Are we pro-business or pro-market?

Today's must-read is this longish piece from U of Chicago economist Luigi Zingales, who says we're at a crossroads in the future of capitalism. American capitalism depends on the shared belief of most of us that the economy is more or less fair -- that is, that even though outcomes may be unequal, most people play by the rules, and the rules allocate resources justly. But American capitalism is now at a place in which people don't trust the system; in fact, they despise financiers and their rent-seeking. Excerpt:

Capitalism has long enjoyed exceptionally strong public support in the United States because America's form of capitalism has long been distinct from those found elsewhere in the world -- particularly because of its uniquely open and free market system. Capitalism calls not only for freedom of enterprise, but for rules and policies that allow for freedom of entry, that facilitate access to financial resources for newcomers, and that maintain a level playing field among competitors. The United States has generally come closest to this ideal combination -- which is no small feat, since economic pressures and incentives do not naturally point to such a balance of policies. While everyone benefits from a free and competitive market, no one in particular makes huge profits from keeping the system competitive and the playing field level. True capitalism lacks a strong lobby.

That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one, though American capitalism has always managed this tension far better than most.

But, as Zingales recounts, the finance sector and its elites, for various reasons, have captured the U.S. government, in the sense that economic policy is largely driven to suit finance's interests. In a fascinating, highly readable discussion too important in its details to excerpt here, Zingales discusses how structural changes in financial regulation suited financial businesses, at the expense of keeping up competitive pressures that would have kept the market healthier. The consolidation of financial firms led to them concentrating power, and using their extraordinary profits essentially to buy influence in Washington. Moreover, the smartest people in the country started flocking to finance, because that's where the money was. The policymaking effect of that, though, is a mistake common to all elites: the assumption that what was good for their part was good for the whole.

And now, we are where we are. But where are we going? Zingales:

We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry -- or any business, for that matter -- and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.

The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.

Zingales is not confident that America, or American capitalism, is on the right path.