When the Berlin Wall fell in November 1989, it marked more than the end of an era. It also symbolised the triumph of the free West against the tyranny of communism. The open society had won against Soviet-style oppression, and there could no longer be any doubt about which of the two social and economic systems was more viable. Freedom’s victory was so remarkable and complete that some political scientists started talking about “the end of history”.
But history did not end in 1989. The excitement of the immediate post-communist years, after seven decades of ideological confrontation, excuses the optimism among proponents of the free society. But still, they should have known better.
Friedrich Hayek and Milton Friedman, key figures in the 20th-century revival of liberal ideas, had warned that history never stops and that intellectual battles are never won once and for all. In a 1944 speech, Hayek told his students at the London School of Economics that “in economics you can never establish a truth once and for all but have always to convince every generation anew”. Hayek believed that “knowledge once gained and spread is often not disproved, but simply lost or forgotten”.
With the world’s financial markets in turmoil for more than a year, and after the collapses of many once respected institutions, we can now experience first-hand what Hayek meant. Where once there was a broad consensus that market solutions are usually producing better results than heavy-handed state intervention, around the world the pendulum is now swinging the other way.
In Britain, Labour prime minister Gordon Brown is back from the political dead after he partly nationalised the country’s banking industry. In Germany, conservative chancellor Angela Merkel and her social-democratic coalition partner have given unprecedented guarantees for Germany’s financial institutions. In the US, Barack Obama owes his presidential election victory to a widespread desire for more government and less market. Meanwhile, in Australia the prime minister has blamed the financial crisis on a “culture of greed” and markets out of control, paving the way for more regulation.
Big government is back on the political stage with a vengeance. Programs that once would have been ridiculed as left-wing lunacies today pass for sensible policy. Nowadays, one can argue for a cap on executive pay, for a ban on short selling, and for nationalising banks and insurance companies, and still feel part of the political mainstream. Two or three years ago, such proposals would have only been heard on the fringes of the political spectrum.
So the defeat of free market thinking - or free market ideology, as it is now more often called - seems all but complete. Decades of consensus that deregulation, privatisation, and free trade are the right way to go have been consigned to the dustbin of history. Everything that once made good sense is now viewed with suspicion. It is not so much that the free market lessons of the past are now “lost and forgotten”, as Hayek put it. Rather, they are deliberately purged from the collective memory as a single big error.
This pendulum swing is too fast and in the wrong direction. The new left populists are making two big mistakes at once. First, they wrongly equate all market problems with market failure. Second, they are throwing out the baby with the bathwater by announcing that markets have failed in general.
The first mistake is understandable. It is too easy to blame market woes on the failures of investment bankers, hedge fund managers, and greedy executives. But one of the most important players in all markets, even seemingly deregulated ones, is government. The low interest rates that encouraged over-borrowing were not determined in the marketplace, but by central banks. Regulatory failures made it too easy for Americans to run away from their mortgages while keeping up the repayments on their credit card bills. And housing markets could only overheat because regulation prevented land supply from expanding to meet rising demand.
The two countries worst hit by the crisis, the US and the UK, are in sorry fiscal shape because their governments spent the past decade accumulating mountains of public debt. Far from practicing free market radicalism, both countries coupled big government with insufficient regulatory frameworks. Whoever wants to say that “Anglo-American capitalism” has failed should first show where we can find it. What is capitalistic about the UK, where nearly every second pound sterling produced in the economy goes through the hands of the state? What is free market about a US budget deficit in the hundreds of billions?
Australia is far less affected by the crisis precisely for the reason that it did not follow the US or the UK. Australian government finances are the envy of the world. As RBA deputy governor Ric Battellino recently reminded us, Australia’s banks are in a much better shape than their international competitors. In terms of practicing free market policies, Australia came closer to the ideal than either the US or the UK, and now it is being rewarded.
The second mistake of the new left-wing populism is to reject free market policies as if they were all the same and all failed. Right now, the markets are in trouble, but there is no evidence to suggest this is a permanent condition or that it represents a generalised failure of markets or of free market policies.