Thursday, October 23, 2008

Free Market Free Fall

It’s a tough time to be a proponent of free-market economics, with the financial system in crisis and the real economy heading into a recession. As markets plunge and the government reaches into taxpayers’ pockets to bail out the Wall Street crapshooters who got us into this mess, the triumphalism on the political left is growing. The narrative is that the ascendancy of free-market ideology beginning in the eighties has led to a worldwide crisis and a wholesome political backlash (as exemplified in Latin America), as victims of global capitalism begin to fight for their alienated rights.

A good summation of this position was the speech by Naomi Klein at the University of Chicago on October 4th opposing the establishment of an economics think tank named for Milton Friedman. In essence Klein accuses Friedman and his followers of peddling a utopian vision which has not stood the test of reality but has been imposed by force around the world to allow the rich to get richer while further impoverishing the poor. She calls it a “class war” and says that the rich have won but the poor are fighting back.

There’s no question that income disparities have grown as real wages have stagnated and tremendous benefits have accrued to the top income levels over the past couple of decades. Whether or not this constitutes a war on the poor depends on whether you are inclined to perceive intentional malice behind every negative social development. Karl Popper warned against this “conspiracy theory of society”, and I am inclined to agree with him.

One of Popper’s key philosophical insights was that we cannot, as a point of logic, know all possible implications of our statements, and in the real world this is amply reflected in the myriad “unintended and unforeseen consequences of our actions.” So I’m not inclined to believe that people in corner office suites on Wall Street sat there plotting to impoverish people; I’m rather inclined to believe that they sat there looking for ways to make lots of money. You don’t need a cackling, moustache-twirling villain to explain this scenario. You just need ordinary human failings.

I even believe that at least some of those Wall Street titans thought about the poor occasionally. They probably thought that by paying taxes, giving to charity, and, most importantly, helping to mobilize capital to create new jobs, they were helping the poor. This may well have been self-serving delusion. But the only sensible question to ask is whether, in fact, they were right or wrong in their belief. I don’t think that talking about a war on the poor contributes to our understanding of what alleviates poverty. But it gets a gratifying reaction from an audience.

I don’t know whether Naomi Klein endorses the conspiracy theory of society, but she certainly believes that Milton Friedman’s ideas have served primarily to justify an illegitmate, anti-democratic wealth grab. She is raising legitimate questions about the consequences of the ideas Friedman espoused, and those of us who tend to agree with Friedman have to answer them. We have to take a hard look at what we believe and whether real-world experience bears it out. Another thing Karl Popper said was that the scientific attitude is the critical attitude, and we can (and should) subject even our basic assumptions to criticism.

Whether you think current events are refuting your position, of course, depends on how you frame your position, and the temptation always is to do some rapid tailoring of your position as events overtake it. (“I never said that! I only claimed...“ etc.) I’ll try to be as honest as possible about what I believe and how events are affecting that.

There’s no doubt that the current financial crisis has to make us think twice about the wisdom of the current regulatory structure. In particular, it’s getting tougher to defend the decision in 1999 to repeal the Glass-Steagall Act, which separated investment banking from commercial banking. When the act was repealed, I remember thinking, “Well, why not? Won’t this allow banks more freedom to innovate?” Well, I guess it did. If you’re paying attention to the real world, I think you have to reconsider this one.

But I’m going to plead innocent, on behalf of market advocates, to one big charge that Klein implicitly made in her U. of C. speech. At several points she seems to conflate two different propositions: that markets are the best way to allocate economic resources and that markets should be totally unregulated. These are two very different propositions, and I only support the first one.

The first proposition has, I think, been amply borne out in the real world. Centralized economic planning has failed wherever it has been tried, because no bureaucracy can possibly match the demand for and supply of the millions of products that modern life involves. Only a relatively untrammeled price system can do that. (Friedman was far from the only economist to make this point and it is, I think, not widely contested among the economically literate.) Further, the attempt to exercise serious control of an economy must at some point devolve to authoritarianism because it criminalizes consensual economic acts.

This is the proposition I have come to support—that the free market is, by and large, allowing for some real-world cases of market failure that can be remedied without vitiating the principle, the best way to provide for people’s material needs. And I think real-world experience bears this out. Millions have been lifted out of poverty in the past couple of decades as planned economies have been liberalized and market principles have spread.

But I have never believed that markets should be completely unregulated. And I don’t know of many who do. There is a faction of capitalist anarchists out on the libertarian right (or would that be left?) who oppose any kind of state whatsoever, but they are a lonely few.

Laissez-faire does not mean no regulation, as Klein seems to believe. It means that the government should let the price system work to direct resources to where they are most in demand. It means, for example, that the government should not subsidize some products (like ethanol) and penalize others (like textiles from poor African countries). There’s a lot in the free-market position that even the left should be able to get on board with, like opposition to corporate welfare. The phrase laissez-faire applies to resource allocation. It doesn’t mean turning a blind eye to abuses.

Even most Wall Street capitalists think they should be regulated. Here’s what one of them has to say in the current edition of the National Review: “ proclaim that free markets are always their own best regulator is not only to fly in the face of history and common sense but also to ensure that the debate will be lost.” That’s Andrew Stuttaford, in a good discussion of right and wrong regulatory responses to the crisis.

The current crisis is the result of a catastrophic failure of regulation. And it’s possible that it was the product of the same mistaken conflation of propositions by people on the right that Klein makes out on the left. If our politicians took the free-market position to mean that the government should abdicate its responsibility to oversee our financial and economic system to insure its smooth and honest functioning, they were in error. But nothing in the current crisis makes me doubt the basic wisdom of Adam Smith’s or Milton Friedman’s insights into the efficiency of markets in providing for our needs.

The problem is to get regulation right. Financial innovators are always one step ahead of the regulators. And sometimes they need to be reined in. But regulation can be too heavy. And deregulation is not always bad. Real life involves trade-offs, and there’s an optimal point in the trade-off between freedom and prudent restriction which is hard to locate. Whether you incline more to the freedom end of the scale or the restriction end is part of what defines you politically. People can differ about this in good faith. It ought to be an empirical question. The right and the left can talk to each other if they avoid demonizing each other.

In her speech at the University of Chicago, Naomi Klein talked about the way Marxists were disillusioned by the Gulag, how the left had to undergo a healthy process of re-thinking in the wake of the manifest failure of communism. That doesn’t seem to have made her abandon the left; she just wants the left to be smarter. In the same way, those of us who believe that a great degree of economic freedom is a good thing need to be alert to real-world wake-up calls. We can re-think some things without abandoning the central insights of the free-market position. When all the shouting is over, I think we’ll still be on firmer ground than those that think the government should be in charge of distributing economic resources.

Sam Reaves

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