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Tuesday, October 21, 2008

"What the Free Market Needs"

I recently said:

I don't think the lesson of this crisis is that markets don't work. I think the lesson is that markets don't always work, that we need to be vigilant in our oversight of markets to make sure they really do satisfy, as much as possible, the competitive ideals that are necessary for markets to perform well.

So it would be hard to disagree with this:

What the free market needs, by Claire Berlinski, Commentary, LA Times:  The free-market system, it is now fashionable to say, is to blame for the current financial crisis. By way of rejoinder,... commentators have argued that the crisis should be understood not as a failure of free-market economic theory but as its vindication. They argue that the U.S. government perverted the wisdom of the market by encouraging banks to make loans no rational actor would make -- and that the players took the risks ... because they held a reasonable expectation of a government bailout... The problem, in this view, is ... that ... markets ... weren't free enough. ...

A bit of intellectual honesty is required of free-market economists. Free markets work splendidly, in theory. But as no less a free marketer than the great Adam Smith himself observed in "The Theory of Moral Sentiments" ... free markets rely on specific social, moral and political institutions. These institutions must be exceedingly robust if the free market is to deliver on all of the splendid promises made for it.

In most of the world, they are not, and the chances of making them significantly more robust are slim.

Contract law, transparent regulatory structures, transparent bookkeeping and systems for exchanging accurate economic information -- such as a free press -- are essential if a free market is to work. Very few countries have any of these, much less all of them. Because it relies on such rare conditions, the smoothly functioning free-market economy that never suffers the financial equivalent of an epileptic seizure is in most of the world almost as much of a utopian ideal as the centralized command economy in which there are no lines for bread. ...

The causes of the Wall Street meltdown will no doubt be debated for a good time to come. But clearly a toxic mixture of a lack of transparency, inadequate regulation, inadequate systems for exchanging crucial economic information and outright fraud was involved.

In the end, the institutions that support free markets were more than weak enough in the United States and other developed nations to cause complete, if temporary, free-market failure.

One obstacle towers above all the others when it comes to the free market: flat-out corruption. ... Corruption frequently leads to a disrespect for private-property rights, a judiciary that doesn't properly enforce contracts, dubious banking practices and a serious lack of regulatory oversight. All will result in economic failure. The blame for this will be placed on the free market, particularly in popular imagination. But this analysis will lead to precisely the wrong kind of corrective action. ...

Without adequate institutional support, free markets will fail -- often -- and free-market economics will be blamed, wrongly.

This does not at all mean the theory is valueless and should no longer command our allegiance; even free markets that fail regularly create more wealth and raise general living standards vastly more effectively than do command economies. It is essential, however, and only honest to acknowledge that free markets in and of themselves are not enough. ...

    Posted by on Tuesday, October 21, 2008 at 03:06 AM in Economics | Permalink  TrackBack (0)  Comments (54)

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