Capitalism for everyone.

• Author: Rajan, Raghuram G.

THE SECOND half of the last century seemed to have settled the debate over economic systems. Natural experiments like the one in Korea, where the South espoused capitalism and moved from underdeveloped to developed country status in a generation while the socialist North descended into starvation and destitution seemed to deliver a clear verdict: Capitalism is by far the best system for the production of wealth.

Yet, ironically, while capitalism has fattened peoples' wallets, it has made surprisingly little inroads into their hearts and minds. Many of the people protesting in the streets against globalization are protesting against capitalism, which they accuse of oppressing workers, exploiting the poor and making only the rich richer.

Take an example that seems to reflect the evils of capitalism. Sufiya Begum, a poor Bangladeshi villager needs twenty-two cents to buy the raw material for the stools she makes. For lack of better alternatives, she has to borrow this money from a middleman, who forces her to sell the stools back to him as repayment for the loan. Of course, he sets the price. Thus, Sufiya gets only two cents for a hard day's labor.

Unfortunately, the response of the traditional Right has been to repeat like a mantra that markets are the best way of creating wealth, that this wealth will eventually trickle down, and, in the long run, a policy of laissez faire will make us all better off. To the slum dweller in Bangladesh or Brazil, confronted by the daily reality of markets that do not work, such words are little comfort.

In this vignette many see the worst of capitalism. This situation could not be further away from the essence of capitalism: free access and competitive markets.

Our Explanation

WHY HAS this occurred? The explanation is simple. In many countries, powerful elites--like the middleman in Sufiya Begum's case--oppose widespread access to markets. They have the political clout to erect direct impediments like mandatory permits to open business or indirect barriers like an inadequate infrastructure.

The reason for their opposition is obvious. These elites already get what they need from the limited markets that exist. They stand to lose if access to markets became fleer and they faced competition. As a result, ordinary people like Sufiya Begum never see true free market capitalism, which implies competition and equal access. They only experience the distorted version that destroys hope. Unfortunately, both the genuine and distorted forms of capitalism get tarred with the same brush, and capitalism is seen as a system of, by and for the rich.

All we are suggesting is a general tendency, not an iron law: When markets start out limited, those who already have access often have very different incentives from those who do not. If, as is likely, the former are more politically powerful because of the wealth they obtain from their privileged access to markets, they can ensure the government does not create the conditions for wider access. Consider Russia. Following privatization, economic power has become concentrated in a small group of businessmen widely known as the "oligarchs." Since they control near monopolies in natural resources, they have very little interest in promoting antitrust regulation and in opening up the market to new competition. Not surprisingly, very little has been done in both these areas.

In fact, incumbents may not need to campaign actively against market-friendly infrastructure: the government may simply not be interested in the welfare of the commoner, and the politically influential and conscious classes may not see it fit to change matters. Neglect can be as effective as overt opposition when it comes to righting unequal and unjust forms of market economics.

The tendency we suggest above can be seen even in a functioning democracy. Consider the Bush Administration tariffs on imported steel. The alleged reason was to protect American jobs. But there are only 190,000 workers producing steel and 9 million in steel-consuming jobs. While steel prices in the United States have indeed gone up, steel prices have fallen below U.S. levels in the rest of the world as exporters redirect their steel away from the United States. This hurts U.S. industries that rely on steel as an input: they can no longer compete with foreign manufacturers who now enjoy cheaper steel inputs.

In June 2002, Brian Dundon, President and CEO of Advance Transformer (an electrical equipment manufacturer) testified at a U.S. International Trade Commission hearing about the costs imposed by the steel tariffs on firms like his. The tariffs created such a substantial increase in demand for domestic steel that suppliers could not meet it all. Rather than deliver steel to Advance at a price negotiated prior to the tariffs, they chose to sell to those who would pay the higher price in the now-protected market. As a result in December 2002, Advance was forced to close its magnetic ballast assembly operations in Monroe, Wisconsin and move production outside the country. Advance's parent company, Philips, is now building ballast manufacturing capability in China. Far more American jobs are put at risk outside the steel industry by the steel tariffs than were saved in it. So the tariffs were certainly not in the public interest.

The truth is that the tariffs were a subsidy--not so much to the steel workers, who could have been helped at lower cost to the economy through a direct handout, but to the owners and top managers of the distressed steel firms, who benefit handsomely from the tariff. The reason they prevailed is that the concentrated lobbying power of established powerful private interests often outweighs the national interest.

If special interests get their way even in a well-functioning democracy like that of the United States, imagine how much more powerful they are in developing countries.

Our point is that the absence of infrastructure supporting markets in much of the world is not because developing countries do not know that well-defined property...