	austerity.
There	were	also	some	important	changes	in	the	international	economic	system	that	facilitated	economic
development	during	the	Golden	Age.
The	1944	meeting	of	the	Allies	in	the	Second	World	War	in	the	New	Hampshire	resort	of	Bretton
Woods	established	two	key	institutions	of	the	post-war	international	financial	system,	which	are	thus
dubbed	the	Bretton	Woods	Institutions	(BWIs)	–	the	International	Monetary	Fund	(IMF)	and	the
International	Bank	for	Reconstruction	and	Development	(IBRD),	more	commonly	known	as	the	World
Bank.23
The	IMF	was	established	to	provide	short-term	funding	to	countries	in	balance	of	payments	crises
(balance	of	payments	is	the	statement	of	a	country’s	position	in	economic	transactions	with	the	rest	of	the
world	–	see	Chapter	12	for	full	details).	A	balance	of	payments	crisis	happens	when	a	country	is	paying
other	countries	(e.g.,	when	it	imports	goods	or	services)	so	much	more	than	it	gets	from	them	that	no	one
is	willing	to	lend	money	to	it	any	more.	The	typical	result	is	a	financial	panic,	followed	by	a	deep
recession.	By	providing	emergency	loans	to	countries	in	such	a	situation,	the	IMF	allowed	them	to	tide
over	such	crises	with	fewer	negative	consequences.
The	World	Bank	was	established	to	provide	loans	for	‘project	lending’	(that	is,	money	that	is	given	to
particular	investment	projects,	such	as	building	a	dam).	By	providing	loans	of	longer	maturities	and/or
lower	interest	rates	than	are	offered	by	the	private-sector	banks,	the	World	Bank	enabled	its	client
countries	to	invest	more	aggressively	than	otherwise	possible.
Making	up	the	third	leg	of	the	post-war	world	economic	system	was	the	GATT	(General	Agreement	on
Trade	and	Tariffs),	which	was	signed	in	1947.	Between	1947	and	1967,	the	GATT	organized	six	series	of
negotiations	(called	‘rounds’)	that	resulted	in	cuts	in	tariffs	(mostly)	among	the	rich	countries.	Being
between	countries	at	similar	levels	of	development,	these	cuts	brought	about	positive	outcomes	by
expanding	markets	and	stimulating	productivity	growth	through	greater	competition.
In	Europe,	a	new	experiment	in	international	integration	with	far-reaching	consequences	was
conducted.	It	started	with	the	creation	of	the	European	Coal	and	Steel	Community	(ECSC)	in	1951	by	six
countries	(West	Germany,	France,	Italy,	the	Netherlands,	Belgium	and	Luxembourg)	and	culminated	in	the
creation	of	the	European	Economic	Community	(EEC)	–	a	free-trade	agreement	–	through	the	Treaty	of
Rome	(1957).24	In	1973,	the	UK,	Ireland	and	Denmark	joined	the	group,	which	was	by	then	called	the	EC
(European	Communities).	By	bringing	peace	to	a	region	riven	with	wars	and	rivalries	and	by	integrating
markets,	the	EEC	contributed	to	the	economic	development	in	the	member	countries.
The	most	influential	explanation	of	the	Golden	Age	is,	however,	that	it	was	mainly	the	result	of	reforms
in	economic	policies	and	institutions	that	gave	birth	to	the	mixed	economy	–	mixing	positive	features	of
capitalism	and	socialism.
Following	the	Great	Depression,	the	limits	of	laissez-faire	capitalism	came	to	be	widely	accepted.	It
was	agreed	that	the	government	should	take	an	active	role	to	deal	with	the	failings	of	unregulated	markets.
At	the	same	time,	the	success	in	wartime	planning	during	the	Second	World	War	diminished	scepticism
about	the	feasibility	of	government	intervention.	Electoral	successes	by	parties	of	the	left	in	many
European	countries,	thanks	to	their	key	roles	in	fighting	fascism,	led	to	the	expansion	of	the	welfare	state
and	greater	labour	rights.
These	changes	in	policies	and	institutions	are	seen	to	have	contributed	to	the	making	of	the	Golden	Age
in	a	number	of	ways	–	creating	social	peace,	encouraging	investment,	increasing	social	mobility	and
promoting	technological	innovations.	Let	me	elaborate	a	little,	as	this	is	an	important	point.
Capitalism	Remixed:	pro-worker	policies	and	institutions
Soon	after	the	Second	World	War,	many	European	countries	took	private	enterprises	into	public
ownership	or	set	up	new	public	enterprises,	or	state-owned	enterprises	(SOEs),	in	key	industries,	such
as	steel,	railways,	banking	and	energy	(coal,	nuclear	and	electricity).	These	were	reflective	of	the
European	socialist	movements’	belief	in	public	control	over	the	means	of	production	as	a	key	element	of
social	democracy,	as	embodied	in	the	famous	Clause	IV	of	the	British	Labour	Party	(abolished	in	1995
under	Tony	Blair’s	‘New	Labour’	make-over).	In	countries	such	as	France,	Finland,	Norway	and	Austria,
SOEs	are	deemed	to	have	played	a	key	role	in	generating	high	growth	during	the	Golden	Age	by
aggressively	moving	into	high-technology	industries	that	the	private	sector	firms	found	too	risky.
Welfare	measures,	first	introduced	in	the	late	nineteenth	century,	were	vastly	strengthened,	with	the
provision	of	some	basic	services	nationalized	in	some	countries	(e.g.,	Britain’s	National	Health	Service).
These	were	funded	by	a	large	increase	in	taxes	(as	a	proportion	of	national	income).	Better	welfare
measures	increased	social	mobility,	increasing	the	legitimacy	of	the	capitalist	system.	The	resulting	social
peace	encouraged	more	long-term-oriented	investments	and	thus	growth.
Managed	capitalism:	governments	regulate	and	shape	markets	–	in	a	variety	of	ways
Learning	the	lessons	of	the	Great	Depression,	governments	in	all	ACCs	started	to	deploy	deliberately
counter-cyclical	macroeconomic	policies,	also	known	as	Keynesian	policies	(see	Chapter	4),	expanding
government	spending	and	money	supply	from	the	central	bank	during	economic	downturns	and	reducing
them	during	upturns.
In	recognition	of	the	potential	dangers	of	unregulated	financial	markets,	as	manifested	in	the	Great
Depression,	financial	regulations	were	strengthened.	Few	countries	went	as	far	as	the	US	in	separating
investment	banking	from	commercial	banking,	but	they	all	had	restrictions	on	what	banks	and	financial
investors	can	do.	This	was	an	era	when	bankers	were	considered	to	be	respectable	but	boring	people,
unlike	their	swashbuckling	successors	today.*
Many	governments	practised	selective	industrial	policy	that	deliberately	promoted	targeted	‘strategic’
industries	through	a	range	of	measures,	such	as	trade	protection	and	subsidies.	The	US	government
officially	had	no	industrial	policy	but	greatly	influenced	the	country’s	industrial	development	by
providing	massive	research	funding	to	advanced	industries	such	as	computers	(funded	by	the	Pentagon),
semi-conductors	(US	Navy),	aircraft	(US	Air	Forces),	the	internet	(the	DARPA,	Defense	Advanced
Research	Projects	Agency),	and	pharmaceuticals	and	life	sciences	(National	Institutes	of	Health).25
Governments	in	countries	such	as	France,	Japan	and	South	Korea	did	not	stop	at	promoting	particular
industries	and	explicitly	coordinated	policies	across	industrial	sectors	through	their	Five	Year	Plans	–	an
exercise	known	as	indicative	planning,	to	distinguish	it	from	the	‘directive’	Soviet	central	planning.
The	new	dawn:	developing	countries	finally	have	a	go	at	economic	development
The	Golden	Age	saw	widespread	decolonization.	Starting	with	Korea	in	1945	(which	was	then	divided
into	North	and	South	in	1948)	and	India	(from	which	Pakistan	separated)	in	1947,	most	colonies	gained
independence.	Independence	in	many	nations	involved	violent	struggles	against	the	colonizers.
Independence	came	later	to	Sub-Saharan	Africa,	with	Ghana	becoming	the	first	independent	country	in
1957.	Around	half	the	Sub-Saharan	African	countries	became	independent	in	the	first	half	of	the	1960s.
Some	nations	had	to	wait	much	longer	(Angola	and	Mozambique	in	1975	from	Portugal;	Namibia	in	1990
from	South	Africa),	and	some	are	still	waiting,	but	the	vast	majority	of	former	colonial	societies	–	now
called	developing	countries	–	gained	independence	by	the	end	of	the	Golden	Age.
Upon	independence,	most	post-colonial	nations	rejected	the	free-market	and	free-trade	policies	that
had	been	imposed	on	them	under	colonialism.	Some	of	them	became	outright	socialist	(China,	North
Korea,	North	Vietnam	and	Cuba),	but	most	of	them	pursued	state-led	industrialization	strategies	while
basically	remaining	capitalist.	The	strategy	is	known	as	the	import	substitution	industrialization	(ISI)
strategy	–	so	called	because	you	are	substituting	imported	manufactured	goods	with	your	own.	This	was
done	by	protecting	domestic	producers	from	superior	foreign	competition	by	restricting	imports	(infant
industry	protection)	or	heavily	regulating	the	activities	of	foreign	companies	operating	within	national
borders.	Governments	often	subsidized	private-sector	producers	and	set	up	SOEs	in	industries	in	which
private-sector	investors	were	unwilling	to	invest	due	to	high	risk.
With	independence	dates	stretching	from	1945	to	1973	and	beyond,	it	is	impossible	to	talk	about	the
‘economic	performance	of	developing	countries	during	the	Golden	Age’.	The	usual	compromise
timeframe	for	judging	developing	country	economic	performance	is	1960–80.	According	to	the	World
Bank	data,	during	this	period,	per	capita	income	in	the	developing	countries	grew	at	3	per	cent	per	year,
which	meant	that	they	kept	pace	with	the	more	advanced	economies,	in	which	growth	was	3.2	per	cent.
The	‘miracle’	economies	of	South	Korea,	Taiwan,	Singapore	and	Hong	Kong	grew	at	7–8	per	cent	per
year	in	per	capita	terms	during	this	period,	achieving	some	of	the	fastest	growth	rates	in	human	history
(together	with	Japan	before	them	and	China	after	them).
One	thing	to	note,	however,	is	that	even	the	more	slowly	growing	developing	regions	saw	considerable
progress	during	this	period.	During	1960–80,	with	per	capita	income	growth	of	1.6	per	cent	per	year,
Sub-Saharan	Africa	was	the	slowest-growing	region	in	the	world	–	Latin	America	grew	at	double	that
rate	(3.1	per	cent),	and	East	Asia	at	more	than	triple	that	rate	(5.3	per	cent).	However,	this	is	still	not	a
growth	rate	to	be	sniffed	at.	Recall	that	during	the	Industrial	Revolution,	the	growth	rate	of	per	capita
income	in	Western	Europe	was	only	1	per	cent.
The	middle	way:	capitalism	works	the	best	with	appropriate	government	interventions
During	the	Golden	Age	of	capitalism,	government	intervention	increased	enormously	in	almost	all
areas	in	all	countries,	with	the	exception	of	international	trade	in	the	rich	countries.	Despite	this,
economic	performance	both	in	the	rich	and	in	the	developing	countries	was	much	better	than	before.	It	has
not	been	bettered	since	the	1980s,	when	state	intervention	was	considerably	reduced,	as	I	shall	show
shortly.	The	Golden	Age	shows	that	capitalism’s	potential	can	be	maximized	when	it	is	properly	regulated
and	stimulated	by	appropriate	government	actions.
1973–9:	The	Interregnum
The	Golden	Age	started	to	unravel	with	the	suspension	of	US	dollar–gold	convertibility	in	1971.	In	the
Bretton	Woods	system,	the	old	Gold	Standard	was	abandoned	on	the	recognition	that	it	made
macroeconomic	management	too	rigid,	as	seen	during	the	Great	Depression.	But	the	system	was	still
ultimately	anchored	in	gold,	because	the	US	dollar,	which	had	fixed	exchange	rates	with	all	the	other
major	currencies,	was	freely	convertible	to	gold	(at	$35	per	ounce).	This,	of	course,	was	based	on	the
assumption	that	the	dollar	was	‘as	good	as	gold’	–	not	an	unreasonable	assumption	when	the	US	was
producing	about	half	of	the	world’s	output	and	there	was	an	acute	dollar	shortage	all	around	the	world,	as
everyone	wanted	to	buy	American	things.
With	the	post-war	reconstruction	and	then	rapid	development	of	other	economies,	this	assumption	was
not	valid	any	more.	Once	people	realized	that	the	US	dollar	was	not	as	good	as	gold,	they	had	a	greater
incentive	to	convert	dollars	into	gold,	which	reduced	the	US	gold	reserve	even	further	and	made	the
dollar	look	even	less	reliable.	The	US	official	liabilities	(dollar	bills	and	Treasury	Bills,	namely,	the	US
government	bonds),	which	had	been	only	half	the	size	of	its	gold	reserve	until	1959,	became	one	and	a
half	times	larger	by	1967.26
In	1971,	the	US	dropped	its	commitment	to	convert	any	dollar	claims	into	gold,	which	led	other
countries	to	abandon	the	practice	of	tying	their	national	currencies	to	the	dollar	at	fixed	rates	over	the	next
couple	of	years.	This	created	instability	in	the	world	economy,	with	currency	values	fluctuating	according
to	market	sentiments	and	becoming	increasingly	subject	to	currency	speculation	(investors	betting	on
currencies	moving	up	or	down	in	value).
The	end	of	the	Golden	Age	was	marked	by	the	First	Oil	Shock	in	1973,	in	which	oil	prices	rose
fourfold	overnight,	thanks	to	the	price	collusion	of	the	cartel	of	the	oil-producing	countries,	OPEC
(Organization	of	Petroleum	Exporting	Countries).	Inflation	had	been	slowly	increasing	in	many	countries
since	the	late	1960s	but,	following	the	Oil	Shock,	it	shot	up.
More	importantly,	the	next	several	years	were	characterized	by	stagflation.	This	newly	coined	term
referred	to	the	breakdown	of	the	age-long	economic	regularity	that	prices	fall	during	a	recession	(or
stagnation)	and	rise	during	a	boom.	Now,	the	economy	was	stagnating	(albeit	not	exactly	in	a	prolonged
recession,	like	during	the	Great	Depression)	but	prices	were	rising	fast,	at	10,	15	or	even	25	per	cent	per
year.27
The	Second	Oil	Shock	in	1979	finished	off	the	Golden	Age	by	bringing	about	another	bout	of	high
inflation	and	helping	neo-liberal	governments	come	to	power	in	the	key	capitalist	countries,	especially	in
Britain	and	the	US.
This	period	is	often	depicted	as	one	of	an	unmitigated	economic	disaster	by	free-market	economists,
who	are	critical	of	the	mixed	economy	model.	This	is	misleading.	Growth	in	the	ACCs	may	have	slowed
down	compared	to	the	Golden	Age,	but,	at	2	per	cent	per	capita,	income	growth	rate	during	1973–80	was
still	much	higher	than	any	period	up	to	the	Second	World	War	(1.2–1.4	per	cent)	and	slightly	higher	than
what	followed	in	the	next	three	decades	of	neo-liberalism	(1.8	per	cent	for	1980–2010).28	The
unemployment	rate,	at	4.1	per	cent	average,	was	higher	than	that	of	the	Golden	Age	(3	per	cent),	but	not	by
much.29	Still,	the	fact	remains	that	there	was	enough	dissatisfaction	with	economic	performance	during
this	period	for	there	to	be	radical	changes	in	the	following	years.
1980–Today:	The	Rise	and	Fall	of	Neo-liberalism
The	Iron	Lady:	Margaret	Thatcher	and	the	end	of	British	post-war	compromise
A	major	turning	point	came	with	the	election	of	Margaret	Thatcher	as	the	British	prime	minister	in
1979.	Rejecting	the	post-Second	World	War	‘wet’	Tory	compromise	with	Labour,	Thatcher	began	a
radical	dismantling	of	the	mixed	economy,	in	the	process	earning	the	sobriquet	‘The	Iron	Lady’	for	her
uncompromising	attitude.
The	Thatcher	government	lowered	higher-rate	income	taxes,	reduced	government	spending	(especially
in	education,	housing	and	transport),	introduced	laws	reducing	union	power	and	abolished	capital	control
(restriction	on	the	cross-border	movement	of	money).	The	most	symbolic	move	was	privatization	–	sales
of	SOEs	to	private	investors.	Gas,	water,	electricity,	steel,	airline,	automobile	and	parts	of	public	housing
were	privatized.
Interest	rates	were	raised	in	order	to	reduce	inflation	by	dampening	economic	activities	and	thus
demand.	The	high	interest	rate	attracted	foreign	capital,	driving	up	the	value	of	the	British	pound,	thus
making	British	exports	uncompetitive.	The	result	was	a	huge	recession,	as	consumers	and	companies
retrenched,	between	1979	and	1983.	Unemployment	soared	to	3.3	million	people	–	this	under	a
government	that	came	to	power	by	criticizing	James	Callaghan’s	Labour	government’s	record	on
unemployment,	which	went	over	the	1	million	mark,	with	the	famous	slogan	‘Labour	isn’t	working’,
invented	by	the	advertising	agency	Saatchi	&	Saatchi.
During	the	recession,	a	huge	chunk	of	British	manufacturing	industry,	which	had	already	been	suffering
from	declining	competitiveness,	was	destroyed.	Many	traditional	industrial	centres	(such	as	Manchester,
Liverpool	and	Sheffield)	and	mining	areas	(North	England	and	Wales)	were	devastated,	as	depicted	in
movies	such	as	Brassed	Off	(about	coal	miners	in	Grimley,	a	thinly	disguised	version	of	Yorkshire	coal
town	Grimethorpe).
The	actor:	Ronald	Reagan	and	the	re-making	of	the	US	economy
Ronald	Reagan,	the	former	actor	and	a	former	governor	of	California,	became	the	US	president	in	1981
and	outdid	Margaret	Thatcher.	The	Reagan	government	aggressively	cut	the	higher	income	tax	rates,
explaining	that	these	cuts	would	give	the	rich	greater	incentives	to	invest	and	create	wealth,	as	they	could
keep	more	of	the	fruits	of	their	investments.	Once	they	created	more	wealth,	it	was	argued,	the	rich	would
spend	more,	creating	more	jobs	and	incomes	for	everyone	else;	this	is	known	as	the	trickle-down	theory.
At	the	same	time,	subsidies	to	the	poor	(especially	in	housing)	were	cut	and	the	minimum	wage	frozen	so
that	they	had	a	greater	incentive	to	work	harder.	When	you	think	about	it,	this	was	a	curious	logic	–	why
do	we	need	to	make	the	rich	richer	to	make	them	work	harder	but	make	the	poor	poorer	for	the	same
purpose?	Curious	or	not,	this	logic,	known	as	supply-side	economics,	became	the	foundational	belief	of
economic	policy	for	the	next	three	decades	in	the	US	–	and	beyond.
As	in	the	UK,	interest	rates	were	jacked	up	in	an	attempt	to	reduce	inflation.	Between	1979	and	1981,
interest	rates	more	than	doubled	from	around	10	per	cent	to	over	20	per	cent	per	year.	A	significant
portion	of	the	US	manufacturing	industry,	which	had	already	been	losing	ground	to	Japanese	and	other
foreign	competition,	could	not	withstand	such	an	increase	in	financial	costs.	The	traditional	industrial
heartland	in	the	Midwest	was	turned	into	‘the	Rust	Belt’.
Financial	deregulation	in	the	US	at	this	time	laid	the	foundation	for	the	financial	system	we	have	today.
The	rapid	increase	in	hostile	takeovers,	in	which	a	company	is	taken	over	against	the	will	of	the	existing
management,	changed	the	whole	corporate	culture	in	the	US.	Many	of	those	taking	over	were	‘corporate
raiders’	only	interested	in	asset	stripping	(namely,	the	sales	of	valuable	assets,	regardless	of	the	impact
on	the	long-term	viability	of	the	company),	immortalized	by	Gordon	‘Greed-is-good’	Gekko	in	the	1987
movie	Wall	Street.	To	avoid	such	a	fate,	firms	had	to	deliver	profits	faster	than	before.	Otherwise
impatient	shareholders	would	sell	up,	reducing	the	share	prices	and	thus	exposing	the	firm	to	greater
danger	of	hostile	takeover.	The	easiest	way	for	companies	to	deliver	quick	profit	was	through	downsizing
–	reducing	the	workforce	and	minimizing	investments	beyond	what	is	necessary	for	immediate	results,
even	though	these	actions	diminish	the	prospect	of	the	company	in	the	longer	run.
The	Third	World	debt	crisis	and	the	end	of	the	Third	World	Industrial	Revolution
The	most	lasting	legacy	of	the	high	interest	rate	policy	in	the	US	in	the	late	1970s	and	the	early	1980s	–
sometimes	called	the	Volcker	Shock,	named	after	the	then	chairman	of	the	US	central	bank	(the	Federal
Reserve	Board)	–	was	not	in	the	US	but	in	the	developing	countries.
Most	developing	countries	had	borrowed	heavily	in	the	1970s	and	the	early	1980s,	partly	to	finance
their	industrialization	and	partly	to	pay	for	the	more	expensive	oil,	following	the	Oil	Shocks.	When	the
US	interest	rates	doubled,	so	did	international	interest	rates,	and	this	led	to	a	widespread	default	on
foreign	debts	by	developing	nations,	starting	with	the	default	of	Mexico	in	1982.	This	is	known	as	the
Third	World	Debt	Crisis,	thus	known	because	the	developing	world	was	then	called	the	Third	World,
after	the	First	World	(the	advanced	capitalist	world)	and	the	Second	World	(the	socialist	world).
Facing	economic	crises,	developing	countries	had	to	resort	to	the	Bretton	Woods	Institutions	(the	IMF
and	the	World	Bank,	just	to	remind	you).	The	BWIs	made	it	a	condition	that	borrowing	countries
implement	the	structural	adjustment	programme	(SAP),	which	required	shrinking	the	role	of	the
government	in	the	economy	by	cutting	its	budget,	privatizing	SOEs	and	reducing	regulations,	especially	on
international	trade.
The	results	of	the	SAP	were	extremely	disappointing,	to	say	the	least.	Despite	making	all	the	necessary
‘structural’	reforms,	most	countries	experienced	dramatic	growth	slowdown	in	the	1980s	and	the	1990s.
Per	capita	income	growth	rates	in	Latin	America	(including	the	Caribbean)	collapsed	from	3.1	per	cent	in
1960–80	to	0.3	per	cent	in	1980–2000.	In	Sub-Saharan	Africa	(SSA),	per	capita	income	fell	during	this
period;	in	2000,	it	was	13	per	cent	lower	than	in	1980.	The	result	was	an	effective	arresting	of	the	Third
World	Industrial	Revolution,	which	is	the	name	that	Ajit	Singh,	the	Cambridge	economist,	used	in	order	to
describe	the	economic	development	experience	of	developing	countries	in	the	first	few	decades	following
decolonization.
Only	Chile	did	well	out	of	neo-liberal	policies	of	the	1980s	and	the	1990s,	but	at	considerable	human
cost	under	the	Pinochet	dictatorship	(1974–90).30	All	the	other	success	stories	of	this	period	were
economies	that	used	state	intervention	extensively	and	liberalized	only	gradually.	The	best	examples	of
this	were	Japan,	the	‘tiger’	(or	‘dragon’,	depending	on	your	animal	preference)	economies	of	East	Asia
(South	Korea,	Taiwan	and	Singapore)	and,	increasingly,	China.
The	wall	comes	crashing	down:	the	collapse	of	socialism
Then,	in	1989,	a	momentous	change	happened.	That	year,	the	Soviet	Union	started	to	unravel,	and	the
Berlin	Wall	was	torn	down.	Germany	was	reunited	(1990),	and	most	Eastern	European	countries
abandoned	communism.	By	1991,	the	Soviet	Union	itself	was	dismembered.	With	China	gradually	but
surely	opening	up	and	liberalizing	since	1978	and	with	Vietnam	(unified	under	the	Communist	rule	in
1975)	also	adopting	its	‘open	door’	policy	(Doi	Moi)	in	1986,	the	socialist	bloc	was	reduced	to	a	few
die-hard	states,	notably	North	Korea	and	Cuba.
The	problems	with	the	socialist	economies	were	already	well	known:	the	difficulty	of	planning	an
increasingly	diverse	economy,	incentive	problems	arising	from	weak	links	between	performance	and
reward	and	widespread	politically	determined	inequality	in	an	ostensibly	equal	society	(see	Chapter	9).
But	few,	including	the	most	anti-socialist	commentators,	had	thought	that	the	bloc	would	implode	so
quickly.
The	ultimate	problem	was	that	the	Soviet	bloc	economies	had	tried	to	build	an	alternative	economic
system	based	on	essentially	second-rate	technologies.	There	were,	of	course,	areas	like	space	and	arms
technologies	where	they	were	leading	the	world	(after	all,	in	1957	the	Soviet	Union	put	the	first	ever	man
in	space),	thanks	to	the	disproportionate	amount	of	resources	poured	into	them.	However,	when	it	became
evident	that	it	could	only	offer	its	citizens	second-rate	consumer	products	–	as	symbolized	by	Trabant,	the
East	German	car	with	plastic	body,	which	quickly	became	a	museum	piece	after	the	fall	of	the	Berlin	Wall
–	the	citizens	revolted.
In	the	next	decade	or	so,	the	socialist	countries	in	Eastern	Europe	made	a	headlong	dash	to	transform
themselves	(back)	into	capitalist	ones.	Many	thought	that	the	‘transition’	could	be	made	quickly.	Surely,	it
was	just	a	matter	of	privatizing	SOEs	and	reintroducing	the	market	system,	which	is	after	all	one	of	the
most	‘natural’	human	institutions?	Others	added	that	the	transition	had	to	be	made	quickly,	in	order	not	to
give	time	to	the	old	ruling	elite	to	regroup	itself	and	resist	change.	Most	countries	adopted	‘Big	Bang’
reforms,	trying	to	bring	capitalism	back	overnight.
The	result	was	nothing	short	of	a	disaster	in	most	countries.	Yugoslavia	disintegrated	and	descended
into	wars	and	ethnic	cleansing.	Many	former	republics	of	the	Soviet	Union	experienced	deep	depressions.
In	Russia,	the	economic	collapse	and	the	resulting	unemployment	and	economic	insecurity	caused	so	much
mental	stress,	alcoholism	and	other	health	problems	that	it	is	estimated	that	millions	more	people	died
than	would	have	been	the	case	if	the	pre-transition	trends	had	continued.31	In	many	countries,	the	old	elite
simply	‘changed	their	suits’	and	transformed	themselves	from	party	apparatchiks	into	businessmen,
enriching	themselves	hugely	by	acquiring	state	assets	at	knock-down	prices	through	corrupt	practices	and
‘insider	dealings’	in	the	privatization	process.	The	Central	European	countries	–	Poland,	Hungary,	the
Czech	Republic	and	Slovakia	–	fared	better,	especially	after	they	joined	the	European	Union	in	2004,
thanks	to	being	more	gradualist	in	their	reform	and	to	their	better	skill	bases.	But	even	in	the	case	of	these
countries,	it	is	difficult	to	hail	the	transition	experience	as	a	great	success.
The	fall	of	the	socialist	bloc	ushered	in	a	period	of	‘free-market	triumphalism’.	Some,	such	as	the
American	(then)	neo-con	thinker	Francis	Fukuyama,	pronounced	the	‘end	of	history’	(no,	not	the	end	of	the
world)	on	the	grounds	that	we	had	finally	conclusively	identified	the	best	economic	system	in	the	form	of
capitalism.	The	fact	that	capitalism	comes	in	many	varieties,	each	with	particular	strengths	and
weaknesses,	was	blissfully	ignored	in	the	euphoric	mood	of	the	day.
One	world,	ready	or	not:	globalization	and	the	new	world	economic	order
By	the	mid-1990s,	neo-liberalism	had	spread	throughout	the	world.	Most	of	the	old	socialist	world	had
been	absorbed	into	the	capitalist	world	economy,	either	through	the	‘Big	Bang’	reforms	or,	as	in	the	case
of	China	and	Vietnam,	through	gradual	but	constant	opening	up	and	deregulation.	By	this	time,	market
opening	and	liberalization	had	also	progressed	considerably	in	most	developing	countries.	In	most
countries,	this	happened	rapidly	due	to	the	SAP,	but	there	were	some	others	where	it	happened	more
gradually	through	voluntary	policy	changes,	such	as	in	India.
Around	this	time,	some	important	international	agreements	were	signed	that	signalled	a	new	era	of
global	integration.	In	1994,	the	NAFTA	(North	American	Free	Trade	Agreement)	was	signed	between	the
US,	Canada	and	Mexico.	It	was	the	first	major	free-trade	agreement	between	developed	countries	and	a
developing	country.	In	1995,	the	Uruguay	Round	of	the	GATT	talks	was	concluded,	resulting	in	the
expansion	of	the	GATT	into	the	WTO	(World	Trade	Organization).	The	WTO	covers	many	more	areas
(e.g.,	intellectual	property	rights,	such	as	patents	and	trademarks,	and	trade	in	services)	and	has	more
sanctioning	power	than	the	GATT	did.	Economic	integration	progressed	further	in	the	EU,	with	the
completion	of	the	‘Single	Market’	project	(with	the	so-called	‘four	freedoms	of	movement’	–	of	goods,
services,	people	and	money)	in	1993	and	with	the	1995	accession	of	Sweden,	Finland	and	Austria.*	The
combined	result	was	the	creation	of	an	international	trading	system	that	was	much	more	geared	towards
freer	(although	not	entirely	free)	trade.
Also	the	idea	of	globalization	emerged	as	the	defining	concept	of	the	time.	International	economic
integration	of	course	had	been	going	on	since	the	sixteenth	century,	but	according	to	the	new	globalization
narrative,	this	process	has	reached	an	entirely	new	stage.	This	was	thanks	to	the	technological	revolutions
in	communications	(the	internet)	and	transportation	(air	travel,	container	shipping),	which	were	leading	to
the	‘death	of	distance’.	According	to	the	globalizers,	countries	now	had	no	choice	but	to	embrace	this	new
reality	and	fully	open	up	to	international	trade	and	investments,	while	liberalizing	their	domestic
economies.	Those	who	resisted	this	inevitability	were	derided	as	the	‘modern	Luddites’,	who	think	they
can	bring	back	a	bygone	world	by	reversing	technological	progress	(see	above).	Book	titles	like	The
Borderless	World,	The	World	Is	Flat	and	One	World,	Ready	or	Not	summed	up	the	essence	of	this	new
discourse.
The	beginning	of	the	end:	the	Asian	financial	crisis
The	euphoria	of	the	late	1980s	and	the	early	1990s	didn’t	last.	The	first	sign	that	not	everything	was
fine	with	the	‘brave	new	world’	came	with	the	financial	crisis	in	Mexico	in	1995.	Too	many	people	had
invested	in	Mexican	financial	assets	with	the	unrealistic	expectation	that,	having	fully	embraced	free-
market	policies	and	having	signed	the	NAFTA,	the	country	was	going	to	be	the	next	miracle	economy.
Mexico	was	bailed	out	by	the	US	and	the	Canadian	governments	(who	didn’t	want	a	collapse	in	their	new
free-trade	partner)	as	well	as	by	the	IMF.
In	1997,	a	bigger	shock	came	about	with	the	Asian	financial	crisis.	A	number	of	hitherto	successful
Asian	economies	–	the	so-called	‘MIT	economies’	(Malaysia,	Indonesia	and	Thailand)	and	South	Korea	–
got	into	financial	troubles.	The	culprit	was	the	bursting	of	the	asset	bubbles	(asset	prices	rising	well
above	their	realistic	levels,	based	on	unrealistic	expectations).
While	they	had	been	more	cautious	than	other	developing	regions	in	opening	up	their	economies,	these
countries	opened	up	their	financial	markets	quite	radically	in	the	late	1980s	and	the	early	1990s.	Now
facing	fewer	restrictions,	their	banks	borrowed	aggressively	from	the	rich	countries,	which	had	lower
interest	rates.	In	their	turn,	the	rich-country	banks	saw	little	risk	in	lending	to	countries	with	decades-long
excellent	economic	records.	As	more	foreign	capital	flowed	in,	asset	prices	went	up,	which	enabled	firms
and	households	in	the	Asian	countries	to	borrow	even	more,	using	their	now	more	valuable	assets	as
collateral.	Soon	the	process	became	a	self-fulfilling	prophecy,	as	the	expectation	of	ever-rising	asset
prices	justified	further	borrowing	and	lending	(sounds	familiar?).	When	it	later	became	clear	that	those
asset	prices	were	unsustainable,	money	was	pulled	out,	and	financial	crises	ensued.
The	Asian	crisis	left	a	huge	scar	in	the	afflicted	economies.	In	economies	where	5	per	cent	growth	(in
per	capita	terms)	was	considered	a	‘recession’,	output	fell	in	1998	by	16	per	cent	in	Indonesia	and	6–7
per	cent	in	the	other	economies.	Tens	of	millions	of	people	were	thrown	out	of	work	in	societies	where
unemployment	means	penury,	given	the	small	size	of	the	welfare	state.
In	return	for	the	bail-out	money	from	the	IMF	and	the	rich	countries,	the	crisis-stricken	Asian	countries
had	to	accept	a	lot	of	policy	changes	–	all	in	the	direction	of	liberalizing	their	markets,	especially	their
financial	markets.	While	it	pushed	the	Asian	economies	themselves	on	in	a	more	market-oriented
direction,	the	Asian	crisis	–	and	the	Brazilian	and	the	Russian	crises	that	immediately	followed	it	–
actually	planted	the	first	seed	of	scepticism	about	post-Cold	War	free-market	triumphalism.	There	were
serious	discussions	about	the	need	to	reform	the	global	financial	system,	much	of	them	along	the	same
lines	as	the	ones	that	we	have	seen	following	the	2008	global	financial	crisis.	Even	many	leading
advocates	of	globalization	–	like	the	Financial	Times	columnist	Martin	Wolf	and	the	free-trade	economist
Jagdish	Bhagwati	–	started	questioning	the	wisdom	of	allowing	free	international	capital	flows.	All	was
not	well	with	the	new	global	economy.
The	false	dawn:	from	the	dot.com	boom	to	the	Great	Moderation
When	these	crises	were	brought	under	control,	talk	of	global	financial	reform	receded.	In	the	US,	a
major	push	in	the	other	direction	came	in	the	form	of	the	1999	repeal	of	the	iconic	New	Deal	legislation,
the	1933	Glass-Steagall	Act,	which	structurally	separated	commercial	banking	from	investment	banking.
There	was	another	moment	of	panic	in	2000,	when	the	so-called	dot.com	bubble	–	in	which	internet-
based	companies	with	no	prospect	of	generating	any	profit	in	the	foreseeable	future	had	their	shares
valued	at	absurdly	high	levels	–	burst	in	the	US.	The	panic	soon	receded,	as	the	US	Federal	Reserve
intervened	and	cut	interest	rates	aggressively	and	the	central	banks	of	other	rich	economies	followed	suit.
From	then	on,	the	early	years	of	the	millennium	seemed	to	be	going	swimmingly	well	in	the	rich
countries,	especially	in	the	US.	Growth	was	robust,	if	not	exactly	spectacular.	Asset	prices	(prices	of	real
estate,	company	shares	and	so	on)	seemed	to	be	going	up	forever.	Inflation	remained	low.	Economists	–
including	Ben	Bernanke,	the	chairman	of	the	Federal	Reserve	Board	between	February	2006	and	January
2014	–	talked	of	the	‘Great	Moderation’,	in	which	the	science	of	economics	had	finally	conquered	boom
and	bust	(or	the	economy	going	up	and	down	by	large	margins).	Alan	Greenspan,	the	chairman	of	the
Federal	Reserve	Board	between	August	1987	and	January	2006,	was	revered	as	the	‘Maestro’	(as
immortalized	in	the	title	of	his	biography	by	Bob	Woodward	of	Watergate	fame)	who	had	a	near-
alchemical	skill	in	managing	a	permanent	economic	boom	without	stoking	inflation	or	courting	financial
trouble.
During	the	middle	years	of	the	2000s,	the	rest	of	the	world	finally	started	to	feel	the	‘miracle’	growth	of
China	of	the	preceding	two	decades.	In	1978,	at	the	beginning	of	its	economic	reform,	the	Chinese
economy	accounted	for	only	2.5	per	cent	of	the	world	economy.32	It	had	minimal	impact	on	the	rest	of	the
world	–	its	share	of	world	merchandise	(goods)	export	was	a	mere	0.8	per	cent.33	By	2007,	the
corresponding	numbers	had	risen	to	6	per	cent	and	8.7	per	cent.34	Being	relatively	poorly	endowed	with
natural	resources	and	growing	at	breakneck	speed,	it	started	sucking	in	food,	minerals	and	fuel	from	the
rest	of	the	world,	and	the	effect	of	its	growing	weight	was	felt	more	and	more	strongly.
This	gave	a	boost	to	the	raw-material	exporters	of	Africa	and	Latin	America,	finally	allowing	these
economies	to	make	up	some	of	the	ground	they	had	lost	in	the	1980s	and	the	1990s.	China	also	became	a
major	lender	and	investor	in	some	African	countries,	giving	the	latter	some	leverage	in	negotiating	with
the	BWIs	and	the	traditional	aid	donors,	such	as	the	US	and	the	European	countries.	In	the	case	of	the
Latin	American	countries,	this	period	also	saw	a	departure	from	the	neo-liberal	policies	that	had	served
them	so	poorly	in	several	countries.	Brazil	(Lula),	Bolivia	(Morales),	Venezuela	(Chavez),	Argentina
(Kirchner),	Ecuador	(Correa)	and	Uruguay	(Vasquez)	were	the	most	prominent	examples.
A	crack	in	the	wall:	the	2008	global	financial	crisis
In	early	2007,	alarm	bells	were	rung	by	those	who	were	worried	about	the	(non-)repayment	of
mortgage	loans	that	are	euphemistically	called	‘subprime’	(read	‘having	high	chance	of	default’),	made	by
US	financial	firms	in	the	preceding	housing	boom.	People	with	no	stable	income	and	chequered	credit
histories	were	lent	more	money	than	they	could	afford	to	pay	back,	on	the	assumption	that	house	prices
would	keep	going	up.	They	would	be	able	to	repay	their	loans,	it	was	reckoned,	by	selling	their	houses,	if
worse	came	to	worst.	On	top	of	that,	thousands	or	even	hundreds	of	thousands	of	these	high-risk	mortgage
loans	were	combined	into	‘composite’	financial	products,	such	as	the	MBS	and	the	CDO	(no	need	to
know	what	they	were	at	this	stage	–	I	will	explain	them	in	detail	in	Chapter	8)	and	sold	as	low-risk
assets,	on	the	assumption	that	the	chance	of	a	large	number	of	borrowers	simultaneously	getting	into
trouble	must	be	much	lower	than	that	for	individual	borrowers.
Initially,	the	problem	mortgage	loans	in	the	US	were	estimated	to	be	$50–100	billion	–	not	a	small
amount	but	an	amount	that	can	be	easily	absorbed	by	the	system	(or	so	many	claimed	at	the	time).
However,	the	crisis	erupted	properly	in	the	summer	of	2008,	with	the	bankruptcy	of	the	investment	banks
Bear	Stearns	and	then	Lehmann	Brothers.	A	huge	financial	panic	swept	the	world.	It	was	revealed	that
even	some	of	the	most	venerable	names	in	the	financial	industry	were	in	big	trouble,	having	generated	and
bought	huge	numbers	of	dubious	composite	financial	products.
The	‘Keynesian	spring’	and	the	return	of	the	free-market	orthodoxy	–	with	a	vengeance
The	initial	responses	of	the	major	economies	were	very	different	from	those	following	the	Great
Depression.	Macroeconomic	policies	were	Keynesian	in	the	sense	that	they	let	huge	budget	deficits
develop	–	at	least	not	by	cutting	spending	in	line	with	falling	tax	revenues	and	in	some	cases	by	increasing
government	spending	(China	did	this	most	aggressively).	Major	financial	institutions	(e.g.,	the	UK’s	Royal
Bank	of	Scotland)	and	industrial	firms	(e.g.,	GM	and	Chrysler	in	the	US)	were	bailed	out	with	public
money.	Central	banks	brought	interest	rates	down	to	historical	lows	–	for	example,	the	Bank	of	England
cut	its	interest	rate	to	the	lowest	level	since	its	foundation	in	1694.	When	they	could	not	cut	their	interest
rates	any	more,	they	engaged	in	what	is	known	as	quantitative	easing	(QE)	–	basically,	the	central	bank
creating	money	out	of	thin	air	and	releasing	it	into	the	economy,	mainly	by	buying	government	bonds.
Soon,	however,	free-market	orthodoxy	came	back	with	a	vengeance.	May	2010	was	the	turning	point.
The	election	of	the	Conservative-led	coalition	government	in	the	UK	and	the	imposition	of	the	Eurozone
bail-out	programme	for	Greece	in	that	month	signalled	the	comeback	of	the	old	balanced	budget	doctrine.
Austerity	budgets,	in	which	spending	is	cut	radically,	have	been	imposed	in	the	UK	and	in	the	so-called
PIIGS	economies	(Portugal,	Italy,	Ireland,	Greece	and	Spain).	The	success	of	the	Republicans	in	pushing
the	Obama	government	in	the	US	to	accept	a	huge	spending	cut	programme	in	2011	and	the	reaffirmation
of	the	anti-deficit	bias	of	the	core	European	countries	in	the	form	of	the	European	Fiscal	Compact,	signed
in	2012,	pushed	things	even	further	in	that	direction.	In	all	these	countries,	but	especially	the	UK,	the
political	right	are	even	using	the	argument	for	balancing	the	budget	as	an	excuse	to	severely	prune	back
the	welfare	state,	which	they	have	always	wanted	to	reduce.
The	consequences:	the	lost	decade?
The	2008	crisis	has	had	devastating	consequences,	and	its	end	is	nowhere	in	sight.	Four	years	after	the
crisis,	at	the	end	of	2012,	per	capita	output	remained	lower	than	in	2007	in	twenty-two	of	the	thirty-four
member	countries	of	the	OECD	(Organization	for	Economic	Cooperation	and	Development),	the	Paris-
based	club	of	rich	countries	(with	a	handful	of	developing	country	members).*	GDP	per	capita	in	2012,
when	filtering	out	the	effect	of	price	inflation,	was	26	per	cent	below	the	2007	level	in	Greece,	12	per
cent	below	in	Ireland,	7	per	cent	below	in	Spain	and	6	per	cent	below	in	the	UK.	Even	in	the	US,	which	is
said	to	have	recovered	better	than	other	countries	from	the	crisis,	per	capita	income	in	2012	was	still	1.4
per	cent	below	the	2007	level.†
With	the	austerity	budget,	the	prospect	for	economic	recovery	in	many	of	these	countries	is	dim.	The
problem	is	that	a	radical	cut	in	government	spending	in	a	stagnating	(or	even	shrinking)	economy	holds
back	recovery.	We	have	already	seen	this	during	the	Great	Depression.	As	a	result,	it	may	take	a	good	part
of	the	decade	before	many	of	these	countries	can	get	back	to	what	they	used	to	be	in	2007.	They	could
well	be	in	the	middle	of	a	‘lost	decade’,	as	was	experienced	in	Japan	(the	1990s)	and	in	Latin	America
(the	1980s).
It	is	estimated	that,	at	its	depth,	the	crisis	created	80	million	extra	unemployed	people	worldwide.	In
Spain	and	Greece,	unemployment	shot	up	from	around	8	per	cent	before	the	crisis	to	26	per	cent	and	28
per	cent	respectively	in	the	summer	of	2013.	Youth	unemployment	is	well	over	55	per	cent.	Even	in
countries	experiencing	‘milder’	unemployment	problems,	such	as	the	US	and	the	UK,	official
unemployment	rates	reached	8–10	per	cent	at	their	heights.
Too	little	too	late?:	prospects	for	reform
Despite	the	scale	of	the	crisis,	policy	reforms	have	been	slow	in	coming.	Despite	the	fact	that	the	cause
of	the	crisis	lay	in	excessive	liberalization	in	the	financial	market,	financial	reforms	have	been	rather	mild
and	are	being	introduced	very	slowly	(over	several	years,	when	the	US	banks	had	a	year	to	comply	with
the	much	tougher	New	Deal	financial	reforms).	There	are	areas	of	finance,	such	as	the	trading	in	overly
complex	financial	products,	in	which	even	mild	and	slow	reforms	are	not	being	introduced.
Of	course,	this	trend	could	be	reversed.	After	all,	in	both	the	post-Depression	US	and	Sweden,	the
reforms	came	only	after	a	few	years	of	economic	downturn	and	hardship.	Indeed,	the	electorate	in	the
Netherlands,	France	and	Greece	voted	out	pro-austerity	parties	in	the	spring	of	2012;	Italian	voters	did
likewise	in	2013.	The	EU	has	introduced	some	financial	regulations	that	are	tougher	than	what	many
people	had	imagined	likely	(e.g.,	financial	transaction	tax,	cap	on	financial	sector	bonuses).	Switzerland,
frequently	considered	the	haven	of	the	super-rich,	passed	a	law	in	2013	preventing	high	rewards	for	top
managers	with	mediocre	performances.	While	there	remains	a	lot	more	to	be	done	in	relation	to	financial
reform,	these	are	actually	developments	that	would	have	been	considered	impossible	before	the	crisis.
Further	Reading
P.	BAIROCH
Economics	and	World	History:	Myths	and	Paradoxes	(New	York	and	London:	Harvester	Wheatsheaf,
1993).
H.-J.	CHANG
Kicking	Away	the	Ladder:	Development	Strategy	in	Historical	Perspective	(London:	Anthem,	2002).
B.	EICHENGREEN
The	European	Economy	since	1945:	Coordinated	Capitalism	and	Beyond	(Princeton,	NJ:	Princeton
University	Press,	2007).
A.	GLYN
Capitalism	Unleashed	(Oxford:	Oxford	University	Press,	2007).
D.	LANDES
The	Unbound	Prometheus	(Cambridge:	Cambridge	University	Press,	2003).
A.	MADDISON
Contours	of	the	World	Economy,	1-2030	AD	(Oxford:	Oxford	University	Press,	2007).
S.	MARGLIN	AND	J.	SCHOR	(EDS.)
The	Golden	Age	of	Capitalism	(Oxford:	Clarendon,	1990).
D.	NAYYAR
Catch	Up:	Developing	Countries	in	the	World	Economy	(Oxford:	Oxford	University	Press,	2013).