A Review of Anatole Kaletsky’s “Capitalism 4.0  The Birth of a New Economy”

I am terribly inspired.  I’m inspired by Anatole Kaletsky’s terrific book, Capitalism 4.0 (Bloomsbury 2010).  I received this book, as a gracious surprise, following the Strategic Investment Conference that I attended at the end of April.  Louis Gave, a brilliant analyst and thinker with GaveKal Research thought that I would enjoy Anatole’s book.  I’d never heard of it; but, later in May, it arrived at my office.  I spent the better part of the summer trying to get through the first meaty 100 pages.  Then, on my unexpected second trip to Europe this summer, I found time to work through the next 230 pages.

I agree with Kaletsky, that when the historians write about our time, they will say that the 21st century began in 2010 following the financial disaster of 2007-2009.  We in the investment community and you in your communities are all struggling with so many things. We’re identifying what is changing and what it means. Further, we’re thinking more about the relationship between markets and governments, the social contract and the working poor, the developing world and the developed one. And we’re pondering how we negotiate through the debt crisis and into the next energy crisis.  The challenge, too, is this: How do we do it with optimism? Who is right, the optimists or the pessimists?

One of my goals this year has been to ask better questions.  I recently posed a few questions and comments to some clients of mine.  That action set off a flood of email replies, with one fellow firmly convinced that the human race will reach a breaking point in probably the second half of this century, collapse, and then have to start over.  While the other side is more optimistic.  She sees opportunity.  And she reminded me, it starts right at home.  If we all make better individual decisions, then collectively the collapse of our civilization is by no means assured.  This brings me to why I am so excited about Kaletsky’s book: namely, I believe that Capitalism 4.0 sheds great historical and philosophical light on the questions of our time.

Kaletsky’s puts the last 30 years, the breaking point of the 2007-2009 financial crisis, and the future all in perspective.  His perspective could not be more timely.  In the next several issues of Barnes Capital’s “Insight Newsletter,” I will review and synthesize Kaletsky’s main points.  I hope you enjoy it.  It’s not terribly light reading, and it includes and requires more than a modicum of background in political philosophy and history — and some in economics, too.  I’ll do my best to distill the main points.  If I get long-winded at times, my apologies.

Anatole Kaletsky’s Background
Kaletsky was born in 1952.  His parents experienced true calamities and crisis: the Russian Revolution, two world wars, the Holocaust, and the purges of Stalin —  and they survived with joyful and indomitable spirit.  Kaletsky’s a journalist, editor at large of The Times in London, founding partner of GaveKal Capital and Dragonomics, an economic research business.  He has been NY bureau chief and Washington correspondent of the Financial Times and business writer for The Economist.

At first, I thought Kaletsky was a money manager.  I’m impressed, he’s a journalist who also completely understands money management, politics, history, theory, and economics.  A truly educated man, and one obviously embued with the indomitable spirit of his parents.  I hope that I will be able to meet up with Anatole in the next year or two.

Global Capitalism will be replaced by . . .
Kaletsky spends the first 35 pages recounting the first 3 phases of Capitalism.  His central argument is that global capitalism will be replaced by nothing other than global capitalism.  Global Capitalism died on September 15, 2008.   What fell apart the day that the U.S. Treasury allowed Lehman Brothers to fail was an entire political philosophy and economic system.  Systemic collapse of the U.S. and international banking system commenced that day and, with it, the viability of the established market philosophy of the relationship of the government to private enterprise. The status quo was over.

The traumatic events of 2007-2009 set the following in motion: On the left, it seemed that a few weeks of nihilistic capitalist collapse and chaos would bring about the disintegration of two hundred years of political economic success through revolutions, depressions and world wars. On the right, free market zealots insisted that private enterprise would be destroyed.

These are, of course, completely understandable over-reactions. It reminds me a bit of a typical conversations with my teenage daughter, where every new event brings about the end of her existing universe (for that moment, and perhaps the next one) — and that’s developmentally normal for a young teen. That the political and professional elites and idealogues overreact in exactly the same way says little for their depth of understanding of the political and socioeconomic foundation of society.

Capitalism and Democracy: evolutionary stability
A balanced assessment of the hysteria of left-wing idealogues and the right-wing hubris is necessary.  Rather than place the blame on greedy bankers, gullible homeowners, lazy money managers, incompetent regulators, or foolish Chinese bureaucrats, Kaletsky succeeds in putting the collapse in historical and ideological context of the economic and geopolitical reforms and upheavals which have characterized Capitalism’s evolution for 250 years, most recently in crossover to Capitalism 3.0 which was the Thatcher-Reagan revolution of 1979-1989.

Kaletsky’s main point, is that Capitalism has never been static. There have never been fixed rules to govern the relationship between private persons (enterprise) and government.  Rather, Capitalism has always been characterized as a complex adaptive system that fluidly changes the relationships and rules between private persons and government to the mandated politics of each unique era in time.

Kaletsky writes, “When Capitalism is seriously threatened by a systemic crisis, a new version emerges that is better suited to the changing environment and replaces the previously dominant form.”

Once we recognize capitalism as the evolutionary system that it is, instead of a static set of institutions, we can see the Global Capitalist meltdown of 2007-2009 for what it was: The catalyst for the fourth systemic transformation of capitalism, which is  comparable to the changes wrought by the crisis of the 1970s, 1930s and Napoleanic Wars.  Hence the title of Kaletsky’s book: Capitalism 4.0, Birth of a New Economy

Democratic Capitalism is a ruthlessly successful problem-solving machine.  Voters tend to reward politicians for making their lives “better and safer” rather than “worse and more dangerous.”  Democratic competition directs institutions towards solving rather than aggravating society’s problems, even if these changes bring about new problems.  Political competition is slower than market competition, playing itself out over decades and generations instead of quarters and years, but both pull in the same direction. Both are trying  to find solutions to societal and market problems.  Together, democracy and capitalism are the perfectly ruthless and successful problem-solving machine because both are mechanisms that encourage individuals to channel their creativity, efforts and competitive spirit into finding solutions for society’s material and social problems.

Kaletsky shows that in the aftermath of the Great Financial Meltdown, conventional wisdom held that governments are ridiculous because they solve the problems of too much debt, with more debt and they bail out companies that should fail.

But in Capitalist Democracy, whose raison d’être is to meet longstanding social and material demands, a problem postponed is effectively a problem solved.  To be more exact, Kaletsky shows that a problem deferred long enough is a problem that is likely to be solved in ways scarcely imaginable today.

Kaletsky quotes the ever-optimistic Mr. Micawber in Charles Dickens’ novel David Copperfield. Micawber is convinced that “something will turn up.”  However, in order for something to turn up, one condition must exist: Capitalism and democracy themselves must survive.  This is why sacrifices to protect democracy against communism, fascism, religious fundamentalism and even banking collapse are rationally and morally admirable, while sacrifices on behalf of our grandchildren’s purely economic prosperity, are not (pp21).

Karl Marx noted that Capitalism creates internal contradictions that lead to crisis, threatening its survival.  What he and his followers missed, however, was the capacity of politics, particularly, democratic politics, to resolve these contradictions and enable capitalism to survive.

A Complex System
The pre-condition to allow the flexibility that this requires, which we’ve learned from history, evolutionary biology and common sense, is that in order for a complex system to survive in an unpredictable and constantly changing world, the system itself must have internal mechanisms allowing it to undergo radical change.  Kaletsky shows convincingly that both Capitalism and Democracy have the internal adaptability to undergo radical change.  The Global Financial Crisis was the fourth time in the history of Capitalism that the system faced the challenge of comprehensive change. Here are the others:

Capitalism 1.0
Lasting from 1776 until the 1920s, Capitalism 1.0  established itself in Western Europe and North America.  This was the “golden age” of laissez-faire capitalism, complete with robber barons and industry magnates, who created the large industrial enterprises and developed interstate commerce.  Their industriousness and growth pushed the mandate of the nation state as the dominant political entity.  Under Capitalism 1.0, politics and economics were treated as two separate, unrelated spheres of human activity.  While conventional wisdom held that the two spheres be held entirely at arms length from one another, they also held that the politics and Capitalism would rise and fall together.  This internal contradiction was brought to light with the worldwide Great Depression of the 1930s, which necessitating the re-invention of capitalism, namely Capitalism 2.0.

Capitalism 2.0
In Capitalism 2.0, the separation of politics and economics ended.  With the collapse complete in 1931-1933 economics became a branch of politics in Roosevelts New Deal.  Capitalism 2.0 evolved into the militant capitalism of World War II, and then the golden age of the postwar period (complete with a quite efficient military-industrial complex). The key difference between Capitalism 1.0 and Capitalism 2.0 was the relationship of the government to the economy and the market’s (and society’s) understanding of that relationship.

The chief theorists and leaders of this forty-year period assumed that market forces were often wrong and that government’s most important function was to tame and control unstable market forces for the good of the economy. With the great period of stagflation (high unemployment and high inflation) of the 1970s this ideology disintegrated nd ushered in the Reagan-Thatcher revolution (Capitalism 3.0).

Capitalism 3.0
Reagan and Thatcher interpreted Capitalism and its role to governement with a simple 180 degree turn.  In this radical reinvention, suddenly the market instead of the government was proclaimed the superior mechanism for weighing all things.  Instead of treating economics as a branch of politics, Capitalism in 3.0 treated politics as a branch of economics.  The intellectual leaders of Capitalism 3.0 maintained that governments were usually wrong and always inefficient.  The philosophy was this: Markets should be empowered everywhere to discipline and control venal politicians.  Capitalism 3.0 culminated in the final phase of 3.3, which Kaletsky calls “market fundamentalism.”  Solutions proposed outside of market mechanisms were not approachable in 3.3.  The blinders of market fundamentalism ultimately culminated into the global meltdown of the financial system on September 15, 2008.  Since that point in time, capitalism and democracy, in order to survive, have evolved into new era, one that is fundamentally different and with it, the birth of a new economy, Capitalism 4.0.

In the Part 2 of this review, I will examine Kaletsky’s analysis of how Capitalism bends without breaking.  We will also examine why its insane for rich people to bet on Mad Max’s victory and then I’ll attempt to tie together how the most recent era of Capitalism (3.0 from 1979-2008) blinded governments, corporations and citizens to non-market based solutions.

While its easy to conclude that government is indeed often inefficient (social security being the great exception), the call for relentless experimentation also implies that inefficiently going doing the right path may be better than efficiently going down the wrong one.

Daniel Barnes, CFA
Kreuzberg, Berlin                                                                                                             September 11, 2011