Since the world has declared an open season on capitalism, and the US on Milton Friedman, it pays to revisit the topic from time to time.

Friedman, though a libertarian, was inconsistent in his beliefs, particularly about the role of government and that didn’t help matters. I can’t remember the exact quote, or even the name of the person who said it (perhaps Rothbard), but it went something like this – the only reason Friedman is considered a libertarian [on economic issues] is because everyone else was to his left. Friedman, then, would be a centrist – moderate. An article in the NYT last April took “a fresh look at the apostle of free markets”

But with market forces now seemingly gone feral, disenchantment with regulation has given way to demands for fresh oversight, placing Mr. Friedman’s intellectual legacy under fresh scrutiny.

Just as the Depression remade government’s role in economic life, bringing jobs programs and an expanded welfare system, the current downturn has altered the balance. As Wall Street, Main Street and Pennsylvania Avenue seethe with recriminations, a bipartisan chorus has decided that unfettered markets are in need of fettering. Bailouts, stimulus spending and regulations dominate the conversation.

In short, the nation steeped in the thinking of a man who blamed government for the Depression now beseeches government to lift it to safety. If Mr. Friedman, who died in 2006, were still among us, he would surely be unhappy with this turn.

“What Milton Friedman said was that government should not interfere,” said Allen Sinai, chief global economist for Decision Economics Inc., a consulting group. “It didn’t work. We now are looking at one of the greatest real estate busts of all time. The free market is not geared to take care of the casualties, because there’s no profit motive. There’s no market incentive to deal with the unemployed or those who have lost their homes.”

To Mr. Friedman, such sentiments, when turned into policy, deprived the economy of the vibrancy of market forces.

Before I take up those highlighted phrases, here is a Friedman quote – “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.” But that didn’t stop him from giving it (the government) a role in managing the money supply even if it meant putting it on autopilot. This is the problem – granting legitimacy to the government.

First, “unfettered markets.” For a frog in the well, the well is its universe. Similarly, for most people out there, an unfettered market means a step back from socialism – government does not own businesses, factories etc. That is all; they don’t have any other definition. For them-

  • regulations,
  • taxes,
  • anti-trust laws that derail mergers in “public interest,”
  • laws that mandate minimum wages that need to be paid to workers,
  • laws that require businesses to register themselves with innumerable government bodies for innumerable reasons,
  • eminent domain laws that allow the government to take over your property against your will by paying a “reasonable” compensation (in India, the word compensation has been eliminated from the constitution; refer to the Kesavanda Bharati case),
  • municipal zoning laws according to which your land can be arbitrarily “reserved,” or placed into a zone that would make it impossible for you to “legally” develop it the way you want,
  • building codes, fire and other safety codes that specify the whens, wheres and hows of property development,
  • foreign exchange laws that make it illegal to move money without informing the government about every transaction,
  • banking laws that allow – compel – banks to snitch on their customers,
  • laws that place restrictions on how companies can raise capital,
  • laws that force businesses to hire in a non-discriminatory fashion,
  • laws that govern the employer-employee relationship and don’t allow a hire-and-fire policy,

and a thousand such restrictions are all signs of “unfettered markets” – free markets. If this is an example of “unfettered markets”, I wonder what fettered markets would look like. When you can start your own bank with 100 bucks in your pocket, without having to travel through a bureaucratic maze and having to fulfill government specified minimum capital requirements, then you can say that the market is free. When you can take a hand cart and sell vegetables on the road without a policeman coming and telling you that it is illegal because you don’t have a license from the municipality, but that he would overlook it if you coughed up 10 bucks, then you can say that the market is free. Till then, anyone who describes the present market as a “free market” is either devoid of any intelligence, or is a crook.

Second, Friedman, and a million other people, said that the government should not interfere. But it did – it fiddled with interest rates. Just like physics, economics has laws too. If you jump off a cliff, gravity will kill you. Similarly, if you bring interests down to artificial levels (levels at which the market on its own is not willing to lend), it allows people to borrow cheaply. Savers get fucked, spenders enjoy themselves. And they buy houses and cars and plasma television sets and trips to the moon – piling up debt in the process. Continuous spending flushes the market with money and prices rise – the purchasing power of money has fallen. Would you save money if the rate of inflation is 5% and the bank is paying you 1%? I wouldn’t, not in a bank. So savers withdraw money from the bank. But banks have already lent money based on a multiplier set by the government. To avoid a bank run, they have to either increase interest rates, or call in loans, or do both. Either way, the free spenders have a problem because unless you are the government, all debts have to be repaid. People who could afford loans @2% can’t afford them at 10%. They have to begin selling off their properties and curb their spending. Since everybody else is doing the same, the bottom falls of the property market and demand plummets. This is the contraction. This is the recession. The collapse of the derivatives market is not the reason behind the contraction. That it blew up is a symptom. So anyone who says “it didn’t work” better take a look at “what” didn’t work. A hangover is the natural outcome of a drink fest, and the cure for the hangover is anything but another drink fest. But that is precisely what every racketeer from Krugman to Stiglitz have kept recommending. And if the past is any indication, the intervention will necessarily make things worse. [Read a description of the Austrian Business Cycle Theory here.]

Third, the market, its “failure” and “incentives.” A few things need to be understood. One – the market is an abstract concept that refers to millions of individual entities transacting in assets they own and services they can provide, based on information available to them. So, anyone who thinks that he can “control” or “regulate” the market is a prize idiot; the “market” will simply work the regulation or control into its calculation and prices will reflect that. For example, a house in a city with astronomical property tax rates will be valued considerably less than a similar house in a similar city that imposes lower taxes, other things being equal. It will keep working around regulations till the regulations force the market to collapse. Two – the market is not your grandmother, or Jesus, or Gandhi, or Jabba the Hutt for that matter; it is neither benevolent nor malevolent; its neither out to get you nor to save you. And it works purely on the basis of self-interest – the same self-interest by which someone who rides on a public bus (probably) won’t mind scratching his name on the back seat or sticking chewing gum under the seat – the bus does not belong to him, but wouldn’t think of doing the same with his own car; the self-interest that comes out of ownership. And the profit-motive is a form of self-interest.

It is true that the market has no incentive to deal with any “casualties.” But it is not true that it does not have the incentive to deal with the unemployed or those who lost their homes. The mistake here is assuming that the first term refers to the second group. The market is not in the casualty business – “it” is in the business of hiring qualified people who are unemployed, at lower salaries than they got previously; “it” is in the business of offering apartments on rent to those who lost their homes; “it” is in the business of buying houses for cheap on the market because “it” saved money while others spent it on trifles. Anyone who assumes that those who made bad economic decisions are “casualties,” and that those who saved money and now have the opportunity to actually afford houses and cars they previously couldn’t, should now be denied that opportunity and should actually have to subsidize the “casualties”, has a perverted sense of justice.

I talked about racketeers. Krugman and Stiglitz are well known statists who are perennially pissed off that the government is not stimulating the economy enough. Krugman is advocating nationalization of the banks; I support him wholeheartedly. Since the present banking system is not a free market one, the sooner we nationalize everything, the sooner the effects of even more government intrusion will be visible. When government bureaucrats sit in judgment on loans to entire industries, and investment schedules go haywire, we would be nearer to the systemic collapse that I have been openly hoping for since last March than we are now. Free market critic Stiglitz, on the other hand, is overjoyed that the capitalism that he’s been fighting against for so long is now on the verge of collapse, but is worried that poor countries are going to suffer. The last one, Dani Rodrik, praises capitalism for its “infinite malleability.” A consequentialist to the core, for him, capitalism is the means to an egalitarian end-

Capitalism has no equal when it comes to unleashing the collective economic energies of human societies. That is why all prosperous societies are capitalistic in the broad sense of the term: they are organized around private property and allow markets to play a large role in allocating resources and determining economic rewards. The catch is that neither property rights nor markets can function on their own. They require other social institutions to support them.

So property rights rely on courts and legal enforcement, and markets depend on regulators to rein in abuse and fix market failures. At the political level, capitalism requires compensation and transfer mechanisms to render its outcomes acceptable. As the current crisis has demonstrated yet again, capitalism needs stabilizing arrangements such as a lender of last resort and counter-cyclical fiscal policy. In other words, capitalism is not self-creating, self-sustaining, self-regulating, or self-stabilizing.


This “mixed-economy” model was the crowning achievement of the twentieth century. The new balance that it established between state and market set the stage for an unprecedented period of social cohesion, stability, and prosperity in the advanced economies that lasted until the mid-1970’s.

This model became frayed from the 1980’s on, and now appears to have broken down. The reason can be expressed in one word: globalization.


The lesson is not that capitalism is dead. It is that we need to reinvent it for a new century in which the forces of economic globalization are much more powerful than before. Just as Smith’s minimal capitalism was transformed into Keynes’ mixed economy, we need to contemplate a transition from the national version of the mixed economy to its global counterpart.


Designing the next capitalism will not be easy. But we do have history on our side: capitalism’s saving grace is that it is almost infinitely malleable.

“Capitalism” is not “infinitely malleable”; its bastardized version is, however – you could call it capitalism, it probably makes no difference to the average man on the street. The fact that “capitalism requires compensation and transfer mechanisms to render its outcomes acceptable” speaks a lot about the political system we follow – the “mixed economy.” Never before has highway robbery been described so eloquently. Rodrik wants “Capitalism 3.0”. He will get it; I am sure of that. But when that collapses too, and we feel the need for “Capitalism 4.0,” we won’t have to take pains to discover it. Germany followed it in the 1930s, under Adolf Hitler. It was called National Socialism (na-zi) – “mixed economy” socialist style-

National Socialism typically promotes uniting the working class of a specific ethnic, national, or racial group into a proletarian nation while socializing the industry, providing an extensive welfare state and opposing capitalism, communism, conservatism, international socialism, liberalism.

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  • Hal  On February 24, 2009 at 10:07 pm

    It’s a huge fiasco. Definitely aren’t seeing promised change but more of the same. With the DOW failing I’ve been watching the precious metals markets with the widget ExactPrice and it looks like a number of those dropping out of the stocks are putting money in gold and silver as a hedge. And given the way the printing presses at the FED are running on full tilt that may not be a bad bet.

    What I wish they would do is let the banks fail, cover the FDIC insured accounts and be done with it. It’ll hurt in the short but the long term result is far healthier then what we’re doing now. Besides, the government isn’t going to just nationalize the banks for a season. Social security was supposed to operate that way too. Once, they’re allowed to take over it’s a done deal.

  • Pramod Biligiri  On February 24, 2009 at 11:57 pm

    Awesome rant! Even CynicusEconomicus (you read him I hope?) wrote today that the worst predictions are coming true one by one, and there’s no stopping them.

  • you12  On February 25, 2009 at 7:58 pm

    This is possibly the most brilliant satire on current crisis. Rachetonomics indeed.

    • Aristotle The Geek  On February 26, 2009 at 1:06 am

      The man in the video, he’s Fred Thompson that actor-politician. And yes, its satire alright, but with plenty of truth in it.

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