Reality Check for Dionne

July 22, 2008 9:57 AM by Art Carden | Other posts by Art Carden | Comments (5)

Is capitalism inherently unstable, and has unfettered capitalism caused the recent woes in financial markets? Are enthusiasts for laissez-faire blinded by ideology and hubris? Do unregulated markets visit horror upon an unsuspecting populace if left to its own devices? Do we need a new era of financial market regulation--a New Deal for the twenty-first century, so to speak?

No, no, no, and no. In spite of the apparent troubles of modern capitalism highlighted by E.J. Dionne in a July 12 article, what we need is not more regulation and oversight, but a better and more nuanced understanding of how markets work. The alleged "instability" of capitalism has its foundations not in anything inherent to the market system but in monetary systems whereby banks are able to expand the supply of credit without having to suffer market penalties.
Unchecked expansion of the money supply distorts interest rates and creates tension between investors, who wish to undertake long-run projects in response to lower interest rates, and consumers, who wish to enjoy greater current consumption because lower interest rates mean that the reward for waiting has fallen. More money gives the illusion of a greater supply of real resources--more building supplies, more concrete, more bread, more baubles, more stuff--when in fact money is all that has increased in supply. This theory was originally formulated by Austrian economists Ludwig von Mises and F.A. Hayek, and it has its ablest modern expositor in Auburn University's Roger Garrison.

Dionne argued that international trade has somehow been "monopolized" for the benefit of a select few around the world. I'm not sure that there is any evidence for this. The Chinese economy, which is the poster child for twenty-first century globalization, has grown at robust rates for several decades as the country has liberalized. In addition, Apple has shipped millions upon millions of iPods, which are fundamentally the product of the international division of labor under capitalism. The rapidly-improving quality and rapidly-falling price of rapidly-diffusing gizmos like iPods, iPhones, and competing products from Verizon, Blackberry, Samsung, and others hardly suggests that the benefits of globalization are being shared widely rather than concentrated into the hands of a small global oligarchy.

Research in economic history has also set the record straight on the New Deal, which was a microeconomic disaster that prolonged the Great Depression. Research by acclaimed economic historian Robert Higgs argues that the anti-capitalist rhetoric and anti-market policies of the Roosevelt administration did more harm than good by creating what he calls "regime uncertainty." Uncertainty about the economic institutions that would ultimately emerge cooled off the business climate and reduced investment. Higgs's findings receive further support in a 2007 study by economic historian Frank Steindl, who argues that the policies of the New Deal upset the "endogenous propagation" mechanism that would have brought the U.S. economy out of the Great Depression.

Even the conventional view that "World War II ended the Great Depression" is incorrect, as research by professors Higgs and Steindl shows. The United States emerged from the Great Depression in spite of, rather than because of, government policies that circumvented the market.

A cavalier attitude about government regulation can have disastrous consequences. First, regulation makes it difficult to get into some markets. Thus, today's corrective intervention is tomorrow's source of monopoly power. Second, as 1986 Nobel Laureate James Buchanan has pointed out, people who work for the government are not immune to incentives. Government intervention is an invitation to corruption, and even beyond this, the fact that the incentives facing government are political rather than economic means that it may be extremely difficult to correct today's policy mistakes tomorrow.

Wasteful agricultural subsidies in the United States and Europe suggest that this is the case. Most economists agree that there is no economic justification for agricultural subsidies, and yet they continue to expand.

John Dewey once said that more democracy was the cure for the problems of democracy. Similarly, the cure for economic problems is not more government, but more markets. Unfortunately, reflexive anti-capitalism is all too common in times of economic distress. Rather than eliminate the interventions that caused the problems to begin with, we are likely to adopt further interventions that will create more problems than they solve.