THE AGE OF TURBULENCE
phasize personal initiative: "The natural effort of every individual to better
his own condition, when suffered to exert itself with freedom and security
is so powerful a principle, that it is alone, and without any assistance ca-
pable of carrying on the society to wealth and prosperity" He concluded
that to enhance the wealth of a nation, every man, consistent with the law,
should be "free to pursue his own interest his own way" Competition was
a key factor because it motivated each person to become more productive,
often through specialization and division of labor. And the greater the pro-
ductivity, the greater the prosperity
This led Smith to his most famous turn of phrase: individuals who
compete for private gain, he wrote, act as if "led by an invisible hand" to
promote the public good. The metaphor of the invisible hand, of course,
captured the world's imagination—possibly because it seems to impute a
godlike benevolence and omniscience to the market, whose workings are in
reality as impersonal as natural selection, which Darwin came along and
described more than half a century later. The expression "invisible hand"
does not seem to have been very important to Smith; in all his writings, he
used it only three times. The effect it describes, however, is something he
discerns at every level of society, from the great flows of goods and com-
modities between nations to everyday neighborhood transactions: "It is not
from the benevolence of the butcher, the brewer, or the baker, that we ex-
pect our dinner, but from their regard to their own interest."
Smith's insight into the importance of self-interest was all the more
revolutionary in that, throughout history in many cultures, acting in one's
self-interest—indeed, seeking to accumulate wealth—had been perceived
as unseemly and even illegal. Yet in Smith's view, if government simply
provides stability and freedom and otherwise stays out of the way, personal
initiative will see to the common good. Or as he put it in a 1755 lecture:
"Little else is requisite to carry a state to the highest degree of opulence
from the lowest barbarism but peace, easy taxes and a tolerable administra-

sixteenth and seventeenth centuries. But the pace of growth was glacial. In
the seventeenth century, the great mass of people still were engaged in the
same productive practices as their forebears many generations earlier.
Smith held that working smarter, not merely harder, was the way to
wealth. In the opening paragraphs of The Wealth of Nations, he underscored
the crucial role played by the expansion of labor productivity. An essential
determinant of a nation's standard of living, he said, was "the skill, dexter-
ity, and judgment with which labor is generally applied." This flew in the
face of earlier theories, such as the mercantilist precept that a nation's
wealth was measured in troves of gold bullion, or the Physiocrat tenet that
value derived from the land. "Whatever be the soil, climate, or extent of
territory of any particular nation," Smith wrote, "the abundance or scanti-
263
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THE AGE OF TURBULENCE
ness of its annual supply" must depend upon "the productive powers of
labor." Two centuries of economic thought later, little has been added to
those insights.
With the help of Smith and his immediate successors, mercantilism
was gradually dismantled and economic freedom spread widely In Britain,
this process reached its finale with the 1846 repeal of the Corn Laws, a set
of tariffs that for many years had blocked imports of grain, keeping grain
prices and therefore landowners' rents artificially high—and elevating, of
course, the price paid by industrial wage earners for a loaf of bread. The ac-
ceptance of Smith's economics was, by then, prompting the reorganization
of commercial life in much of the "civilized" world.
Yet Smith's reputation and influence eroded as industrialization spread.
He was no hero to many who struggled during the nineteenth and twentieth
centuries against what they saw as the barbarism and injustice that accom-

George Bernard Shaw
;
H. G. Wells, and Bertrand Russell.
The Fabians laid the groundwork for modern social democracy and
their influence on the world would end up being at least as powerful as that
of Marx. While capitalism succeeded brilliantly in delivering higher and
higher standards of living for workers throughout the nineteenth and twen-
tieth centuries, it was the tempering effect of Fabian socialism that many
argued would make market economies politically palatable and keep com-
munism from spreading. Fabians took part in founding Britain's Labour
Party. They also had a profound influence on British colonies as the colonies
gained independence: in India in 1947, Jawaharlal Nehru drew on Fabian
principles to set economic policy for one-fifth of the world's population.
When I first read Adam Smith after World War II
;
regard for his theo-
ries was at a low ebb. And for much of the cold war, economies on both
sides of the iron curtain remained either heavily regulated or centrally
planned. "Laissez-faire" was practically a term of opprobrium; the most
prominent advocates of free-market capitalism were iconoclasts like Ayn
Rand and Milton Friedman. The pendulum of economic thinking began to
swing in Smith's favor in the late sixties, just as I began my public career.
The comeback has been long and slow, particularly in his native land. A
U.S. economist looking for Smith's grave in an Edinburgh churchyard in
2000 reported having to clear away beer cans and debris to read the worn
inscription on the stone:
HERE ARE DEPOSITED THE REMAINS OF ADAM SMITH.
AUTHOR OF THE THEORY OF MORAL SENTIMENTS
AND WEALTH OF NATIONS.
Yet Scotland, too, has come around to according Smith the kind of

national Monetary Fund. While we finance ministers and central bankers in
the room couldn't make out the words of the chants, it wasn't hard to un-
derstand the gist. They were protesting what they viewed as the depreda-
tions of increased global trade, particularly the oppression and exploitation
of the poor in developing countries. I was, and am, saddened by such events,
since were the protesters to succeed in destroying global trade, those most
harmed would be hundreds of millions of the world's poor, the very people
in whose name the protesters had chosen to speak.
While central planning may no longer be a credible form of economic
organization, it is clear that the intellectual battle for its rival—free-market
capitalism and globalization—is far from won. For twelve generations, capi-
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THE AGE OF TURBULENCE
talism has achieved one advance after another, as standards and quality of
living have risen at an unprecedented rate over large parts of the globe.
Poverty has been dramatically reduced and life expectancy has more than
doubled. The rise in material well-being—a tenfold increase in real per
capita income over two centuries—has enabled the earth to support a six-
fold increase in population. Yet, for many capitalism still seems difficult to
accept, much less fully embrace.
The problem is that the dynamic that defines capitalism, that of unfor-
giving market competition, clashes with the human desire for stability and
certainty. Even more important, a large segment of society feels a growing
sense of injustice about the allocation of capitalism's rewards. Competi-
tion, capitalism's greatest force, creates anxiety in all of us. One major
source of it is the chronic fear of job loss. Another, more deeply felt angst
stems from competition's perpetual disturbance of the status quo and style
of living, good or bad, from which most people derive comfort. I am sure
the American steel manufacturers I advised in the 1950s would have been

Regrettably, economic growth cannot produce lasting contentment or
happiness. Were that the case, the tenfold increase in world real per capita
GDP over the past two centuries would have fostered a euphoric rise in
human contentment. The evidence suggests that rising incomes do raise
happiness, but only up to a point and only for a time. Beyond the point at
which basic needs are met, happiness is a relative state that, over the long
run, is largely detached from economic growth. The evidence shows it is
determined mainly by how we view our lives and accomplishments rela-
tive to those of our peers. As prosperity spreads, or perhaps even as a result
of its spread, many people fear competition and change that threaten
their sense of status, which is critical to their self-esteem. Happiness de-
pends far more on how people's incomes compare with those of their per-
ceived peers, or even those of their role models, than on how they are doing
in any absolute material sense. When graduate students at Harvard were
asked a while back whether they would be happier with $50,000 a year
if their peers earned half that, or $100,000 if their peers earned double
that, the majority chose the lower salary. When I first saw the story, I chuck-
led and started to brush it off. But it struck a chord that unearthed a long-
dormant memory of a fascinating 1947 study by Dorothy Brady and Rose
Friedman.
Brady and Friedman presented data showing that the share of income
that an American family spent on consumer goods and services was largely
determined not by the level of family income but by its level relative to the
nation's average family income. Thus, their study suggests that a family
with the nation's average income in 2000 would be expected to spend
the same proportion of its income as a family with average family income
in 1900, even though in inflation-adjusted terms the 1900 income was only
a small fraction of that of 2000.1 reproduced and updated their calculations
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income for those households with a third of the nation's average income concentrates around
1.3 (their spending exceeds income by 30 percent). The spending/income ratio then falls even-
tually to about 0.8 at double the average income level.
tAn alternate way to reach the same conclusion is to observe that there is no discernible long-
term trend in the nation's household saving rate. Yet all surveys show the saving rate is higher
for upper-income households than for lower-income households. For both statements to be
true (and if the distribution of incomes does not veer outside its historical range), households
at any given dollar income level must be saving less as the aggregate incomes rise with time.
The extent of the downward creep in saving must be directly related to the growth rate of aver-
age household income.
tFood, of course, is a very useful proxy for the subsistence level, which shouldn't be tied to
where a family stood in the income pecking order.
2 70
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THE MODES OF CAPITALISM
ria of a higher standard of living soon wears off as the newly affluent adjust
to their better status in life. The new level is quickly perceived as "normal."
Any gain in human contentment is transitory*
People's conflicted reactions to capitalism have spawned a variety of
modes of capitalist practice in the postwar years, from highly regulated to
lightly constrained. While each individual has an opinion, there is a visible
tendency for much of a society to coalesce around a common point of view,
which often differs measurably from the choices of other societies. This, I
sense, results from the need of people to belong to groups defined by reli-
gion, culture, and history, which, in turn, is fostered by an innate need of
people for leaders: of the family, the tribe, the village, the nation. It is a uni-
versal trait that probably reflects the imperative for people to make choices
to govern their day-by-day behavior. Most people, much of the time, feel in-
adequate to the task and seek guidance from religious direction, the recom-

prises far greater freedom to compete than a society that perceives com-
petitive business as unethical or unsettling. In my experience, even many of
those who acknowledge the advantages to material well-being of competi-
tive capitalism are conflicted for two somewhat related reasons. First, com-
petition and risk taking cause stress, which most people wish to avoid;
second, many feel deep-seated ambivalence toward the accumulation of
wealth. On the one hand, wealth is a much-sought-after means of flaunting
status (Veblen would understand). But that view is opposed by the well-
nurtured belief best captured by the biblical injunction "it is easier for
a camel to go through the eye of a needle than for a rich man to enter
the kingdom of God." The ambivalence toward accumulation of material
wealth has a long cultural history that pervades society to this day. It has
had a profound influence on the development of the welfare state and the
social safety net that is at its core. It is argued that unconstrained risk taking
increases the concentration of income and wealth. The purpose of the wel-
fare state is to lessen that income and wealth concentration, which it does
largely through legislation that, via regulation, constrains risk taking and, via
taxation, reduces the pecuniary rewards that may result from taking risks.
Although the roots of socialism are secular, its political thrust parallels
many religious prescriptions for a civil society, seeking to assuage the an-
guish of the poor. The pursuit of wealth has been deemed unethical, if not
immoral, since long before the emergence of the welfare state.
This antimaterialist ethic has always been a low-intensity suppressant
to the acceptance of dynamic competition and the unfettered institutions
of capitalism. Many of the business titans of nineteenth-century American
industry were conflicted about the morality of holding on to material gains
from their ventures and gave away much of their wealth. To this day, a resi-
due of guilt about wealth accumulation exists under the surface of our
272
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worse, foreign ownership. That is a dangerous restraint on international
competition and another issue that differentiates one culture from another.
In 2006, for example, French officials blocked an Italian firm's attempt to
buy Suez Company, a large Paris-based utility manager, by promoting the
merger of Suez and Gaz de France. Both Spain and Italy have made simi-
larly protectionist moves.
The United States is scarcely innocent of such behavior. For example,
273
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THE AGE OF TURBULENCE
in June 2005, China National Offshore Oil Corporation (CNOOC), a sub-
sidiary of China's third-largest oil company, made a bid to buy Unocal, an
American oil company, for $18.5 billion in cash. This topped an earlier
$16.5 billion cash-and-stock offer from Chevron. Chevron cried foul, say-
ing the bid represented unfair competition from a government-controlled
company. U.S. lawmakers complained that "China's governmental pursuit
of world energy resources" represented a strategic threat. By August politi-
cal opposition rose to such a pitch that CNOOC withdrew its bid, saying
the controversy had produced "a level of uncertainty that presents an unac-
ceptable risk." Chevron got the deal, at the expense of a valuable U.S. asset:
our reputation for nondiscriminatory international fair dealing, particularly
our pledge to treat foreign corporations the same as domestic ones for reg-
ulatory purposes.
Just three months later, an Arab corporation named Dubai Ports World
bought a company that managed container terminals on the U.S. East and
Gulf coasts. The deal touched off more protest in Congress, as legislators
from both parties claimed that Arab management of U.S. ports would un-
dermine antiterrorism efforts and hurt national security. Finally, in March
2006, under pressure, Dubai Ports World announced it would transfer man-

have favors to extend, or something to sell. If there were unobstructed,
free flow of goods and people across national boundaries, customs and
immigration officials, for example, would have nothing to sell. Indeed,
their jobs would not exist. This was largely the case in the United States
before World War I. It is difficult for a twenty-first-century American to
comprehend the extent to which government was separated from business
in those early years. The little corruption that existed drew large newspaper
headlines. There were questionable transactions relating to the construc-
tion of canals in the early 1800s. Similarly, the building of the transconti-
nental railroad, with its huge land-grant subsidies, engendered much
duplicitous activity, leading to the Union Pacific-Credit Mobilier scandal of
1872. As infrequent as they were, such scandals are what people remember
of that period.
Despite the heavy involvement of government in business since the
1930s, a number of countries have achieved high ratings for staying free of
corruption, even though their civil servants have potentially sellable discre-
tion in fulfilling their regulatory roles. Particularly impressive have been
Finland, Sweden, Denmark, Iceland, Switzerland, New Zealand, and Singa-
pore. Culture obviously also plays a role in a society's level of corruption.
My longtime good friend Jim Wolfensohn, as president of the World Bank
from 1995 to 2005, fashioned the bank's policies to constrain corruption in
the developing world. I always thought this was a critical contribution to
world development.
There is no direct measure of the impact of cultural mores on eco-
nomic activity. But a joint venture of the Heritage Foundation and the Wall
275
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THE AGE OF TURBULENCE
Street Journal has in recent years combined statistics from the IMF, the Econ-

markets are quite restrictive; discharging employees is very expensive. Yet
*In some instances, however, political impediments have prevented governments from creating
or abolishing institutions to better reflect the cultural choices of their constituents.
2 76
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THE MODES OF CAPITALISM
at the same time, Germany ranks among the highest in terms of the free-
dom of its people to open and close businesses, property-rights protection,
and the overall rule of law. France (number forty-five) and Italy (number
sixty) have profiles that are similarly mixed.
The ultimate test of the usefulness of such a scoring process is whether
it correlates with economic performance. And it does. The correlation coef-
ficient of 157 countries between their "Economic Freedom Score" and the
log of their per capita incomes is 0.65, impressive for such a motley body
of data.*
Thus, we are left with a critical question: Granted that open competi-
tive markets foster economic growth, is there an optimum trade-off be-
tween economic performance and the competitive stress it imposes on the
one hand, and the civility that, for example, the continental Europeans and
many others espouse? Many Europeans contemptuously brand America's
economic regime "cowboy capitalism." Highly competitive free markets are
viewed as obsessively materialistic and largely lacking in meaningful cul-
tural values. This marked difference between the United States and conti-
nental Europe on support for competitive markets was captured most
clearly for me several years ago in a soliloquy attributed to former conser-
vative French prime minister Edouard Bahadur. He asked, "What is the
market? It is the law of the jungle, the law of nature. And what is civiliza-
tion? It is the struggle against nature." While acknowledging the ability of
competition to promote growth, many such observers nonetheless remain

these aberrations. It is instructive that despite the egregious breaches of
trust by some of America's business and financial leaders in recent decades,
productivity growth, an important metric of corporate efficiency, between
1995 and 2002 accelerated. I will have more to say on corporate gover-
nance in chapter 23.
What can history tell us about the stability of economic cultures over
the generations? What does it suggest about culture's impact on future out-
comes? Today, America's culture is much changed from what it was at our
founding, though it remains rooted in the values of our Founding Fathers. As
unfettered as today's American capitalism may appear, it is a pale image of
the capitalism of our earlier years. We probably came as close as we will ever
come to pure capitalism in the decades before our Civil War. Following a
largely, but not wholly, laissez-faire policy toward business and business
practice, the federal government provided little or no safety net for aspiring
capitalists in the race for wealth creation. If you failed, as many did, you
were expected to pick yourself up and start from scratch, often in the rap-
idly growing settlements of America's frontier. Decades later Herbert Spen-
*The tragedy of the denuding of Brazil's Amazon rain forests is that the inhabitants of the re-
gion need to cut down trees to survive.
2 78
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THE MODES OF CAPITALISM
cer, a follower of Charles Darwin
;
coined the phrase "survival of the fittest/'
a philosophy of competition that captured much of the prevailing ethos of
early America. FDR's New Deal was still a century in the future.
In my early twenties, I was drawn to this image of a rough-and-tumble
capitalist society based, I fantasized, largely on merit. I did not dwell on the

2 79
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THE AGE OF TURBULENCE
tion from Latin America will alter the cultural composition of our society.
But these are people who have chosen to leave their home countries, a
seeming rejection of much of the populist culture that has so inhibited
Latin American economic growth. That was also the case with the open
immigration at the turn of the last century. Those immigrants were success-
fully absorbed in our nation's "melting pot."
In the less pressing period after World War II, but before globalization
took hold, governments were able to construct social safety nets and engage
in other policies to shelter citizens from the gale of creative destruction. In
the United States, major expansions of Social Security, unemployment
insurance, worker-safety legislation, and, of course, Medicare headed a
much longer list. Most industrialized nations did likewise. The share of
U.S. GDP accounted for by government social benefits rose from 3.4 per-
cent in 1947 to 8.1 percent in 1975 (and has since drifted higher). Even
though such safety-net initiatives were often recognized as adding substan-
tial costs to labor and product markets, thereby reducing their flexibility,
policymakers did not judge them as meaningful impediments to economic
growth. Pent-up demand from the Depression and World War II drove
world GDP forward.
In economies not broadly subject to international trade, competition
was not as punishing to the less efficient as it is today, and there is clearly a
significant segment of society that looks back at such circumstances with
nostalgia. In today's global competitive markets, maintaining the kind of
safety net that evolved in an earlier day is proving increasingly problematic,
notably in most continental European countries, where high unemploy-
ment appears chronic. Governments of all persuasions may still choose to

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Across the net from Treasury Secretary Lloyd Bentsen at the Senate tennis court,
1994. Lloyd, a good friend, played an underappreciated role in launching Clinton's
successful economic policies. Courtesy of the U.S. Department of the Treasury
As America's economy became
more and more integrated with the
world's during my tenure as Fed
chairman, I became increasingly
involved in aid for other countries
in economic crisis. Magazine cover
hyperbole aside, Treasury Secretary
Robert Rubin, Deputy Treasury
Secretary Lawrence Summers, and I
had an unusually fruitful and
harmonious working relationship;
I greatly respect them both.
Time Magazine/Time Life Pictures/
Getty Images
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At the height of the dot-com boom,
CNBC invented a gimmick called the
briefcase indicator, in which cameras
would follow me on the mornings of
FOMC meetings as I arrived at the
Fed. If my briefcase was thin, one
theory went, then my mind was
untroubled and the economy was
well. But if it was stuffed full, a rate
hike loomed. Courtesy of CNBC