Friday, January 2, 2009

Stop Blaming the Free Market

It seems almost every time I turn on the TV or read a mainstream news article about the economic collapse, it is once again the "free market" who is the culprit. When times are good, everybody - even liberals - loves the free market. When the going gets rough, all of a sudden, it is the free market that is to be blamed!

But what is the free market? It seems that people have all kinds of funny preconceptions about what the free market is, ranging from criminal anarchy to European mercantilism.

The free market consists of just two concepts:

- Property
- Exchange

The free market has its ultimate roots in humanity and human evolution. Even animals exhibit the concept of property. Dogs mark their territory. Birds protect their nests, and so on. And, at some point in human evolution (possibly before), people began to exchange items with one another... my sharpened stone for your club. This is the origin of barter.

But not all property is alike and not all exchange is alike. What makes the free market free is:

Private property 
Voluntary exchange

The reason private property is superior to its alternatives is the simple principle Milton Friedman mentions in his video series Free to Choose, "People never care for the property of others as well as they care for their own." Since depreciation of the value of property is a significant social cost (i.e. when people don't keep up their homes or cars or other possessions), society is wealthier and the market operates more efficiently when property is privately owned. Private property makes the caretaker and owner one and the same person. Public restrooms versus your private bathroom are a perfect illustration of this principle at work.

It should be obvious why voluntary exchange is superior to the alternatives, but people seem to be confused about this, as well. In a voluntary exchange (say, my sharpened rock for your club), both parties have to desire the exchange to occur, otherwise it will not occur. Another way to say it is that either both parties desire the exchange to occur or it is not voluntary. If both people desire the exchange to occur, that is because both people believed they would be better off after exchanging than before. Since wealth is the subjective satisfaction with one's circumstances, wealth has almost invariably increased whenever two people voluntarily exchange.

The other possibilities are:

- One party coerces the other to exchange - most people understand this to simply be immoral, criminal
- A third party (usually, the government) coerces both people (usually justified by appealing to children, or the homeless, or the infirm, or whatever) to exchange.

The last condition - government coercing (or, logically equivalent, prohibiting) private exchange - cannot be as beneficial as voluntary exchange to the wealth of society (and each individual). It is simple to see why. Assume that the government has access to Divine omniscience. Whenever two people are about to exchange, a police officer steps in and consults the divine oracle whether they would have preferred to exchange with someone else for something else. Other people who were not intending to exchange at all might similarly be induced to make exchanges they had not thought to make since they will be better off this way than had they not made any exchange. Since God knows all, the exchanges always reflect the best, true desire of each individual and society is better off since people always make better choices through this intermediated Divine coercion than they would have if left to their own devices.

But what happens once we remove the access to Divine omniscience? State actors are no more omniscient than any other individual. They have no better information or intelligence than any average person and they certainly have no means of ascertaining what exchanges will maximize individual satisfaction with the state of affairs since the subjective is, by definition, not measurable. In short, coercion or prohibition of exchange can only result in a degradation of the degree of satisfaction (wealth) of all individuals in society with their circumstances compared to what would have obtained had individuals been left free to exchange with one another voluntarily.

So, back to the economic collapse - exactly how are private property and voluntary exchange to blame for this economic collapse? Would banks have made less faulty loans if property rights were weakened? Perhaps if the government had prohibited more transactions (e.g. the absurd derivatives), the economic collapse would not have occured.

But none of this holds up to even the most cursory scrutiny. Banks made these faulty loans as a direct consequence of the weakening of property rights and responsibilities - the socailization of risk and losses (aka Republican "capitalism"). By means of Fannie and Freddie, investors were betting that they would be bailed out on all these ridiculous investment vehicles which were ultimately backed by F&F mortgage guarantees. It was free money... the government would never let these institutions fail. Remember Friedman, "People never care for the property of others as well as they care for their own" - taxpayer dollars are no one's property, so no one cares for them. When taxpayer dollars are being risked on mortgages, no one takes care to ensure the mortgages will not default because it doesn't matter. "It's not my money."

You could lay the blame at the feet of deregulation (and in a very proximate sense, you'd be right), but this is actually special pleading. The job of the SEC, Fed, Treasury, et. al. et. al. is to prevent these kinds of catastrophes from happening. When catastrophe strikes, we say, "Oh, we need more of the same regulation and increased funding for oversight bodies!" when it was these very same regulatory agencies who were on watch when the failure occurred! In what universe does it make sense to increase funding and regulatory powers of agencies which fail to prevent fraud and economic collapse?!

The ultimate problem is not deregulation which, in the case of deregulating fraud, is bad (which is essentially what happened here). The deregulation of securities and the subsequent catastrophe are symptoms of a larger problem... the inability of a monopolistic regulator to control fraud in the market. Or, more poignantly, the incentive of a monopolistic regulator to subsidize certain kinds of fraud which are politically useful (e.g. Fannie, Freddie, CRA, etc.)

Every time you blame the free market - or support those who do - you are blaming yourself and excusing the ruling elite who are responsible. The ruling elite have always blamed the unwashed masses for the calamities the rulers have brought upon themselves (and the masses along with them). The free market is just the sum of all of our individual choices. The fat cats on Wall St. hate the free market whenever it's not making them rich (i.e. whenever they make a bad investment). Whenever this happens, they call up their buddies on Capitol Hill and start promising favors in exchange for a bailout, errr excuse me, an "economic rescue plan."

Economic downturns - even in a free market - are inevitable since resource allocation and prediction are never perfect. The free market is not a panacea. But the kind of artificial economic catastrophe which we are currently looking at (very much like the Great Depression) requires something more than random, isolated human errors and frauds spread throughout the economy. It is the consequence of coordinated, central action through the central banking system and monopolistic regulatory agencies. Not that they intended the economy to crash - far from it, they believed they could cause artificial prosperity to continue unabated. But in pursuing such an obviously impossible goal, the seeds for economic catastrophe were sown. Free money, easy credit, bad borrowers, taxpayer guarantees all combined to create a perfect storm of irresponsible investment.

This crash is not the fault of the free market. It is the fault of government and their corporate cronies. Consequently, more government intervention (which caused the crisis to begin with) is certainly not the answer. The government needs to stop causing harm to the economy as soon as possible. With each new intervention, the depth and magnitude of this crisis is increased.

Stop buying the ruling elite's pig slop about you and I being to blame for the mess they created. Stop blaming the free market. Start blaming the crooks on Wall St. and Capitol Hill (and the White House).

No comments: