Is there a useful distinction between Capitalism and Free Enterprise? I am convinced that the answer to that is an emphatic yes; and that the distinction is vital to a proper understanding of the wreck of our political economy.
Free enterprise is characterized, above all, by a wide private field for business competition and innovation, operating under a structure of laws analogous to a good referee in a ball game. Savers, under free enterprise, extend their capital to the successful enterprisers in the community. The economy is not isolated — some of its magnates aspire to national or even world prominence — but its core is local or regional. Its health is the effective and trustworthy lending of the capital of the older folks of the community, who have savings, to the industrious and virtuous of the younger businessmen. The old generation earns a return on this lent capital; and the younger businessmen are able, when successful, to build and distribute new wealth.
There is definitely risk in the system, but it is risk faced primarily on a personal level. Risk is intimately linked to trust. The man of means wants to know the men he invests his capital in. He'll ask about their families. He'll do his homework, but often he’ll have to take his risks based on his gut sense about men.
The great seaports of New England in colonial and early Republican America are exemplars of the free enterprise system. It is manifest that remarkable risk was undertaken in the whaling trade, when ships and stores and whalers were out to sea for a year and more, or any of the other thousand seafaring enterprises the New Englanders developed to generate their wealth. It is manifest that the trade by which this wealth was generated was a global operation. But the core of the capital at back of it was anchored in the integrity and independence of the New England towns.
Not infrequently, free enterprise — especially when it expands to a national level — will feature some mercantilist elements. With mercantilism, the state intervenes to favor domestic manufactures and merchants as a matter of national interest or policy. The fortunes of the New England shipping towns were for decades subject to the whims of British imperial policies on exports and imports. There were some noteworthy examples in decade before the American Revolution of these towns adopting temporary mercantilist policies to protest and counteract British measures.
So free enterprise, we might say, is that system of political economy characterized by a broadly free private sector composed of business enterprises rising and falling on their own merits; and a limited state which intervenes only to preserve the rule of law, and occasionally to favor the merchants of the community.
I contrast this with the kind of political economy America has had for the past 30 years or so. (Its roots go farther back than that.) It makes good sense to call this Capitalism, I think. Its preoccupation is with capital, particularly of the sort that can be neatly packaged into securities and traded. In the past 30 years a decisive shift occurred, away from the local and human-sized model and toward an engineered world of abstraction. The shift came from private enterprise, but it was aided all along by the state. The referee was favoring one team: the financiers of globalization. The future of the American economy was hitched to a peculiar system of finance, which grew into a vast and stupefying infrastructure of debt that became the conduit by which capital from the most far-flung corner of the world flowed into US securities markets, above all those attached to real estate. Instead of personal connections, the basis of trust became and elaborate system of payments and hedges, all overseen (it was thought) by objective ratings agencies and alert regulators. Alas, it turns out that these are no effective substitute. There is, of course, no perfect system of social trust available to men here below; we have only approximations or approaches toward it. And it seems very clear now that the one used over the past couple decades has been a pretty poor approximation.
The crisis that exploded in our faces last fall was, in fact, a collapse of trust. The major actors in the financial system began to doubt the ability of their counterparties to meet obligations. Overnight repo markets froze. Creditors demanded damaging margin calls. Funds of all varieties faced mounting withdrawals from investors. Assets classes across the financial spectrum degraded in value.
Periodic crises of lesser severity have been a regular feature of financial markets. But as financial markets came to dominate the Western economies, these crises became increasingly perilous.
Capital was protected through most of this. The state’s interventions became more and more extensive, and increasingly made little distinction between domestic and foreign business. The state’s primary role became the stabilization of capital markets, which in practice worked out as a guarantee on sufficiently large-scale risk by financial firms. "Three decades of subsidized risk," CNBC’s Charles Gasparino calls it. Almost always, the financiers were rescued: Continental Illinois and the Resolution Trust Corporation in the 1980s; the "private" rescue of the geniuses at Long-Term Capital Management in 1998; the rise of shadow banking; the removal of the firewalls between deposits and exotic securities; the transformation of investment banks from private partnerships into public corporations. The tale is a long and intricate one. (Self-promotion alert: I'll have an essay in a forthcoming New Atlantis discussing some of it.)
The point here is that recent revelations shown us pretty dramatically that finance capitalism is not the same thing as free enterprise. The shift in focus from business enterprise to financial engineering, and from local and personal to global and abstract, marks the gradual transformation of American free enterprise into American capitalism.