The Commanding Heights: A Book Review 3

Why competition isn't wasteful

So far in our discussion of the book The Commanding Heights: The Battle for the World Economy (TCH), by Daniel Yergin and Joseph Stanislaw, we've explored the ongoing conflict between those who think government should be in overall charge of the economy and those who prefer private independence and enterprise.  We've also discussed the first wave of globalization under the British Empire and showed why government-run economies have such markedly inferior economic results when compared to market-based economies.

Post-War Economics

Commanding Heights starts after World War II.  The American economy grew during the late 1930’s and 1940’s to the point that manufacturing employees became aggrieved about their working conditions and pay.  Their discontent led legislatures to pass laws favoring the formation of unions, and large-scale manufacturing enterprises were swiftly unionized.

Labor laws specified working conditions, overtime, and, over the decades, went into more and more detail about exactly how factories had to operate.  American manufacturers enjoyed worldwide sales after WW II because most of their competitors’ factories had been bombed out.  The resulting high profitability led to great growth in the American economy.

Despite being nominally on the winning side, British factories were badly damaged during World War II.  After the war, the government passed laws which were sympathetic to labor unions.  The British went further than the Americans in that many large businesses were nationalized and government control played a large part in driving the rebuilding effort.  This resulted in not a whole lot of effective rebuilding being accomplished for many years.  The former British colony of India won independence and adopted a socialist economy in the same model.

The American Lend-Lease program contributed billions of dollars to help European nations rebuild their infrastructure and capital stock.

The Soviet Union had adopted the Marxist-Leninist economic model after the 1917 “October revolution.”  Having fought the Germans, the Soviets were on the winning side in WW II.  The Chinese communist party under Mao tse Tung let the Nationalists do most of the fighting against the Japanese.  After the Americans defeated the Japanese, the communists went to war with the Nationalists and took over China in 1949.  The losing Nationalists took the island of Taiwan as a consolation prize.

In the aftermath of WW II, Britain had opted for more government control of the economy.  American companies were subject to the demands of unions but had relatively light regulatory burdens.  The Russians and the Chinese had decided on Communism.  When the Korean War broke out, America went to great lengths to persuade the Japanese to avoid the Communist system in favor of the free market; South Korea and Taiwan did more or less the same.

Thus, the world was divided.  There was a relatively free market system in America. Britain, India, and most of Europe had more government control than in America, and Japan, Taiwan, and Korea chose to operate market economies somewhere in between.

Commanding Heights explains what happened after that.

The Battle of the Half-Century

The period from the start of the Cold War around 1950 until the collapse of the Soviet Union was essentially a battle between two competing theories about how an economy ought to be managed.  Marxist theory sounded extremely logical.  The difference was encapsulated when a Russian cosmonaut visited a NASA facility and was incredulous at finding that each of the astronauts preferred a different hand-held calculator.  One had a Hewlett-Packard, another had bought a Texas Instruments, and another had something else.

“Why doesn’t the government just decide on the best calculator and make only one?” the Russian asked.  He didn’t understand that the government isn’t smart enough to determine the best calculator, and neither were any of the marketing wizards at any of the technology firms.  The only way to find the best was to let the various designs fight it out in the marketplace where users spent their own money on the calculator they preferred.

The “battle of the calculators” illustrated the battle of economic theories between the United States and the Soviet Union.  The Chinese and Indian governments chose to seal their economics off from the global economy.  Although the United States government was somewhat aware of India and realized that China existed, their main conflict was with the Soviet Union.

At first glance, the Russian’s question seems reasonable – isn’t it a waste of societal recourse to design, market, and manufacture so many different calculators?  Wouldn’t society be better off if government experts simply selected the best one?  This has been tried many times, and this reasonable-seeming idea has always foundered on the fact that nobody, no bureaucracy, and no venture capitalist is smart enough to make such decisions once the economy becomes complex.

At the time the Korean War broke out in 1950, the Japanese Communist Party held the affection of a great many voters.  The destruction of World War II had resulted in extreme poverty and Communism seemed a reasonable way to make people better off.  The American government understood the threat and worked with the Japanese government to encourage Japanese businesses to sell goods into the world-wide export market.  Through great effort, the Japanese managed to export 15% of their GDP, but they imported 14%.  The Japanese saw themselves as running their country on a 1% margin and worked incredibly hard in order to feed their children.  The Wall Street Journal described the result:

After World War II, Japan developed rapidly by prioritizing export manufacturing, making products for consumers in advanced economies faster, more cheaply and more reliably. Government policies encouraged a high savings rate and channeled that capital to exporters. In a phenomenon known as the "flying geese," South Korea, Taiwan and Malaysia prospered in Japan's slipstream by adopting similar policies and joining the supply chains pioneered by Japanese companies.

None of these countries had a large enough domestic market to support modern mass production, particularly with their shrunken post WW II economies.  Small countries such as New Zealand also imitated the Japanese model of government encouragement of favored businesses and prospered.  This growth exponential started from a small base.  It took 40 years for globalization to show its good effects, but they have been profound:

Since the early 1990s, daily life in poor countries has been changing profoundly for the better: 1 billion people have escaped extreme poverty, average incomes have doubled, infant death rates have plummeted, millions more girls have enrolled in school, chronic hunger has been cut almost in half, deaths from malaria and other diseases have declined dramatically, democracy has spread far and wide, and the incidence of war - even with Syria and other conflicts - has fallen by half. This unprecedented progress goes way beyond China and India and has touched hundreds of millions of people in dozens of developing countries across the globe from Mongolia to Mozambique, Bangladesh to Brazil. 

Foreign Affairs, January / February 2016 p 85

There were down-sides to participating in the global economy, of course.  If a major part of a country’s economy depends on selling products to other nations, economic problems in countries that buy the goods cause severe suffering in selling countries.  In extreme cases, this can force government-owned businesses to be broken up.

Clothed for decades in a heavy social-democratic coat, New Zealand was an unlikely but important laboratory for economic liberalization. One of the richest countries at the beginning of this [the 19th] century, New Zealand had developed a classic mixed economy in the postwar years that was intended to fulfill the social democratic dream of “cradle-to-grave security against economic uncertainty.”  It was highly regulated and highly protected, with a large state-owned sector and a commitment to generate full employment. Wages were controlled; so were prices.  As in many other countries, the two television channels were state owned.  But unlike other countries, the state also determined who produced television sets and how much they cost.  By the 1980s, it was clear that the entire system was malfunctioning.

TCH p 122

Exporting earns foreign exchange which pays for imports.  New Zealand’s state-managed businesses had become uncompetitive and exports didn’t cover the bills.  A foreign exchange crisis in 1984 led to a snap election.  The new labor government instituted a massive program of privatization, deregulation, and, rejecting egalitarian theory, slashed taxes at all levels.  Businesses became more competitive, and New Zealand became internationally competitive.  As one prime minister put it,

You can't have social justice if you've got no economy.

TCH p 122

The New Zealand experience echoes the British cycle of nationalization followed by getting government out of the business of running businesses.  British state-owned businesses suffered the usual problems of overmanning and inefficiency which are common to enterprises which aren’t subject to the dictates of the market.

While it is possible that government involvement in the economy was more effective in recovering from the damage of WW II than a market-driven system would have been, it was undeniable to all except the most die-hard socialists that government-run economies had stopped delivering the goods.  It would have been impossible to replace nationalization with a market economy, however, without a body of ideas of a) what a more competitive economy would look like and b) how to get there.

Just as the Atlee consensus of the 1940s [about nationalization and government involvement in the economy] had become the “text” for governments and politicians for more than three decades following, so what began around the seminar tables in research institutes in the 1970s and took shape in the Thatcher program of the 1980s would do much to set the global agenda for the 1990s.

TCH p 75

British industry could not compete internationally, high tax rates discouraged productive work, and even union members were complaining about what they had to pay in taxes.  The 1973 oil crisis hit Britain hard and the resulting hardship was made worse by a coal minter’s strike which brought down the government.  The problem was that government was trying to do too much.

A new approach to a market-based economy came from the Institute for Economic Affairs (IEA), which had been funded by a farmer who made a fortune mass producing chickens. The IEA attracted the attention of Margaret Thatcher, who had been Minister of Education under Prime Minister Heath.  She had read Friedrich von Hayek's classic The Road to Serfdom as an undergraduate, but she re-read it with new eyes based on her observations of Britain’s economic distress.

Prime Minister Heath lost power to Harold Wilson in 1974.  Mrs. Thatcher challenged him for leadership of the opposition, and won.  Over the next years, her associates made speech after speech, showing that incentives mattered and that capitalism, although imperfect, was the least bad system known for increasing wealth and consumption.

This message found gradual acceptance as the government-run British economy continued its decline.  The whole country went on welfare, borrowing from the IMF.

By the end of 1978, many unions went on strike, and the Labor party lost a vote of confidence by one vote.  The Conservatives won the resulting election, and Mrs. Thatcher became Prime Minister in 1979.

Mrs. Thatcher had a stroke of luck – the 1982 Falklands War immensely boosted her standing with the voters.  She had a 144-seat majority after the election of 1983.  The National Union of Miners went on strike in 1984.  The mines had been losing more than a billion pounds per year, and Mrs. Thatcher knew that the economy would never improve unless she could stop the bleeding of taxpayer cash into failing businesses.  It took a year, but the strike finally petered out.  The miners had been defeated.

Now came the hard part.  Nobody had ever gotten a government out of the business of being in business before.  None of the managers of government on businesses wanted to see their empires reduced, and the unionized government employees suspected that private employers would make them work harder.  The British Gas company had a nationwide monopoly selling gas and they also had a monopoly on selling gas appliances through their 900 showrooms. The Thatcher government wanted to sell these stores to private buyers.  The head of British Gas and the union representing the employees fought bitterly.  Although the sale went ahead eventually, it had to be postponed for several years.

Deregulation didn’t work out quite as well in Japan.  By the late 1980’s, the Japanese economy had become complex enough it was clear that government control of the economy was holding back growth.  The politicians who advocated opening up the economy were defeated by the forces who favored the status quo, and Japanese economic growth has been anemic ever since.

So, as we've seen, there's a stark contrast between the economic performance of various nations based on the economic model their politicians and voters chose.  And yet, despite the clear cost of overregulation and socialism, voters keep choosing those sclerotic systems!  In the last article in this series, we'll draw some conclusions from history and human nature.

Will Offensicht is a staff writer for and an internationally published author by a different name.  Read other articles by Will Offensicht or other articles on Economics.
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