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Is the Big Idea of free markets dead?

Posted by Richard D North in Interrogating the Media / Money / Truth & Trust on 24 November 2009

Why we posted this: It’s become a commonplace that the world fell prey to a  capitalist and free market ideology and that the Credit Crunch has killed all that. But does this revisionism hold water?

The original story:
“Has capitalist ideology failed us?”
BBC Radio 4 Today Programme (listen again)
23 November 2009, 08.55hrs

Summary of the story:
The Today programme set up their “listen-again” with this blurb:

In his new book How Markets Fail, John Cassidy claims that the economic calamity of 2008 did not shatter principles of capitalism as there is not a static set of capitalist principles to destroy. John Cassidy and Executive vice chair of the Work Foundation, Will Hutton, debate who got it most wrong in the Credit Crunch.

John Cassidy argues that we are at a turning point after 30-odd years of Thatcherite Reaganism which discredits “ultra versions” of the free market especially as applied to financial markets. Will Hutton said that it had been a “giant intellectual mistake” to think that while markets work some of the time, they could work all the time.  Alan Greenspan, both contributors thought, was at the centre of all this, based on an ideological view of how markets work. The result is a “vast problem for Britain”. JC said we would “row back” from the extremes of the market view. WH said that there’s a lot of new economic thinking springing up without a clear left right view and a new interest in behavioural economics. JC finished with the remark that Adam Smith’s view that “we can all leave it to the market has been discredited.”

livingissues comment:
It is certainly true that a good deal of commentary suggests that we are re-evaluating free markets. We are revisiting the idea that markets are in equilibrium, that economic players are both rational and selfish, that deregulation is good. It is also often said that John Maynard Keynes has been returned to favour and Milton Friedman and Friedrich Hayek are out of it and that fiscal intervention not monetarism are the order of the day.

However, it is only fair to say that “old” economics has been discussing all these themes for a very long time and there is no particular hope that some new style of the discipline will spring up and solve ancient problems. For instance, whilst “behavioural” economics does indeed discuss economic players who have consciences and moods, old economics itself spent a good deal of time discussing, for instance, the mood swings which afflict markets. I’m thinking of Keynes’s “animal spirits” and the reviled Greenspan’s “irrational exuberance”, just to cite two sources thought to be at opposite ends of the spectrum.

It is true that market theory discusses the idea of a crowd of perfectly-informed players producing a market-clearing price in a way which can’t be bettered. But even market enthusiasts accept that all players are not likely to be equally well-informed, and that markets are not all-wise (for a start there are “market failures” to do with “externalities” such as environmental issues (which the market doesn’t price properly).

Even though its own fans acknowledge that the free market is richer, weirder and less perfect than theory suggests, in the current crisis they stress that financial breakdowns  like the present really might have been avoided if the markets had been freer. In short, financial institutions took risks in part because they were encouraged by governments to do so. There was, for instance, a surplus of cheap money, a surfeit of government encouragement (and even a tacit guarantee) of “bad” loans to customers (who were also voters) who were not good risks.  Besides, the banks fooled themselves that new-fangled and complex financial instruments were safe. This was a mistake which flowed from their not being rational enough market players who ruthlessly sought full information because failure would have been fatal to their own livelihoods. A truly free market would have kept them more fearful and lot less trusting.

In short, it is not as clear as some commentators suggest that there was once an all-powerful freemarket ideology which created a colossal danger and which now be over-ridden in favour of a more statist, enriched, socialised capitalism which would be vigorous, attractive, safe and responsible.

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