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Book Review: Commanding Heights

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--Rex Sinquefield, Active vs. Passive Management, October 1. 1995

There’s little more frustrating than being stuck in a traffic jam, especially when you’re trying to get somewhere important. The same can be said for the way developing and third-world countries anxiously awaited what a changing world economy had in store for their governments, businesses, and laborers during the 20th century.  The comparison of the free markets to traffic belongs to Ludwig Von Mises (1881-1973), an Austrian School economist who was a strong advocate for keeping government intervention out of the economy. He is well known for his analogy of prices in a free market system to “traffic signals.” Interestingly, Dimensional Fund Advisors co-founder, Rex Sinquefield (retired), drew upon Von Mises’ analogy in a 1995 speech on active vs. passive investment management stating: “The price system acts to spread this knowledge and coordinate the actions of these individuals.” Both Sinquefield and Von Mises purported that these “signals” engender and enforce an efficient economic system that should not be tinkered with. In his speech Sinquefield also draws heavily von Mises’ protégé, Nobel Laureate Frederich von Hayek (1972) who famously declared in The Road to Serfdom that free market capitalism is a superior economic model to communism or socialism. He declared that centralized planning by a government is not democratic and that market economies are the result of spontaneous order, resulting in a more efficient allocation of resources than any other system could achieve. Hayek argued that in socialist or communist societies, an individual or a small group of people inefficiently determines the distribution of resources. His findings support the concept that prices in a free market, such as the global stock exchanges, reflect the available information and the forecasts of all market participants. This is clearly the message Sinquefield drew upon for his coup de gras in the debate over active vs. passive investing: “So who still believes markets don't work? Apparently it is only the North Koreans, the Cubans and the active managers.”

These important, yet conflicting concepts of socialism vs. capitalism and their historic underpinnings are well-chronicled in Daniel Yergin’s Commanding Heights: The Battle for the World Economy. Yergin’s 3-part video series and book of the same title carefully detail the historic rise and retreat of government intervention, or socialism/communism, as an economic system to manage the socio-political and financial concerns of a developing world thrust into change. I have both read the book and watched the entire series, and I highly recommend either as a means to improve one’s understanding of the personal and political aspects at play. Impressively, Yergin explains the didactic viewpoints regarding the role of markets and their impact on economic freedom, and the activities that led to the perception that socialism/communism was a viable means for satisfying the economic needs of the people.

In Depth: A Challenge to Free Markets

Ludwig von Mises asserted that government works best when it stays far afield from intervening in economic activity, and that the market system operates most effectively when its participants rise and fall on their own merits, with the market itself as the ultimate arbiter. However, in the challenging times of the industrial revolution, laborers clearly experienced the problem of immobility, and von Mises’ views of the market and its traffic signals grew on the irritation of many, as they felt as though they were caught in traffic. Karl Marx seemed to bring a solution to get people moving again.  Instead of complying with the free markets, this German sociologist and philosopher sought to abolish them in order to advance a vision that he perceived to be more fair, progressive, and egalitarian. As laborers lost faith in Von Mises’ “traffic signals” to stabilize the economy, Marx’s philosophy quickly caught on, inspiring workers to unite together in pursuit of equality. “During the 1920’s, the market system had not performed anywhere near adequately in many countries,” cites Yergin, “In fact, during the 1930’s, the system as it was appeared to be a colossal failure. Consequently, Marx’s teachings inspired prominent leaders/thinkers such as Bolshevik revolutionary Vladimir Lenin, Indian prime-minister Jawaharlal Nehru, and Chilean president Salvador Allende.”

Many nations around the world looked to their governments to enforce market stability. Socialism took rank above free market capitalism in both popularity and progress. Most of the 20th century marked the golden years of central planning, and some form of Socialism or Communism was the controlling force for most countries throughout the world. It seemed as if the onward march of government control of progress and people would not stop until it controlled the entire world economy.

In particular, the middle decades of the 20th century brought deep despair for those clinging to the ideal of free markets. Against the backdrop of the Great Depression, capitalism seemed to be on the decline, leading many to look to government intervention to pave the way to peace and prosperity. During this time, Labour Parties in Europe and Great Britain rose to power, with a strong commitment [i]to “conquer the commanding heights of the economy,” says Yergin.

In a systematic takeover, Labour Parties nationalized the once fragmented independently and privately owned industries including coal, iron, steel, railroads, and all of the utilities. Some 30 years prior to this massive unionization, Communist revolutionary Vladimir Lenin had proclaimed these very industries the “commanding heights” of the world economy. He had prophesied that his Bolshevik party would one day own them. Lenin’s vision moved swiftly toward reality as certain factions of organized labor continued to successfully pressure nations to take up the Marxist/Leninist torch, continuing the assault that Lenin initiated against the free markets.

Meanwhile, in India, the idea of a government-run economy grew on Prime Minister Nehru, who had governed by implementing a blend of European and Soviet systems. Many were interested in his experiment, believing that the result would be a “best of both worlds” economy, one that would enable a “big push” through heavy industrialization, “delivering development and growth,” according to Yergin.

Nehru, studied mathematics at Cambridge, and believed that “the economy could be measured and rationally managed with the precision of a physics experiment,” observes Yergin. Nehru believed that he could manage a more complex economic system than that of any European country by using “simple science.”

The Soviet, Eastern and European march toward government run populaces moved into Latin America as government officials decided to follow Lenin and Nehru’s examples, adopting central planning believing they could modernize their economies. Salvador Allende, the 29th president of Chile was a self-proclaimed Marxist.

However, the cracks in the communist/socialist infrastructure began to grow and reveal themselves in the 1980’s as the Cold War began to thaw amidst the challenges of the governments to sufficiently and properly grow their economies and provide for their people. Frustration led to a cry for independence among the people, and free market capitalism peeked through to spark a newly forming global economy. This new economic system which relied more on von Mises’ traffic signals, and fewer traffic police, brought less government regulation and provided more flexibility for people in the markets.

An Idea Whose Time Had Come

Von Mises and his protégé, Friedrich August von Hayek had long viewed government control over the markets as a recipe for disaster, and they were proven right. Von Mises had long predicted that “the new Soviet socialist economy would never work, precisely because of government controlled prices and wages,” cites Yergin. Von Mises viewed government control of prices as a major cause of economic crises, and completely unnecessary. Hayek believed that central planning enforced by the likes of Lenin, Nehru, and Allende gave government too much power and would eventually endanger individual liberty. In an effort to dissuade countries from adopting socialism and other political systems that promoted government control over their economies, Hayek wrote the Road of Serfdom. In this book, Hayek asserts that too much government control over the economy destroys freedom and makes men slaves. Hayek admonished that a Marxist society would inevitably resemble Feudalism, making everyone serfs, or servants of the state. Hayek’s comparison is striking. Feudalism, a social stratification that dominated medieval politics, maintained an orderly yet unequal class system in which all power was concentrated within the monarchy. A king and queen ruled the fates and livelihoods of the many subjects who were serfs or slaves, residing at the bottom of society. Similarly, socialism/communism thrive on a command economic system, concentrating control into the hands of bureaucrats who have total power over the economic activities and livelihood.

During the 1970’s and 80’s, the shortcomings of Marxism were becoming apparent as the economy of the Soviet Union rapidly declined to the point where its own citizens began to question the very system that their parents and grandparents grew up with. In Leningrad, where Lenin first embarked on his communist revolution, students at university began to wonder if the solution lay not in Marxism but in free markets.  Younger generations grew weary of the system that made daily life hard.  Basic necessities such as toothpaste and soap were unavailable. Soviet general secretary Mikhail Gorbachov (1985-1991) admitted it was “preposterous and embarrassing to work in such a government,” according to Yergin. Gorbachov answered the cry of his people by passing Perestroika, allowing greater freedom in the markets, and a spark of capitalism was lit.

World leaders including British Prime Minister Margaret Thatcher; aka the “Iron Lady”, U.S. President Ronald Reagan, and Polish trade-union organizer Lech Walesa, and Pope John Paul II each well understood the ills of socialism/communism, and their impact on personal freedom and economic liberty. Thatcher studied carefully Hayek’s Road to Serfdom, and the book was instrumental to her iron-fisted stance to beat back socialist factions. One such example of Thatcher’s willingness to challenge labor unions was her confrontation with the National Union of Miners, believing that they could “make or break governments” (Yergin 95). In March of 1984, miners carried out a strike, which was angry and violent at times (Yergin 95). The following year, the strikers caved into the British government, raking in a new era of less protection for organized labor. Reagan embarked on a similar course as then prime minister Thatcher as he talked about “rolling back government and cutting programs; he promoted free enterprise and celebrated the magic of the market” (Yergin 342). Unlike Thatcher and Reagan, Walesa had a powerful ally in the Pope, who “kindled a new sense of faith, confidence, and national unity” amongst the Polish (Yergin 272). The alliance between Walesa and Pope John Paul II was based on the misery they both shared in their native Poland under communism. In fact if it hadn’t been for Pope John Paul’s powerful support of Walesa then Walesa’s movement for solidarity, or trade unions independent from communist party control probably would have never taken off. Both were instrumental in the collapse of communism in Poland. Together, the four leaders applied pressure to central planners, labor unions, and even the people that were subjected to communism to push for more freedom and less government control in their respective countries.

Winston Churchill famously referred to socialism as “shared misery.” While it took some seven decades for that shared misery to manifest itself into the inevitably broken system that squelched personal freedom and prosperity, Hayek never wavered in his commitment to personal liberty and free markets. Lenin’s promise of egalitarianism that began in 1917, toppled under the weight of its own destruction in 1991 as capitalism has proceeded to once again dominate the global markets.

Despite the fact that communism was such a dominant force with a wide head start in the race to control the global economy, free markets prevail.  One might wonder how capitalism, a philosophy of individual works and initiative managed to gain the upper hand against the seemingly logical and appealing socialist viewpoint -- that the needs of the masses transcend the wants of the few. Perhaps the simple answer to a complex question lies in the fact that capitalism better facilitates both the wants and needs of the many by affording capitalists the opportunity to make their own way, and by fostering personal liberty and the right to freely traverse the highway of the global economy.