Tuesday, October 14, 2008

Capitalism - Still an Unknown Ideal

While I was chatting with a friend on the phone this past weekend I was asked a question. "Has Capitalism failed? Now that everyone is questioning the lack of regulation which has led to the near collapse of the global economies, isn't it time to rethink the primacy of Capitalism?" Both of us - let me mention upfront, are laymen; salaried employees who are not experts at economics. But ,we have studied economics and its many theories as part of our MBA course. Both of us are still students of economics and are learning to appreciate the many nuances which each theory in economics poses to the interested mind. But when it comes to the debate between which solution - Free Market Capitalism, Keynesian Economics or Communism should be at the helm of the commanding heights of the economy, one of us - me, is not open for debate. The solution has to come from Laissez Faire capitalism. I may have doubts about how a free market solution can be achieved to a particular problem, even profess the need for certain degree of policy regulation, but it is irreconcilable to me that such a solution can be better than one which a free market can provide - in the long run.

The problem, I think, which leads people to end up believing that Free Market Capitalism is bound to fail, or has failed is the undue importance to human greed which people attribute to an unregulated economy. It is common to hear people say of the collapse of Lehman Brothers that "Isn't it obvious? When you let people indulge their greed unabatedly, there is bound to be such failures. We should restrict their blatant freedom!". But this is a knee jerk reaction. One which casts a doubt over a system based on the symptoms of the affliction ailing it, and not the cause. This is beautifully described in an article by Quinglian He, a chinese economist. When asked "Does The Free Markets Corrode Moral Character" she replies "No" and rightly points out -

"Ofcourse, the market economy is not a perfect system. But the market's flaws stem from the actions and motivations of its human participations rather from its design"

Free markets allow us to be what we are. It gives all of us a playing field where we compete based on merit and the rewards are directly proportional to the level of risk we are willing to take based on the merit of our judgements and capability. Free markets nurture the individual's rights and allow him to pursue his goals. It is also a test to his character and as Tyler Cowen points out,

"By placing more wealth and resources at our disposal, [free market] tends to boost and accentuate whatever character tendencies we already possess."

Ayn Rand wrote in her book "Capitalism: The Unknown Ideal" about the form, nature and purpose of government as being a means to protect man's right - protecting him from physical violence. It is from the person who is bound to utilize the unregulated free market for personal corruption and greed, that the government needs to protect others from. Not regulate the system itself. Any other interference by the government in the functioning of the market is detrimental. But most people find this line of reasoning a hard pill to swallow. Today when governments around the globe are bending backwards to come up with plans to 'bail out' underperforming financial institutions, it seems a far cry for anyone to keep believing in the merits of 'unabated capitalism' and the extent of greed of people who are not regulated.

But, this is again a case of assigning blame to the symptom and not the cause. It is a mistake to point blame at the capitalist ideaology for the current financial industry meltdown, because it is not under a purely capitalist system that these financial institutions functioned. Observe the conditions of pseudo-capitalism which has been at the commanding heights of every major economy in the world today. There is always an ever present creditor of final resort which each of these countries have - a central bank. As rightly pointed out by this article,

"Additionally, the only reason why the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were able to guarantee nearly $5 trillion in home loands with merely $100 billion in net equity is that both their management and other market operators knew that the government would step in if things took a turn for the worse. Acting as lenders of last resort, the Federal Deposit Insuarance Corporation (FDIC), the treasury department, and the Federal Reserve Bank fueled the crisis by encouraging a decade of careless lending"

A classic case of a Moral Hazard where the proper functioning of a free market does not happen because the players are tempted to risk more than what their judgements and analysis lead them to believe, because a pseudo net is ever apparent to cushion their fall. Free markets punish those who make unwise decisions and reward only those who take calculated risks. Free market success stories are those which exhibit fundamental growth and true value creation as against a 'sentiment' based growth.

There are many opinions about the bailout plans which are unfolding around the world - most, even pro-libertarian ones are saying that maybe a bailout was inevitable. But interventionist solutions are unfortunately never better than what a free market can come up with - in the long run. It is almost uncanny to see how the 'bailouts' have started popping up across the world after the US Treasury department came up with the $700 billion plan. It is seen as the repercussion of the failure of the 'capitalist bastion' of United States of America and leads many an undecided mind to disbelieve the essential efficiency of a free market.

To such doubters, I can only say - please observe where you cast the shadows of your doubts. The world may not be facing this problem in the first place had the true ideals of Free Markets been adhered to. The question of greed and favouritism does not hold too much merit in a free market economy because, like Milton Friedman said,

"In a capitalist society, it costs money to discriminate, and it is very difficult given the impersonal nature of market transactions"

Viva Liberty!

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