How the Market System Developed

The Hong Kong Skyline in 2013

The Hong Kong Skyline in 2013

by Ryan Allis

To be a good entrepreneur, it is helpful to understand how the system of the competitive market economy has developed. The system of entrepreneurship and competitive market economies was threatened during most of the 20th century by the concept of centrally planned state economies in a massive battle of ideas.

In the 20th century, we used the new tools of the Industrial Age to create major scientific advances. The century was filled with technological innovation as well as an ideological struggle between centrally planned economies based on state control and distributed planning economies based on the competitive market economy.

From two atomic bombs dropped on Japan to Mao’s Great Leap Forward to the Khmer Rouge in Cambodia to the Rwandan Genocide it was a turbulent century that brought approximately 200 million deaths from war.[foot]Add source[foot]

The first World War began in 1914 when Archduke Ferdinand was shot by Serbian nationalist Gavrilo Princip in Sarajevo. Should you ever have any doubt that the world of today is substantially more peaceful and interconnected than the world of 1914, read the July Ultimatum between the Austro-Hungarian Empire and Serbia. It was a world of miscommunication and mistrust in which national and religious identity often trumped human identity and the broader empathy circles and better communication tools we have today.

World War I ended with the Treaty of Versailles in Paris 1919. With the treaty, the Allied Forces compelled Germany to pay reparations roughly equivalent to $440 billion (in today’s dollars), strongly against the wishes of British economist John Maynard Keynes, who saw the payments as excessive and counterproductive to continued peace.

“If we take the view that Germany must be kept impoverished, and its children starved and crippled, vengeance I dare predict will not limp. Nothing can delay that final war that will destroy the civilization and progress of our generation.”  – John Maynard Keynes, The Economic Consequences of the Peace (1919)

Changes were at hand in Russia as well, an Allied country in World War I, much affected by the conflict with Germany. In 1922, the Soviet Union was formed following the 1917 Bolshevik Revolution and a Russian Civil War. The Lenin-led USSR, influenced by the ideas of German philosopher Karl Marx, implemented a centrally planned economic model in which prices, outputs, and professions were determined by the government instead the market.

Against the background of the new Soviet economic model, the U.S. the Dow Jones Industrial Average dropped 89% between 1929 and 1932 from a high of 380.3 in 1929 to a low of 42.8. The U.S. GDP dropped from $103.6 billion in 1929 to $56.4 billion in 1932.[foot]Bureau of Economic Analysis, Current-dollar and “real” GDP, –[/foot]. Unemployment in the U.S. rose from 4% in 1928 to 24% in 1933, as government fiscal policy under President Hoover remained conservative.

John Maynard Keynes’ General Theory of Employment, Interest and Money (February 1936 ) laid out the plan for President Franklin Roosevelt. It wasn’t until the implementation of Roosevelt’s New Deal Reforms of the mid-1930s, based on the counter-cyclical fiscal policy of Keynes, followed by the economic expansion from World War II, that the U.S. economy got back on track. The debate as to whether an economy should be based on central state planning or decentralized market prices was on.

How the Global Economic System Formed

World War II was a war caused, in part, by economics. The German disgust over the forced World War I reparations and the subsequent German hyperinflation enabled the rise to power of Adolf Hitler, who became Chancellor of Germany in 1934 with a nationalistic perspective combined with a belief that the Aryan race was superior to others. Hitler’s attack on Poland in 1939 thrust the world into World War II, in which France, Britain, Russia, China, and the United States (and their colonial-tied countries) fought Germany, Italy, and Japan (and the countries they influenced). At the beginning of World War II, Japan controlled much of Eastern China after the Second Sino-Japanse war.

The destruction to lives, dignity, and property caused by World War II cannot be overemphasized. From the Holocaust extermination camps in Germany and Poland to the Nanjing Massacre in China, our species went through a six year period that showed the worst of the human condition. As an aside, my father (Andrew P. Allis) was born in 1938 and was a young boy growing up in Pennsylvania during this period of atrocities. Although two generations have now passed since those times, I hope we never forget the horrors of World War II and that the continued innovation in global communication technologies and trade continues to bring us closer together as a single, empathetic species in which we all see ourselves as part of the same human tribe. Happily, the internet is beginning to play a major role in creating a single connected human identity and consciousness at the species level.

Near the end of World War II, in 1944, the Allied powers gathered in Bretton Woods, New Hampshire, to lay out the rules of the new global economic system. The Bretton Woods conference created the World Bank and the International Monetary Fund, and laid the foundations for the 1947 General Agreement of Tariffs and Trade (GATT), the forerunner to the World Trade Organization and our global economic system. The Bretton Woods delegates established these global organizations to govern international trade and finance in the hope of never returning to the protectionist economic policies that decreased trade, fostered an “us vs. them mentality,” and worsened the Great Depression.

In June 1945, the United Nations was created by 51 original signatories, designed to reduce conflict and provide a forum for diplomacy to reduce the likelihood of another devastating world war.

In World War II, the United States, Russia, and China all fought on the same side. But by the late 1940s, tensions grew as the dominant division was no longer between Democracy and Fascism, but between Capitalism and Communism.

In 1949, Mao Zedong’s Communist Party of China won the Chinese Civil War and set up the People’s Republic of China, sending much of the formerly ruling nationalist party to Taiwan.

By 1950, the U.S. had entered a war with Soviet Russia and China in the Korean theater. Divided at the 38th parallel in 1945, the Korean Peninsula was split between a Soviet-backed government in the North and a Western-backed government in the South. Northern forces crossed the 38th parallel in June 1950 and had nearly consolidated the entirety of the Peninsula by late June 1950. President Truman, backing up his 1947 Truman Doctrine that he would not let Communism spread, sent in American troops under General MacArthur to Korea, creating a drawn-out three year war with massive casualties and numerous massacres in which the USSR, China, and North Korea battled the United States and South Korea. Over 500,000 troops were killed on both sides, with another 2.5 million civilians killed or wounded.[foot][/foot]

The beginning of the Cold War wasn’t actually all that cold.

In the USSR, the perspective was that the Red Army of Stalin had defeated the fascism of Hitler and Mussolini and that state planning was the way to go.

New Economic Models in Germany, India, and Britain

In Germany, because of the separation beween East and West Berlin, there was a unique opportunity to see a comparison of the two competing economic models. Ludwig Erhard, from 1946 to 1949, was the West German Minister of Economics (and later the Chancellor of West Germany). One of Erhard’s first tasks as Minister of Economics was slowing hyperinflation by removing price controls to enable markets to properly function and get goods into stores. In the ensuing decades, West Germany would have a competitive market economic combined with a strong safety net.

In 1947, India became independent of Britain and Jawaharlal Nehru became the first Prime Minister. Nehru led India into an economic model focused on the scientific state planning of a mixed economy. India’s socialist model was looked to across the developing world as the preferred model of development. By 1950, Socialism, planning, government control, and government ownership became the standard in the developing world. India chose to shut out foreign imports based on the ideals of self-sufficiency.

“If you have a controlled economy cut off from the rest of the world by infinite protection, nobody has any incentive to innovative, nobody has any incentive to increase productivity, to bring new ideas.” – Manmohan Singh, Finance Minister, 1991-1996, and current Prime Minister of India[foot]The Commanding Heights, Episode 2, The Agony of Reforms, 19 min 14 sec[/foot]

In Britain, the Labour Party’s Clement Attlee won the 1945 election, defeating Winston Churchill. He argued that the way to “win the peace” was with a socialist state, with many private owners compelled to sell their businesses to the State. The British government took over enterprises like coal, steel, and the railroads. The sense was  that the way forward was through government ownership of the largest, most important industries. It took until the 1980s for the determined Margaret Thatcher, influenced by F.A. Hayek’s Road to Serfdom, to move the United Kingdom away from price controls and worker’s strikes and toward a competitive market-based economy.

Winning the Battle of Ideas

In 1947, President Harry Truman signed the National Security Act in the United States, creating the Central Intelligence Agency. The CIA played a significant role in enforcing the Truman Doctrine to contain the spread of communism. The United States government, sadly, in many cases undermined the role of democracy globally in order to “protect” capitalism.

To put into context just how hot the proxy wars were between the USSR and the USA between 1949 and 1991, here’s a list of just a few of the countries that had civil wars, coups, or revolutions related to the “Cold” War between communism and capitalism: North Korea (1950), Iran (1953), Guatemala (1954), Brazil (1964), Vietnam (1965), Greece (1967), Cambodia (1970), Bolivia (1971), Chile (1973), El Salvador (1979), and Afghanistan (1979).

As an American, I am honestly embarrassed by some of the actions our government took from 1950-1980. While the battle of economic ideas was ultimately won with the market system demonstrating much better results for both the poor and the well-off than a centrally planned economy was ever able to, I am still disturbed by the number of coups and assassinations against democratically elected leaders our Central Intelligence Agency was part of, leading to continued mistrust and conflicts to this day. Ultimately, I hope that 2015-2050 will be a time of much greater compassion and understanding between cultures across the world—spurred on by the growing connection to human identity that many of us in Generation Y are feeling as we communicate and connect with people all over the world.

It took the combination of Ronald Reagan in the U.S. and Margaret Thatcher in the UK and the collapse of the Soviet Union to swing the pendulum back toward a global belief in competitive market economies. In the 1980s and 1990s, industries around the world were privatized, regulations were reduced, and the model of the market-driven economy became the primary world model.

The Advancing Market Economy

“You can’t get away from the fact that globalization makes us more interdependent. It’s not an option to shed it. So is it going to be on balance positive or negative?” – Bill Clinton, 42nd President of the United States

The basis for today’s global system was formed in Bretton Woods in 1944. That meeting formed the basis for today’s global banking, trading, and currency system, and set up the World Bank, International Monetary Fund, and the General Agreement of Tariffs and Trade.

Fifty years later, on April 15, 1994, the Uruguay round of the General Agreement on Tariffs and Trade was completed. Delegates had agreed to form the World Trade Organization (WTO), based in Geneva, to govern international rules on tariffs, subsidies, intellectual property, and foreign investment.

These economic standardizations did not come without event. The 1997 Asian crisis followed the Thai Bhat devaluation, caused by markets overly open to speculative currency trades. The 1998 Argentinian default followed a similar track.

In the 1999 Seattle meetings, the 2001 Doha meetings, and the 2003 Cancun meetings of the World Trade Organization, developing countries combined forces to negotiate updates to the rules to allow emerging markets to better prosper.

Why does all this matter to entrepreneurs? Because after a 20th century of warfare, genocide, conflict, and a battle of ideas between centrally planned and market economies, the global system was finally developing sufficiently to enable greater global stability, transparency, and rules that made it easier for anyone to start and build a business and solve problems in their community.

In 1979 the World Economic Forum (based in Switzerland) began publishing an annual Global Competitiveness Report and in 2004 the World Bank (based in Washington D.C.) began publishing an annual Doing Business Report comparing business regulations in 185 countries.

Instead of focusing on consolidating power through military means as they did in the 20th century, world leaders today focus on consolidating power by creating legitimacy in the eyes of their people through the pursuit of a strong, growing, and efficient economy in which the needs of the people are served.