Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity.

• Author: Lindsey, Brink
• Position: Book Review

Raghuram G. Rajan and Luigi Zingales New York: Crown Business, 2003, 369 pp.

This is an excellent book. It concerns a crucially important and poorly understood subject; it is timely; it is clearly and interestingly written; and its main argument is in all significant respects correct. These virtues are all the more noteworthy now that one of the coauthors, Raghuram Rajan, has become chief economist of the International Monetary Fund and thus can exert some practical influence over the policy questions the book addresses.

At the heart of any economic system are the decisions about how to allocate capital among rival uses. Saving Capitalism from the Capitalists makes a powerful case for entrusting those decisions to competitive financial markets--as opposed to the alternatives of outright government control or clubby "relationship capitalism" that predominate around the world in rich and poor countries alike. The book carefully analyzes both the benefits and the risks of financial liberalization and concludes that market-driven financial sectors offer sizable net benefits. In so doing, it provides an excellent synthesis of recent scholarship, including several important contributions by the authors themselves. This survey of some of the best recent work in financial economics is alone worth the price of the book.

But Rajan and Zingales do not stop with demonstrating the superiority of financial markets over more centralized decisionmaking systems. They proceed to wrestle with the fascinating question of why, despite that superiority, financial markets are so routinely suppressed and underdeveloped. Their thesis (hence the title of the book) is that market incumbents frequently use their political muscle to throttle financial markets because they fear the competitive uncertainties caused by open access to financing. In other words, the problem with capitalism is that, too often, the capitalists don't want it. Only under exceptional conditions--such as when new markets arise due to technological change, or existing markets are opened to foreign competition--do incumbents find existing financing channels inadequate and switch to support for liberalization.

Rajan and Zingales tell a fascinating and little-known story of financial development's ups and downs over the past century. They document a "great reversal" in financial openness that occurred during the interwar period: in major economies around the world, the percentage of national...