Forging capitalism

This is the text of my recent book review in the Financial Times

Astute observers of capitalism have long recognised there is a tension at its heart. Although the market economy is based on the pursuit of self-interest, its legitimacy depends on benefiting the wider society.

These two contrasting elements were understood as far back as the second half of the 18th century. Adam Smith, viewed by many as the founder of modern economics, famously argued in The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Less well known is that in his other great book, The Theory of Moral Sentiments, he emphasised the importance of human sociability. Smith saw virtue as necessary to keep the pursuit of self-interest in check.

Capitalism’s subsequent history amply illustrates both the broader benefits of a market economy and the problems that arise when self-interest becomes selfishness. There can be little doubt that popular living standards have increased enormously over the decades. Even the poorest sections of society have access to material possessions that the wealthy of the 18th century would have found unimaginable. On the other hand, there is always the temptation for those pursuing honest profit and self-interest to cross over the line to greed and fraud.

Forging Capitalism is an engaging history of how Britain attempted to negotiate this tension in the century running up to the outbreak of the first world war. The title is a pun. It is a study of the rogues, swindlers and fraudsters who tried to benefit from the market economy through the use of deceit. It is also an examination of how capitalism itself was forged through evolving mechanisms to curb these dishonest tendencies.

Ian Klaus, a member of the policy planning staff of the US state department and a former Harvard academic, includes many colourful rogues. Among them are Lord Thomas Cochrane, who in 1814 attempted to benefit from spreading false rumours of Napoleon’s death. Since the Napoleonic wars were coming to an end such news would have a substantial impact on asset prices. Cochrane quickly sold his holdings in Omnium, a form of government stock, which had risen in price on the false news.

If such stories have a familiar ring it is probably because they provided raw material for some of the most prominent figures in English literature. Novelists such as Charles Dickens, William Thackeray and Anthony Trollope were inspired by some of the same characters and tales.

The other side of Klaus’s story is how different mechanisms evolved to tackle breaches of trust. In the early 19th century the emphasis was on status and virtue. Transactions were typically underpinned by the standing of those involved and market participants were expected to behave virtuously.

By the mid-19th century these notions were giving way to reputation. Although the concept was not new, it became more important and prominent. An increase in literacy and technological developments played an important part. The expansion of the press meant that news about an individual’s reputation could be more easily transmitted to the public.

Finally, in the latter part of the century, there was the shift to what Klaus calls verification. This form of regulation is closer to what exists today, including institutions such as credit rating agencies and the financial media, to check the veracity of transactions. There were also new technologies, such as fingerprints, to verify individual identity. It was during this period that the state came to play a much more prominent role in authenticating information.

The one weakness of Forging Capitalism is that it underestimates the extent to which the market economy was transformed over the century it covers. Klaus sometimes refers to free market capitalism as if it is a system that still exists. Yet by the late 19th century it was already clear the state was playing a central role in supervising and underpinning economic activity. Certainly by the eve of the first world war the role of government was vastly greater than a century earlier.

There is considerable room to debate whether this transition was desirable or even inevitable. But it is striking how few contemporary commentators are willing even to acknowledge it.