Free Markets Failed? Hardly

Monday, 08 June 2009 11:22 Last Updated on Monday, 08 June 2009 11:23 Written by David Strom

It has become commonplace for left-leaning economists and politicians to blame the current financial crisis on unbridled capitalism.

This story—this fantasy—is nothing but a fable they have cooked up to justify new government interventions into the economy on a grand scale.

I’m not talking about the bailouts, as bad as they are. Those could have been (wrongly) justified as necessary interventions to prevent the imminent collapse of our economy. No, what I am speaking about is the massive restructuring of our economy planned by the Obama Administration.

Their plans include completely reworking the energy, health care, educational and industrial sectors of our economy. They have begun implementing industrial policy on a grand scale, justified by the claim that the current economic mess we are in was caused by excessive reliance on free markets.

That justification, of course, is based upon pure bunk.

While America has certainly had markets which have been in general freer and more flexible than Europe’s and indeed most of the world, it is not the case that we followed laissez faire policies. Not by a long shot.

For the indictment of free markets to hold water, you would have to believe that the financial industry and corporate America were unregulated by the government. This, obviously, was far from true. In fact the financial industry is one of the most tightly regulated industries in our economy.

It was also one of the most poorly regulated industries, and that is saying a lot. Government regulations not only did not prevent the crisis, but in some cases exacerbated the tendencies which helped cause the crisis. Highly regulated does not mean well-regulated. And the solution to poor regulation is not necessarily more regulation.

The belief in more regulations as the solution to our problems is based upon faulty assumptions: that regulators are omniscient and omnipotent, and that the regulated aren’t wily enough to game the new system to their advantage.

Relying on regulations to tame the market system into submission is pretty much a fool’s errand. More often than not you fail, and when you don’t fail the consequences of that tamed system is often economic sclerosis. Socialism provides a tamed market, but not one that works.

Which gets us back to the whole question of those bailouts I alluded to above. More than any regulatory failure over the past several years, the growing belief that government will cushion the blow of failures in the marketplace has made our financial and economic system more, not less risky.

Government’s willingness to backstop private businesses when their losses become truly staggering has encouraged behavior that results in truly staggering losses.

The cost of the current bailouts and government guarantees has been estimated to be as high as $15 trillion. If you had a $15 trillion insurance policy on your bad behavior, wouldn’t you be just a tad more likely to take big risks in pursuit of huge rewards? Economists call this the problem of moral hazard.

We’ve created a pseudo-capitalist system that privatizes profits and socializes losses. Is it any surprise that the results of that system are economic actors willing to do almost anything, no matter how risky, in pursuit of profits because they know that others will bear the cost of their losses?

Blow up a bank? Collect the bonuses and walk away. Destroy an auto company? Keep your gold-plated pay and benefits. Write billions in risky mortgages that blow up a housing bubble? Take the profits and begin investing in property once the bubble has burst.

Government is trying too hard to tame the market, rather than not hard enough. Only with the rough justice of failure and its consequences will market actors begin to manage risk in a reasonable way.

It wasn’t inadequate regulation that created this mess. It was the “too big to fail” policy of lemon socialism that has brought us to the brink of disaster.

And as far as I can see, things are only getting worse. The advent of industrial policy on a grand scale will mean a gradual takeover of much of the economy by the government, and the politicization of economic decision-making on a scale never before seen here in the US. If that happens the US truly will become a second-rate power with an economy to match.