In this edition of Author Talks, McKinsey Global Publishing’s Raju Narisetti chats with Ruchir Sharma, chairman of the wealth management company Rockefeller International, founder and chief investment officer of Breakout Capital, and Financial Times contributing editor, about his new book, What Went Wrong with Capitalism (Simon & Schuster, June 2024). Sharma outlines the role that government plays in unintentionally undermining economic growth, as well as the impact of the “productivity paradox.” Highlighting the ill effects of income inequality, financial-market deregulation, and other challenges, Sharma delineates what it would take to restore the balance of capitalism and government intervention. An edited version of the conversation follows, and you can also watch the full video at the end of this page.
Why write a fifth book about nations, economies, and government policies?
Writing this book has been a fascinating journey; it’s my most ambitious project. I conceived the ideas during the [COVID-19] pandemic—when governments excessively spent.
One chapter in the book is dedicated to staggering government spending and the distortions it caused in a so-called attempt to satisfy everyone. I felt outraged about what happened during the pandemic and about who benefited from those actions. The rich profited during that time due to the government throwing money away and financial bailouts.
My ideas came from that. I intend to take readers on a 100-year capitalism journey and show helpful signs of what capitalism can do when it works as it should.
The first and most important step to a cure is correctly diagnosing the problem. There are a lot of feelings, especially among progressives, that the fundamental problem in America is that governments should be doing more to rescue the poor.
Capitalism has not failed, but it has become socialism for the rich.
It’s a noble intention, but “the road to hell is paved with good intentions.” First, you need to understand what the problem is. Why are we in this mess today? Why does capitalism disaffect so many people? Why would young people rather try socialism? The diagnosis of the problem is essential. Once you appreciate what that is, a solution will come into view.
Capitalism has not failed, but it has become socialism for the rich.
Aren't you a capitalist?
Yes. You can argue that we’ve all benefited enormously from capitalism, but why is the number of start-up businesses in America declining? Why are economic and social mobility declining? These are issues that require serious introspection.
Solutions are often offered. The easy fix is to “throw more money at the problem.” If you keep doing that, you will repeatedly see more of the same issues you’ve seen over the last 20 to 30 years—rising inequality, more deadwood in the system, and lower productivity.
Why is corporate inequality a new threat to capitalism?
One striking change in capitalist economies is that income inequality is now rising more rapidly between “superstar” companies than it is growing inside companies. We’re familiar with the statistic that US CEOs earn 400 times more than their staff members. This ratio has increased dramatically since the 1960s but has barely moved over the last two decades.
Instead, the current primary driver of income inequality is where you work—every employee at a megafirm earns much more than a comparable employee at a smaller firm. This gap continues to grow. Corporate inequality rises across capitalist economies from the United States to France, Germany, and Sweden.
Why is a government being pro-business not the same as being pro-capitalism?
Politicians often take actions that are seen as favoring businesses, such as offering bailouts, extending subsidies, erecting barriers to foreign trade, providing special tax breaks, or making public investments in the name of industrial policy. These actions are typically presented as being pro-business.
In turn, being pro-business often ends up being pro-incumbent. It’s not pro-competition or pro-churn; capitalism is essentially about both things.
What state interventions end up doing is creating winners and often helping the incumbents. That’s not the same as being pro-capitalism. That’s the distinction between pro-capitalism and pro-business.
What do you mean by ‘big government acting as sand in the gears’?
The standard story is that the government has been in retreat for four decades, particularly by deregulating financial markets, which are left free to run wild. The resulting distortions, such as the runaway price of big capex stocks, are market failings that spring from excessive market fundamentalism.
It’s true that financial-market deregulation eliminated many barriers to the global flow of capital and gave investors numerous options that they didn’t have before. However, deregulation is only a small part of the story.
The bigger part of the story is that governments and central banks intervene much more in the markets, whether by bailing out companies, extending massive amounts of monetary stimulus, or cutting interest rates. They put out so much capital that markets cannot deploy it efficiently.
The surge in government interventions that propelled financial-market growth has led to price distortions, with the government emerging as a major buyer of bonds and other assets. Investors constantly ask, “When and where will the government step in?” Then they make their bets.
You reference a quote from Robert Frost, ‘the only way out is through’ downturns and recessions. What does that mean?
You must evaluate the trade-offs governments like to believe in; if you prevent any pain and help people, that’s great. Intuitively, it sounds appealing, but problems arise when the government attempts to save the deadwood. Who are you preventing from entering the system? What’s the insidious damage that the help causes?
This hubris of governments and central banks is that they can micromanage everything—including the business cycle and the idea that no one should suffer. Therefore, you see less frequent recessions.
The problem is, it creates a massive number of distortions with enormous debts and deficits. Corporate deadwood is kept alive; the number of “zombie” companies in America is nearly 20 percent of the number of existing organizations. It’s a startling number compared with the 1990s, when the number of zombie companies in America was 2 to 3 percent.
An explosion in zombie companies keeps deadwood alive, which hurts subsequent recoveries. Productive growth is now lower because if you keep deadwood, you have lower productivity and fewer fresh start-ups. It’s now a question of getting the balance right.
In the 1920s, there was an opposite approach—let everything die and let all regeneration occur naturally. Of course, that point was taken too far. The whole liquidation theory came into play in 1929 with the Great Depression.
We’ve gone to the other extreme, which in turn prevents new talent and companies from emerging.
How is the right balance of ‘mixed’ capitalism and a strong role for a government achieved?
In the 1920s, there was a real extreme when government spending was 3 percent of GDP, and there was no return to that. The question is: can we let the government debt and deficit keep exploding at its current pace?
Today, the United States has a budget deficit of 6 percent of GDP, compared with 3 percent, which is where it has mostly been for the last couple of decades. The government debt and the share of GDP is crossing 100 percent—behind only Italy and Japan. America is the leading financial power in the world. Are we going to allow our debt and budget deficit to keep increasing?
Government interventions also have many nonfiscal costs, including moral hazard and, of course, the issues with keeping deadwood companies alive.
Interventions or some types of support are necessary when a recession arises. However, the mindset that no one is allowed to fail and that the government will keep intervening to boost growth wherever it can needs to change. That thinking increases debt and deficits and lowers the economy’s productive capacity.
America’s attitude is that it doesn’t matter. “We are the world’s reserve currency and can fund whatever deficit we want.” When you run up deficits to more than 6 percent of GDP annually, that tests the market’s limit. There’s no discussion of how to get close to balance or even cut the deficit back, and that’s concerning.
Can any government sensibly spend the right amount of money?
I avoid offering fixed solutions in the book. Everyone keeps asking, “What’s the solution?”
Offering fixes is pointless when we know the solution but there’s no chance of anything being done until there’s a crisis. Governments around the world tend to act only when faced with a crisis because of excessive spending; governments don’t act until then.
It’s a tall ask. I don’t expect governments, including the United States, to do anything to cut spending or budget deficits preemptively. The crisis will occur when the markets stop funding these massive deficits.
Cutting spending doesn’t happen unless a government faces a crisis, and I fear that one may be closer than many expect.
There is chaos in many emerging markets. Recently, we’ve seen economies in Argentina, Türkiye, Nigeria, and Kenya run out of money. Those countries have been forced to chainsaw their spending in the last few months to regain balance.
Cutting spending doesn’t happen unless a government faces a crisis, and I fear that one may be closer than many expect.
Should government spending prioritize productivity gains?
The government has numerous priorities, such as spending money on defense, perceived technological threats, climate change, and the aging population. There’s also populist anger at the amount of inequality that exists in capitalist societies.
These are all legitimate threats, but how do you determine where and how to spend money?
There are two ways: the first is prioritization, and the second is growing the pie sufficiently to have enough money to spend on the various crises, which accumulate as a poly-crisis. The question is, how do you grow that pie?
With an aging populace, the only way to do so is to increase the economy’s productivity. In the book, I argue that the productivity paradox we currently see is that despite the massive technological advancements over the past couple of decades, productivity has been declining.
The productivity paradox we currently see is that despite the massive technological advancements over the past couple of decades, productivity has been declining.
It has picked up a bit recently because of the thought that AI will help. If you look at the broad trends, productivity growth has been declining so far. The only way to explain declining productive growth in the face of sure technological innovation is that something else is occurring.
In the book, I argue that the creative-destruction fiber of the economy, which is the essence of capitalism, is not being freed by noncapitalist interventions. Instead, we must focus on raising productivity, because that’s the only way to grow the overall pie and spend on so many of these priorities.
The way to begin growing productivity is to allow capitalism to work again. Currently, we aren’t allowing capital to work in its full form. We distort it with so many interventions. The government’s role is in every sphere—helping the incumbents and the entrenched. That goes against the productive capacity of smaller businesses, which generally tend to have higher productivity.
Will AI drive productivity regardless?
The evidence is already in; it’s a fair bet that AI will help increase productivity. Suppose you look at the last ten to 20 years. In that case, other technological advancements should have increased productivity, whether by introducing smartphones, the cloud, or other technology from which we benefit.
If we’ve had all these advancements, why aren’t they showing up in more significant productivity growth? A force is counteracting, and that counteractive force is the amount of government intervention. It undermines economic growth.
Can governments protect domestic economic and political stability while seeking global trade?
There’s a misunderstanding of industrial policy and how it worked in East Asia. East Asian countries are invoking China’s development model, not realizing that China’s economy is losing.
It’s a backward argument and a fundamental misconstruction of China’s economy. Yes, China did back industries over the last 40 to 50 years. Still, the fundamental reason for the Chinese economic miracle was the decision to reduce the state’s role in the economy.
In the 1970s, the Chinese state controlled every aspect of its economy. By the early 2010s, before Xi Jinping came to power, China’s role in the economy was significantly reduced—the total amount of assets and share in employment fell to below 20 percent.
China’s primary economic growth comes from going from total control to 20 percent, and that’s been a growth driver in many other emerging economies, including India. Both countries have allowed private sector entrepreneurs to bloom.
I’m not sure what role industrial policy played, but the government’s retreat played a more significant role. If you look at successful East Asian models today, such as Taiwan and Korea, they spend a share of GDP that’s around 20 percent. I refer to them as the “gold medalists of growth.” They spend below what Western economies spend.
They are getting the balance correct. In the book, I devote a chapter to economies that master balance, countries like Switzerland and Taiwan, but I also discuss Vietnam’s economy, which is a communist state.
Today, the communist state is liberalizing and drastically opening up to foreign investment. You must put that into perspective, keep in mind where capitalism has been working, and avoid learning the wrong lessons at the wrong time.
Why are voters, especially younger voters, not focused on government’s role in economic systems?
Voters are misled by the hubris of economists, who tend to talk about economics as if it’s a hard science and that the economy is an engine or machine. There’s more art to it than they claim. The “machine” is susceptible to fine-tuning by government technocrats and central bankers. We must understand that human behavior drives economic behavior.
It isn’t science; it’s art. Natural ecosystems are very complex and fragile, and trying to fine-tune them can backfire.
We’ve become addicts of sorts. We want to intervene and fix things immediately at the slightest hint of pain or trouble. We aren’t allowing anything to heal naturally.
We need balance. If something severe happens, then you need intervention and external aid. Conversely, we don’t need the same treatment for every slight, odd pain. Constant intervention is a fundamental problem that we play with nature.
Do economic empires see an end to their currencies?
The dollar is highly overextended. Looking at the world’s history, we’ve had a reserve currency, the dominant currency, for around 100 years. Before the dollar, there was the pound; before that was the French franc, and before that, there were Spanish, Portuguese, and Dutch currencies. After 100 years, all those countries became overfatigued, overindebted, and arrogant about their currencies’ power. This eventually led to their empires unwinding and falling.
In America’s case, we aren’t anywhere close to that scenario. However, the arrogance of power that the US has [comes from being] the world’s reserve currency, and the world will keep funding its deficits. In return, America can expect no reaction as it does whatever it takes, including imposing sanctions and using the dollar as a weapon against countries that it deems aren’t behaving correctly.
There could be a reaction, and there’s already a budding reaction. Why has the price of gold increased drastically? Even the rush to purchase Bitcoin indicates there’s a desire to reduce reliance on the dollar. If this continues, the US will have difficulty funding its deficits. That’s the warning. Again, until you experience a crisis, there’s no expectation to change behavior.
What is your hope for capitalism?
I escaped socialism when I came to America, and I end the book by stating that America is the place that I love and love to live in still. I want to see it prosper and improve in the capitalist system, but we cannot ignore all the problems when so many people are disaffected with it today.
I offer my vantage point from being in the financial marketplace and seeing how it works; I see the weeds. Looking at how much money people make and how billionaires walk away with so much wealth, just having benefitted from the massive stimulus, it’s important to show how the system is working and where it is dysfunctional.
I’m presenting evidence. As a writer and someone who’s grown up in the system, I aim to illustrate what I think are the problems. If I whistle past them, it’s irresponsible.
Watch the full interview
