Peter Lyons: Capitalism's flaws are fixable

The anti-greed protests are likely to fizzle out due to a lack of clarity as to what they are protesting about and what changes they actually want. There is general unease amongst many people in Western societies that our economic system is not serving us well in ensuring increased general prosperity.

This unease has morphed into anger at greedy bankers and the one-percenters labelled as the winners in our current version of capitalism.

Since the 18th century there has been three broad versions of industrial capitalism. The first version called classical capitalism was described by Adam Smith in The Wealth of Nations published in 1776. He described a system of markets, prices, profit and private property that created a natural order of how humans could live. He believed that humans acting with enlightened self interest and motivated by profit could benefit the whole of society without actually intending to do so. His famous quote was "it is not from the benevolence of the butcher, the brewer or the baker that we expect our evening meal but rather from their regard for their own self interest".

Under such a system markets set the prices for goods and services and resources. If the price of an item increased producers would produce more of it motivated by profit. This ensured that resources would be used efficiently to meet people's needs and wants.

Smith's version of a self regulating natural economic order ran into serious problems in the 1930s with the Great Depression. Capitalism has an unfortunate tendency to suffer from periodic booms and slumps often due to shoddy lending practices by the financial sector. The 1930s was a decade of painfully high unemployment, falling incomes and general despair throughout much of the world.

It was following this bleak period of Depression and World War that Capitalism Version 2 emerged. In the post war period this version known as Keynesian economics prevailed in most Western economies. It was named after its intellectual founder, John Maynard Keynes. Key features of this system included government policies focused on growth and full employment.

There was tight regulation of financial sectors and global finance. Banking was regarded as boring. There were no credit swaps or CDO's or sub prime mortgages. Banks took in deposits and lent them out mainly to local businesses and home buyers. Credit was tightly controlled by the level of savings and direct government controls. A fixed system of exchange rates was created against the US dollar which was in turn fixed against gold.

Governments also controlled key areas of production such as electricity and water as well as the provision of education and healthcare. Governments were generally committed to providing basic safety nets for less well off citizens in the form of sickness and unemployment benefits and pensions. This policy of income redistribution was funded by progressive income taxes where higher income earners paid a higher average tax rate. An unwritten social contract ensured that income inequalities did not spiral to obscene levels.

Capitalism Version 2 unravelled in the early 1970s. Huge US government deficits and spending mainly to fund the Vietnam war undermined international confidence in the US dollar as the benchmark for exchange rates. In 1971 President Nixon removed the US dollar from the gold standard. Most nations eventually floated their currencies unhooking them from the US dollar.

Spikes in oil prices following war in the Middle East in 1973 led to inflation and unemployment. There were further oil price hikes throughout the 1970s as oil producing nations flexed their market power. Governments responded by trying to spend their way to growth and full employment. This led to rising inflation and more unemployment in a phenomenon known as stagflation.

Capitalism Version 3 emerged from the early 1980s with the elections of Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States. Its intellectual father was Milton Friedman of the University of Chicago. This version currently prevails. It is sometimes called Neoclassical economics or monetarism. It harks back to version 1 with the belief that if the government would just leave the economy largely untouched people could pursue their own self interest and society would benefit. It is based on Smith's concept of a natural economic order if people are left to do their own thing.

History shows that capitalism is the worst economic system apart from all the alternatives as yet known. The past few hundred years of industrial capitalism has lifted the vast mass of humanity out of lives that were described as "nasty, brutish and short".

Compared to our ancestors we live far longer, healthier and more productive lives. We have access to food, housing, healthcare, education, electricity, cars, computers, telephones, The Simpsons and Coronation Street which would have been beyond the wildest dreams of our ancestors. In the developed world we are living in the best of all possible times.

So back to the protesters. They are right to protest against the fundamental flaws of capitalism. The most obvious social flaws are the tendency towards massive and unhealthy inequalities of income and wealth and the booms and slumps created by unregulated financial sectors that run amok. Both of these flaws are fixable if the political will exists.

The last time that political will existed on a scale large enough to create meaningful change was following the misery and horror of the Great Depression and Second World War.

* Peter Lyons teaches at Saint Peters College in Epsom and has authored several Economics texts.