Free Market

[This is the first in a series of posts I plan to write on free markets. As and when I write them, the posts will be accessible under this tag – free market series. In the current post, I argue that a free market cannot exist under a statist system of government.]

Some sound bites-

Champions of “free markets” and “deregulation”
“Globally, the sustained and systemic nature of this crisis may mean that an era is ending. In one sense, it already ended when Washington, under the tutelage of the Bush administration which champions deregulation, took over giant mortgage agencies (Fannie Mae and Freddie Mac) and took an 80 per cent stake in the American International Group.

Deregulation began as a way out of the stagflation of the seventies. It’s generally associated with the advent of Ronald Reagan in the US and Margaret Thatcher in the UK, both of whom championed free markets and took their respective national economies out of the rut each was stuck in.” – Crisis as Opportunity, TOI Editorial

Narayanamurthy The Philanthrocapitalist
“Infosys Chairman NR Narayana Murthy suggested stricter regulations and increased vigilance. ‘Even in countries that follow the capitalist system of government, there should be more regulations. It is an extraordinary event that a capitalist government such as US is considering the acquisition of shares in companies to bail them out,’ he said.” – Infy beats St, but stays cautious

Keynes The Capitalist
“There are some people, such as former White House economist Nouriel Roubini, who feel that the government’s active role in rescuing Wall Street firms is turning America into a socialist state. There are others, particularly in India, who sees the crisis as proof of the inevitable failure of markets and capitalism. Both these views are wrong. There is nothing in capitalist systems that prevents the government from regulating markets. Indeed, that is the contribution of Keynesian economics, which requires the state to help maintain growth and stability in free market economies.” – Not Apocalypse Now, TOI Editorial

In a world where people kill themselves in the mistaken belief that a black hole generated by the Large Hadron Collider will bring about an apocalypse, where astrologers sue space agencies, where experts routinely go about spewing nonsense based on a theory of government they don’t understand, or bother explaining (see sound bites above), trying to convince people that the free market is less about the market and more about freedom is like trying to move a mountain. But if the free market has to see the light of day, those who believe in it will have to keep defending the idea even if it means the same points have to be made again and again and again and again and again and again, to the point of utter boredom, lest its written off as “dead”.

There are three broad classifications of government- anarchism, constitutionally limited government and statism. Anarchism is an umbrella term used to describe various political philosophies that deny (some of them fanatically) the need for government of any kind. Limited government is the theory that a government is necessary to secure the rights of the people, but to prevent government from becoming the people’s enemy, its powers need to be specified – curtailed – through a tightly written constitution. Statism is an umbrella term that is used to describe various political philosophies which essentially give governments unlimited power over people, their lives, property, everything. Communism, mixed-economies, fascism, democracy (as opposed to a constitutional republic – limited government), and any system of government that governs not to protect individuals and their rights, but for some other reason, are all various forms of statism.

A free market can only exist in some forms of anarchist societies (particularly anarcho-capitalist ones, assuming private defense works) and in societies governed by a limited government (assuming the constitution does not permit a US style constitutional disaster) – that is, in societies that practice laissez-faire capitalism. A free market cannot exist in a Statist system of government – it is a theoretical impossibility, so assumptions are useless – irrelevant. Those who believe that governments with unlimited power will somehow let free markets function live in a fool’s paradise. But such people are probably in a minority. A majority of the people know this fact, and are pretty happy with it. They prefer growth and employment over freedom, avoidance of “systemic risk” over freedom, everything over freedom. A free market is too scary a prospect for them because it signifies loss of control.

Now the answer to the question – why is it that “free market” cannot exist within a Statist system of government? Because Statism’s ends-justify-the-means philosophy will necessarily result in interventionist policies. The free market is all about making profit; its not about meeting social responsibilities; its not about nationalism, patriotism and protectionism; its not about charity; its not about some vague feel good factor. And this is precisely why statism will demand regulation; the economic history of the world is proof that statist governments won’t leave markets alone. As for current trends, I will simply quote some paragraphs from Dani Rodrik’s articles-

Good governance is, of course, essential insofar as it provides households with greater clarity and investors with greater assurance that they can secure a return on their efforts. Placing emphasis on governance also has the apparent virtue of helping to shift the focus of reform toward inherently desirable objectives. Traditional recommendations like free trade, competitive exchange rates, and sound fiscal policy are worthwhile only to the extent that they achieve other desirable objectives, such as faster economic growth, lower poverty, and improved equity.

By contrast, the intrinsic importance of the rule of law, transparency, voice, accountability, or effective government is obvious. We might even say that good governance is development itself. (Getting Governance Right)

and

What a difference today’s crisis has made. We now realize even the most sophisticated market players were clueless about the new financial instruments that emerged, and no one now doubts that the financial industry needs an overhaul.

But what, exactly, needs to be done? Economists who focus on such issues tend to fall into three groups.

First are the libertarians, for whom anything that comes between two consenting adults is akin to a crime. If you are selling a piece of paper that I want to buy, it is my responsibility to know what I am buying and be aware of any possible adverse consequences. If my purchase harms me, I have nobody to blame but myself. I cannot plead for a government bailout.

Non-libertarians recognize the fatal flaw in this argument: financial blow-ups entail what economists call a “systemic risk” – everyone pays a price. (Guns, Drugs, and Financial Markets)

and those of Joseph Stiglitz

The world has not been kind to neo-liberalism, that grab-bag of ideas based on the fundamentalist notion that markets are self-correcting, allocate resources efficiently, and serve the public interest well. It was this market fundamentalism that underlay Thatcherism, Reaganomics, and the so-called “Washington Consensus” in favor of privatization, liberalization, and independent central banks focusing single-mindedly on inflation.

For a quarter-century, there has been a contest among developing countries, and the losers are clear: countries that pursued neo-liberal policies not only lost the growth sweepstakes; when they did grow, the benefits accrued disproportionately to those at the top.

Though neo-liberals do not want to admit it, their ideology also failed another test. No one can claim that financial markets did a stellar job in allocating resources in the late 1990’s, with 97% of investments in fiber optics taking years to see any light. But at least that mistake had an unintended benefit: as costs of communication were driven down, India and China became more integrated into the global economy. (The End of Neo-liberalism?)

and

We rely heavily on incentives . Auditors desire to maintain their reputation. But the interlinking of consulting and auditing practices puts other perverse incentives in place: an incentive to please the clients, who dislike unfavorable reports. Arthur Levitt, the former Chairman of the Securities and Exchange Commission, recognized the conflict: as many within the auditing firms focus on their own short-term interests, the integrity of the audits could be compromised. He is perhaps the unsung hero of the entire debacle. But the auditing firms and their corporate clients – not surprisingly, given the cabal that developed – roundly attacked his proposal for separating consulting from auditing.

What Levitt grasped – and what the Enron debacle shows so clearly – is that incentives matter, but that unfettered markets by themselves may not provide the right incentives. Markets may not provide incentives for wealth creation; they may provide incentives for the kind of shenanigans Enron pursued. The new economy – and its complicated new financial instruments – enhance the problems of reliable accounting frameworks; they make it easier to obfuscate. Rather than facing up to the issues, corporate America systematically turns its back – aided and abetted by crony capitalism, American style.

The central issue of our time is finding the right balance between the government and the market. The status quo will argue that Enron is an exception:
[…]
Repeatedly, we have seen the consequences of the excesses of deregulation, of unfettered markets. Now we must resist the temptation to go to the other extreme. The challenge is: get the balance right. (Crony capitalism American-style)

Stiglitz and Rodrik are not ordinary people. They are some of the world’s top most economists (Stiglitz beats Rodrik by a substantial margin, but still) – people whose opinions get heard, at least when it comes to economics. And they are not interested in “unfettered markets”, but in how the market can be controlled so that certain other “desirable objectives” can be met. And politicians and dictators find this to their liking.

Some people might not find this answer convincing enough. But it should, because a government that has unlimited power at its disposal and which believes in the carrot-and-stick approach in the quest for accomplishment of some “desirable objectives” doesn’t sound like some “champion of free markets”. Note that I don’t intend to convince the majority; their intentions are pretty clear. Stiglitz, Rodrik and many others know; the communists and socialists know; the fascists and corporatists know; the utilitarians and consequentialists know. These people will only embrace freedom and free markets when they come to believe that the individual and his rights are superior to that of any other group; and this job cannot be accomplished by economics, but by philosophy. Its those who believe that statism and free markets can somehow coexist that need convincing. And that’s what I am trying to do here to the best of my knowledge and ability (which is at present average, at best, and this is not an attempt at false humility).

Okay, to those who are still not convinced, I will try and give actual examples about how government intervention (regulations) distorts the market, and why a regulated market is not a free market; but every example is a separate topic in itself and will require a post of its own. Over the next few days/ weeks, I intend to cover the following topics (at least)-

  • Money, banking and finance
  • Health and education
  • Competition and antitrust

Therefore, the next post in the series will be on “Money, banking and finance”.

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Comments

  • you12  On October 13, 2008 at 12:32 pm

    Hope you’ll also write a post on Welfare system and economic, social equality and opportunities.

  • Aristotle The Geek  On October 13, 2008 at 1:28 pm

    The welfare system and egalitarianism affects the free market in three ways – taxation for “social justice”, regulation, and affirmative action based on socio-economic criteria. Let me see where I can fit it in.

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