Capitalism Is Broken. Here’s How to Fix It.

It’s becoming a common refrain these days to say “the system is rigged.” When people say that, they are often referring to growing inequality in a country like the United States. There’s a suspicion that the financial system is set up for the rich to get richer and little else. Perhaps unsurprisingly, Americans’ trust in government is at one of its lowest points since surveys began in the 1950s. 

Is capitalism broken? Investor Ruchir Sharma is an unlikely person to make the case, but he does just that in his new book, What Went Wrong with Capitalism. Sharma points out that capitalism has become too distorted, and the United States has kept increasing the size of its government—and its debt—for decades in a way that is introducing inefficiencies into the system. 

Sharma’s views should be juxtaposed with the fact that relative to its rich industrialized peers, the United States is actually doing rather well—it is home to the biggest technology firms and continues to attract the world’s best talent. But Sharma makes the case that it can’t continue forever, and America is missing out on more innovation and competition. I spoke with him on FP Live. Subscribers can watch the full interview on the video box atop this page. What follows is a condensed and edited transcript. 

Ravi Agrawal: A growing number of people think the economy is not working for them. Why?

Ruchir Sharma: Well, Ravi, I think that’s the big disconnect, which is that at the surface, we get all this great data showing us that the American economy is doing relatively well, especially compared to Europe and Japan. But if you look at how people are feeling about it, something feels, as you say, rotten or rigged about the system. Just 35 percent of Americans today feel that they’re going to be better off than their parents. That number a generation or two ago used to be closer to 80 percent. 

I know that the focus has been on President [Joe] Biden’s approval ratings, which are low, but this is not a recent phenomenon. This has been going on now for 20 to 30 years. And it’s not partisan; it’s popular to believe that when a Democrat’s in office, the Republicans feel down about the economy. Six out of 10 independents feel that the economy is moving in the wrong direction. Why is this happening? What I document in the book is that there is a feeling among Americans that there is no longer an equality of opportunity.

Now, remember, capitalism always leads to inequality of outcomes. It’s meant to do that because any meritocracy is supposed to do that. So as long as you had equality of opportunity, it was OK. But there’s a feeling today that the opportunity is not equal, that social mobility, economic mobility have all declined. 

Another problem I have with it is that a lot of young Americans, particularly Democrats, say that they would rather have socialism than capitalism. And that’s what really set the stage for me to write this book, that if so many young Americans feel that they would rather have socialism over capitalism, and this is going on in America, what’s really happened here? But as I document in the book, what we have today is not capitalism or anywhere close to the kind of capitalist model that the founders had in mind.

[U.S. Sen.] Bernie Sanders, of course, called this socialism for the rich. I think he’s partly correct. What we have is socialized risk. It’s most gallingly socialized for the rich. So you have capitalism on the upside, and on the downside, all the risks tend to be socialized.

RA: But Bernie Sanders, for example, would say that the point of government is to socialize the risk. Where you differ from him is that he would actually argue for more big government to try to fix many of the problems you’re describing.

RS: As an old definition goes, if you keep on doing the same thing and expect different outcomes, that’s insanity. What I try to show in the book is that if you look at the last few decades, we never had an era of small government. This whole narrative that we had this neoliberal era where the state and government shrank and the markets were let loose to run wild? Well, that never happened. Yes, you did get increased globalization. You did get a decline in unionization, and you did see some financial market deregulation in the ’80s. And more importantly, you had many socialist countries around the world, including India and China, move toward a more free-market system. So that gave the impression that we are in this free-market, neoliberal era. But if you look at the United States, the role of government kept on expanding in this time.

The government’s [spending as] share in the economy has been increasing, which I think is somewhat well known, from around 3 percent of GDP in the 1920s, 100 years ago, to now more than 36 percent of GDP. So that’s been going up. And during the Reagan era, also, that increase kept happening.

But the focus of my book is much broader than that. It’s to show that the role of government is not just about how much it spends. It’s about its various habits, whether it’s regulation, whether it’s this culture of bailouts or micromanaging the economic cycle, the involvement of the Fed in setting policies and where it’s involved in the economy. There’s a lot of mission creep there—and it’s leading to a lot of perverse outcomes.

There’s that famous line, that the road to hell is paved with good intentions. So, the government wants to come in and fix problems, but it’s making things worse because its role is expanded so much that now we have this great asymmetry in the economy where, on the upside, the rich tend to benefit, and on the downside, everyone, including the rich, feels that the government is going to be there, to protect the downside. So that just seems like a bit of a free lunch and the people who are in positions of entrenched power are able to capitalize on that asymmetry.

RA: The analogy in your book that stayed with me was the analogy about pain management. Talk to us about how regulators, how the government, are thinking about protecting the economy.

RS: As I say in the book, America has been in the midst of an opiate crisis. A lot of serious observers say that the opioid crisis happened simply because at the slightest hint of pain, they would be given some pain relief medicine. And it led to addiction.

I think there is a similar problem now in the American economy. At the slightest hint of trouble, the impulse of the government is to go out there and intervene. Nobody is allowed to fail. Last year, when you had trouble at Silicon Valley Bank in California, the immediate instinct was that you’ve got to bail it out, otherwise the entire system can come down. So there’s zero tolerance for any pain or any risk.

This fear-mongering which policymakers engage in, which is that if you don’t do anything, they will have the Great Depression all over again. And so we need to give the economy very heavy doses of pain medicine at the slightest hint of trouble. And the economy, therefore, has lost its inner ability to be able to cope with any of these natural problems. Any economy, like any organism, will go through ups and downs. But if you’re going to totally eliminate the downside, it seems costless—but it’s not.

RA: What are some of the examples of how a bank bailout imposes all these costs on the broader economy?

RS: What’s happening in America, whether bank bailouts or other bailouts, is keeping a lot of deadwood alive in the economy. It’s about the zombification of capitalism. A zombie company is a company that can’t even earn enough profit to cover its interest payments for three years in a row; they need easy money or zero interest rates to keep borrowing to survive. Today, by some measures, 20 percent of all companies in America can be classified as zombie firms. So this is the real problem: If you’re doing all these bailouts and you have this easy money, it leads to the deadwood staying alive. And when you have so much deadwood in the system, it chokes out newcomers. As a result, the number of start-ups in America today, at least until the pandemic, was declining for a long period of time. It’s almost inversely correlated: A rise in zombie companies and a decline in new start-ups.

The price comes in a couple of ways. One: You’re choking new entrants from coming in. And the second price: It makes the average person wonder, why am I being asked to suffer hardship when these very well-run, well-known companies are being given artificial life support. And then, the other deeper, more insidious consequence is that productivity growth declines. The key to economic growth is productivity growth, so if you have a decline in productivity growth, the overall economic growth of a country also declines. So these are some of the problems with the zombification of capitalism and the indirect, yet very heavy, costs of these bailouts.

RA: Let’s look at the inverse very quickly. I remember with AIG in 2008, for example, regulators often said that its collapse could lead to ordinary savers losing their money, which could then have a ripple effect on jobs and all kinds of other problems in the economy. But what you’re saying is that the alternative, which is what is happening to the American economy now, is far worse. But that is something that middle-class families, for example, who invest in those banks or companies, would be terrified of.

RS: There’s still a role for government, right? My book is not advocating some libertarian approach. In fact, the extreme version of that was in 1929, when the bubble was bursting and the government said, “yeah, we must allow this bubble to liquidate” because it had worked in the past. America had a long history where the entire approach of the government was to allow these things to liquidate and have a fresh start. In the past, that had triggered productivity booms.

Now, it’s gone to the other extreme; now, there is zero tolerance for any of this happening. Right up until the 1980s, there was no real culture of bailouts. The first big bailout in America of a financial institution happened with Continental Illinois back in 1984. So it’s not as if America always had this culture of bailouts and I’m calling for something new or radical to happen. I’m just talking about a return to a center ground where when you have a crisis, you solve that. But now instead, you have bailouts because you fear that every little wiggle is going to cascade into massive job losses.

Fine if that’s your vision, then at least don’t call it capitalism anymore. Let’s say we are for socialized risk, where no one will be allowed to fail because there’s zero tolerance for pain and there’ll be no natural clearing mechanism. So recessions will not be allowed. Stock market declines will not be allowed. Even if it leads to longer-term gain, the sight of anybody losing a job is unacceptable to society. Then we have to be prepared to suffer all the other consequences, which we are: very low productivity growth, where the entrenched benefit at the cost of new entrants. It’s an environment in which big business does better because they are able to know that they are always going to be there, and they’re able to take risks accordingly. It leads to a feeling in the average American that they’re not getting equal opportunity.

I’m presenting that choice in the book, which is that we can carry on this path and just then be happy to live with these consequences, or we course-correct and have some awareness that there is a price to be paid for all these actions.

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RA: The United States, as you’ve been writing, has been expanding the size of its government for some years now. But a response to that could be that America is, in fact, doing much better than any of its peers in Europe or Japan or other rich industrialized countries. In 2008, for example, the U.S. economy was about the size of Europe’s. And today it’s twice the size. All of the world’s top tech firms are in the United States. Most of the world’s top talent still wants to come to the United States. How do you explain what’s going right, despite such a bloated, inefficient system?

RS: Firstly, capitalism is in even worse shape in Europe or Japan. The number of zombie companies in places like the U.K. is even larger than that of America. The regulatory burden there is larger in those countries. Economic dissatisfaction in Europe is even greater. Europe’s adoption of capitalism is even more distorted than what we have in America, and the outcomes there are even worse. So is that the future we want?

The second thing I’ll say is that American economic growth and productivity have slowed down. In Europe, it’s slowed down even more. So the relative benchmark is down even more there.

America looks great, but it’s like that old cliche about the best home in a bad neighborhood. 

But, I think, what’s the alternative? The status quo? If so many Americans are distrusting the government despite its expansion, if so many Americans feel that the economy’s headed in the wrong direction, then I think there’s something very dysfunctional going on. And if you’re going to carry on that path, we’re just going to set the scene for more populist revolts, for more anti-establishment feeling, and for incumbents to get voted out of office. I think that to pursue the status quo really means that you’re asking for greater trouble, both in terms of populist revolts and in terms of what the average voter really wants.

RA: Ruchir, there are a lot of progressive economists, people like Stephanie Kelton or Mariana Mazzucato, who will argue that big debt is not necessarily bad. In fact, they argue that the solution to many of the problems that you are very rightly raising is more debt and bigger government. So bigger investments in public health care, bigger investments in early child care and education, investments in infrastructure, will allow people to actually be more productive.

RS: Firstly, let’s attack the point of the debt. Which countries have more government debt than us today as a share of the economy? Just two countries in the developed world: Japan and Italy. Do we want to go down that path? Countries which those [aforementioned] liberals hold as these great models such as Sweden also ran into big fiscal trouble once their debt levels got very big, once the government’s spending as share of GDP got very big. And then they had to scale it back down. The evidence I have is that the countries running very big debt and deficits, including Sweden, were forced to pare back. These arguments were a bit more popular when there was no inflation around. But you got a surge in inflation the last two or three years, which wiped out the wages of exactly the people you were looking to defend, the poor people.\

But the argument I make in the book is much deeper: When you look at the [government] habits, who are you bailing out? Even in the pandemic, who got to benefit from the massive stimulus? People earning more than $100,000 a year, the Berkshire Hathaways of the world. That’s what it’s getting to now.

The government has a role to play in some welfare, in some education spending. But the list keeps growing. It’s got to spend on climate change. It’s got to spend on green energy. So can we prioritize? Or should the government just do everything indiscriminately and if you rack up more debt, it’s all fine? We are the world’s greatest superpower. We can get away with what we want. I think, even though these debates end up getting wonky at times, the average American knows there’s something wrong with this argument. It just can’t be so sort of simplistic and so easy.

RA: Here’s one thing that was relatively new to me. You point out that when President Biden was elected, everyone was writing that big government was back. But you show pretty convincingly that big government was always there. But also, as much as this is a criticism for how all of us in the media described the Biden agenda, this is also what most people believe.

RS: Yes. That’s because of this narrative out there that we are in some neoliberal era. There’s been a lot of talk that way. Even Biden’s predecessor, [Donald] Trump, came to office and said, “We’re going to do deregulation. For every new regulation we put into place, we’re going to withdraw two.” By the end of Trump’s term, he imposed as many regulations as any president before him. So what is talk, and what is data? That tends to be a disconnect. People speak about how the state and government spending shrunk under Ronald Reagan. Where is the evidence? It’s a very clear line graph going only in one direction. So you look at regulations. You look at government spending as a share of GDP. You look at the Fed’s involvement in the economy, what it buys, where it intervenes. You look at the size of the bureaucracy. You have to see it in a holistic way.

So I think the reason why some people made a mistake, possibly, is that you have someone sitting there and taking ideological positions about this talk. Trump talks deregulation. He talks tax cuts. But then what’s actually happening with policy? What has he done to promote free-market stuff? But people believe a lot of the rhetoric. But from a strict data perspective, the size of government and the suite of government habits has constantly expanded over time. There’s been no era where it really shrank.

RA: Jake Sullivan, the national security advisor, on April 27, 2023, gave a speech at the Brookings Institution titled “Renewing American Economic Leadership.” You describe the speech as emblematic of this new sort of bipartisan consensus that big government is better.

RS: Yes. Because who is he invoking? He’s talking about examples such as China. There’s a big misunderstanding of what happened in China. It started off as a very tightly controlled Communist state, then started to give people lots of economic freedom. I would argue that the success story in China was economic freedom. The role of the state, if you measured in terms of its employment, also went down until the last decade or so, from 90 percent to 30 percent. And then under [President] Xi Jinping, we’ve seen some reversal of that. His move toward a more statist regime has had negative consequences on China and its growth. And here we are invoking China and arguing American leadership needs to copy more of what China has done by having an industrial policy? That was really jarring to me.

But also, I spoke to some Indian business friends and they were aghast that America would dictate who should get subsidies or not. That’s the way we grew up in India in the 1970s and ’80s. Why is America doing this today when it has not worked? With industrial policy, for every example that is cited for having successfully backed this industry or that industry, I can cite five or seven industries where it led to overcapacity and waste because then some new technology came and changed that. If you want to do industrial policy and you want to renew America, but you’re going to keep spending on everything else as well, there’s no limit to it. The idea that we will add five more priorities without scaling back on anything else, that is the typical path that we have been on.

RA: I think the people in the White House would argue back at you and say they’re picking winners and subsidizing them—advanced semiconductors, green technologies like hydrogen, critical minerals—because these are national security domains, not pure economics. Hence the protectionism, hence the industrial policy. But I take your point in that it builds inefficiencies.

I want to just go a little bit more global. You had a line in the book where you said that Nordic states are less socialist than most people think. Explain that.

RS: These are countries which toyed with things like wealth taxes and then had to withdraw them. Sweden is a classic example of a very expansionist state. Government spending as a share of GDP went well above 50 percent or 60 percent. It ran big deficits but got into crisis. And then, in fact, over the last couple of decades, it has been in a reversal mode. So it’s not this country where the state just keeps expanding over time and comes up with great results.

And the second thing, if you’re going to cite examples like Scandinavia, which a lot of liberals do, then what about places like Switzerland? Switzerland is both a happy nation and also the richest nation. And yet Switzerland, in terms of its government spending as share of GDP or its regulatory environment, it’s all much lighter touch.

RA: You also point to Taiwan and Vietnam as countries that have models that other capitalist economies can learn from. What are those lessons?

RS: Of course, those economies are still not as rich as America or Switzerland. But why? I picked those examples because I was keen to show countries across the income curve. Especially with Vietnam, even though they are not there yet, they are moving in the right direction. And what’s the right direction for me? Giving people more economic freedom. In absolute terms, Vietnam is not as free as, let’s say, America, but it’s moving in the right direction. Economic growth is increasing. And we are seeing a much happier society as they move in the right direction.

Taiwan is a great example because it was such a big success story during the pandemic in the way the state handled COVID. And guess what? Its government spending as share of the economy is closer to 20 percent than the 40 percent for America. So you can achieve a lot of economic success and have a successful state without just indiscriminately throwing money at the problem. You have state involvement in all these places, but you have the right-size state with light-touch regulation, and you end up getting more efficient outcomes.

America still has many strengths to it. Its entire tech ecosystem. Its immigrants. It’s still the place that most people want to come to. But we are moving in the wrong direction. And do we want to wait until we really get to a hopeless outcome? The first step to a cure is to at least diagnose the problem correctly. Because if you go on believing this narrative of a shrinking state, we’re just going to end up in bigger trouble and with more disaffected people than even what we have today.