Capitalism in under attack, and the world is dangerously turning to protectionism and the state for answers. But before embarking on a capitalism-bashing spree, there must be 2 questions the taxpayer must ponder. First, what actually went wrong to end up in this mess? (was it capitalism itself?). Second, what was the response of our elected leaders, and regulators, in the face of the looming American election?
During the past month when we have seen and felt the worse of the worldwide financial meltdown, the world over has been keen to bash capitalism, free markets, financial systems and the so called “corporate greed”. But very few have defended the system that have favored the consumers, enriched societies, reduced poverty, and permitted technological breakthroughs, and nations benefiting from bright ideas by taking risks and investing. Such bashing behavior is not only negligent after 30 years of growth, low inflation, low unemployment, and improvements on technology and healthcare, but it is also dangerous and irresponsible with future generations.
Corporate Goals vs. Corporate Responsibility
Let us begin by examining the first question: What went wrong? Many people like to blame the financial system that was too lightly regulated and allowed for corporate greed and banking profligacy, others blame the inherently heartless capitalist ethic, some would blame an increasingly irresponsible consumer who should be watched over. Clearly there is no lack of blame to go around, especially when so many people are losing money and it’s the taxpayer who is footing the bill. However, none of the above mentioned causes alone are responsible for the mess, and more importantly, all of the so called “causes” miss the basic understanding of markets, economic freedom and corporate nature that is essential for finding a viable solution without turning our backs on the markets.
Corporations are created with the single purpose of creating wealth, cutting cost, and all of them are profit oriented, corporations are not in any way created to benefit any goals beyond those of their shareholders. It might sound egoistic, but it is the truth. However, what cannot be overlooked is that under fair competition amongst these entities in a free market, they serve to benefit the goals of societies as a whole and the consumers that they ultimately target. In the face of this current crisis it is hard to forget that these egoistic corporations have provided us all with global progress and created the wealth necessary to improve the lives of billions of people and continue to do so, and in this process they are neither free reigning or unchecked. Unless these firms are a monopoly, they are bound by the rules of the market and the government regulations; hence they can only react to the changes in market conditions imposed by consumers and regulators.
The current crisis has made it seem as if the financial institutions are not bound by the laws of the market, and they behaved as what so many in the media have called ‘masters of the universe’. This is simply not true, and for those people aching for more government action it would be wise to keep the following in mind: For the past decades where free markets have reigned, inflation has been kept at historically low levels, in most parts due to the lowering of trade barriers and sound macroeconomic policies. Thus, banking institutions starting with central banks they were awash with liquidity and were willing to lend at very low interest rates, making credit access more available to millions of people who had never had it before. Furthermore, there was a bi-partisan belief that an ownership society was in the best interests of any nation, and pushed strongly for the liberalization of credit, and led their citizens in the search for ways of joining the trend of ownership (both in home and other kinds of assets).
In the abovementioned scenario, financial institutions reacted to market conditions and pressures just as any other corporation in any other industry would have. Moreover, this particular industry, whose purpose is to raise and allocate capital where it is more productive, found itself awash with liquidity, pressed by eager borrowers and high profit margins, so it was merely natural that it would push for the highest profit maximizing investment available. Of course there is no such thing as a risk free investment, just as there is hardly any competitive industrial sector that is static and remains in the search for better tools to become more competitive and modern. The banking industry was no different, and for an industry that thrives in taking big risks and reaping big rewards, innovation would more than likely be focused on reducing the risk while sustaining profit margins. Thus, the sector came up with the ever-growing Credit Default Swaps (CDS) to do away with risk for any investor willing to buy it for a margin of profit. This in turn gave way to the so call ‘sub-prime’ market where non-prime lenders could be targeted, as risk was no longer a pressing issue.
What is important to see is that in one of the most heavily regulated sectors of the American and world economy as is the mortgage sector, it would be unfair to blame financial corporations for reacting to market conditions which have been set for them, (in most cases by the regulators themselves), and then ask for further regulation as if the capital markets were at fault. Any CEO, even the most conservative ones saw an opportunity for business and would have otherwise been sacked by their shareholders if they failed to capitalize on double digit profit margins by appearing circumspect. Furthermore, it is shortsighted to accuse corporate executives of carelessly mishandling shareholder’s capital, since many of these executives, board members, and bankers are paid in the same company shares that they work for, as was the case with Lehman Brothers.
The financial rescue, and playing politics with panic
Let it be clear that this article does not intend to excuse corporate behavior when it was taking risks that were clearly outside of their capacity to sustain. Democracy Vanguard, a believer in economic freedom, shares the global outrage at the fact that taxpayers are asked to rescue the fat cats of the financial sector. But there are times that ideology must give way to pragmatism and we must understand that it is in the world’s best interests that the financial sector is not allowed to collapse. That said, the current wave of leaders unfriendly to the capitalist system, wishing to vindicate themselves with the electorate, and use the crisis for political gains is shameful, and will eventually lead us in the wrong direction. This brings us to the second question: What was the response of our elected leaders, and how did they present it to us in the framework of the current political landscape?
The response of policymakers from Washington to London, to Paris, to Beijing has been decisive, reasonably well coordinated, and brisk. This is paramount to avoid the mistakes of 1929, and policymakers deserve credit for that. However it is also a testament of the complex and integrated worldwide financial system that has been created, where the mortgage payment defaults of a man in Portland, Oregon can affect the credit available for a small business owner in Colombo, Sri Lanka.
However, the same leaders who have acted quickly have also had their own political agenda as a guideline (perhaps unavoidably). In France and Germany, advocates of big government, like President Nicholas Sarkozy and German Finance Minister Peer Steinbruck, have almost gloatingly spoken of the “end of capitalism”, and have had no reservations to quote Karl Marx in an attempt to legitimize further government intervention in their already heavily regulated markets.
In the United States, the nature of the election year has served to further politicize any response to the crisis and has mostly served to boost the Democrats and their presidential nominee Barack Obama, making him almost unbeatable in November, and ensuring an increase in congressional majorities. With the current public anxiety that exists and fears of recession, Democrats have capitalized in the polls and moved forward to push for regulation and intervention that can eventually backfire. Amongst these regulations are populist-rallying calls such as corporate pay caps; a system which serves no purpose other than politically motivated ones.
While it is important to have the right regulation, the world must not be driven by impulse, or populism to over-regulate. Placing caps on corporate pay or compensation for example is not only not part of the solution to the current crisis; it is irresponsible and populist. In the current so-called “global competition for talent” where companies offer the best perks to attract the best and the brightest, placing caps on a company’s ability to attract the highly qualified people that they need, puts them at a competitive disadvantage in front the rest of the world. In turn, such a policy motivates corporations to shift headquarters elsewhere. Clearly such proposals are political in nature and not financial, an appeal to bi-partisanship must be made and these populist tactics must stop, to avoid hindering the future of the world economy and drive nations away from the free markets, from which they have benefited so much in the past.
Capitalism isn’t broken, but needs some fine-tuning
To allow a new era of big government, state intervention in the markets, protectionism and restrain on risk taking would be dangerous and hurtful for the globe. For those who currently parade themselves across the political arena, gaining supporters, triumphantly claiming the end of Anglo-Saxon capitalism and a return of dirigisme, their gloating mood should put us all on our toes. Capitalism is far from finished, and pandering to populist discourse is just as dangerous as a panic in the stock markets. We must identify that in this time of crisis we cannot shy away from centuries of market-oriented reforms and economic freedom.
Before turning to the populists for answers, first we need to understand what solutions and tools are available. The two most pressing problems before starting to regulate and rewrite the law are ones of liquidity, and investor confidence in the market. If there is no liquidity the crunch will continue and viable investments will go unmade as investors scramble for cash. But liquidity should not only come from the taxpayers, now that inflation fears have subsided across the globe, it is important for the central banks to lower interest rates and place more capital available for banks. The rules for financial rescues on toxic assets must have a clear objective of eventually selling back those assets, and those banks that are nationalized must be re-sold at the earliest opportunity without exception.
The second pressing issue of confidence in the markets will not be easily solved, and will require time. But politicians should be responsible and end their political bigotry and cease to see the panic as a solution to their political problems. Markets have all historically bounced back, and there is little reason to believe that the financial sector will be in the wilderness forever.
The world is not for turning
Just as Margaret Thatcher told her constituency in 1980 standing up for economic freedom that ‘the lady is not for turning’, so must all ‘free-marketeers’ stand up for the markets now more than ever as they are coming under attack from so many fronts. Protectionism and government regulations are on the rise in the most important bastions of free trade, from America, to Britain to Hong Kong. Governments across industrialized nations are intervening in the markets, albeit some times to save them, they must realize that no government regulation, no matter how well intentioned has ever proven to be more beneficial to the world economy than laissez-fair and free trade. Government action at this time of crisis is certainly needed but must be overturned in favor of the free markets at the earliest opportunity when the situation improves. Moreover, no government action should be taken at the expense of discouraging risk taking by investors.
Risk and reward go hand in hand and is the driving force for innovation in any economy. It is the ability of free nations to seek new ideas and invest in them by taking risks and reaping the rewards, which is what keeps the free world always on the move, always improving. It would be unwise to believe that a risk averse investor is best simply because some believe that the rewards are somehow “too large”. Fears of financial or housing bubbles should not be a reason to avoid them altogether for several reasons: first, bubbles are not inherently bad, they help allocate tremendous amounts of capital into sectors that are very productive, generating immense wealth and many times fostering new ideas and inventions that spill over into other sectors. Second, bubbles are virtually impossible to pinpoint, and it is impossible to determine when a particular sector is becoming one, or when it has peaked. In the current housing market bubble, everyone can agree that the bubble has burst, but hardly any two experts would agree as to when the bubble began, or when it reached its zenith.
It’s an intersection not a dead end
Capitalist nations find themselves now at the intersection between choosing to retreat from the markets and favor the protectionist policies that hindered world growth in the past and bankrupted their treasuries, or the harder yet correct choice, to take firm action to muddle through the crisis, without turning their backs on free trade, open markets, and private investment.
History teaches us that freedom somehow always manages to find itself under attack often and for many reasons. We are being offered a unique opportunity, because in this moment, every generation is being called upon to rise up and defend freedom. Every generation faces different challenges when defending their freedom, fortunately the pressing issue of this generation is not the defense of their political freedom. The pressing task that this generation is faced with is the defense of economic and financial freedom, and it is just as important and worthy as any other civil liberty. Fortunately, this time we are equipped with major advantages and tools to make this defense easier to develop. However, any effective defense requires the same determination displayed by free peoples in the past to stand up and take action. Our generation was born and has prospered from the economic freedoms that were handed over to us by honorable defenders of market-oriented policies, such as Ronald Reagan, Margaret Thatcher and even Deng Xiaoping. There is no finer tribute to these leaders, or more responsible action and example for the next generation, than to take up arms (in the philosophical term of course), and defend our precious economic freedom.
By, LUIS F JIMENEZ
June 9, 2009