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Free-marketers must make a convincing case

By Oliver Hartwich - posted Monday, 1 December 2008


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”.

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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.

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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.

Markets, wherever they have been employed to solve economic problems, have been largely successful. This is most evident in cases where countries have chosen different paths. Communist East Germany collapsed, not the social market economy of the West. The Berlin Wall was torn down from the East, not the West. Capitalist South Korea prospers, while in North Korea people starve.

Markets have consistently proven to be better mechanisms for delivering better products and services at cheaper prices. It is easy to forget, but before the Australian economy opened to international competition, the quality of Australian-made products often left much to be desired. Worse still, they were so expensive that applying tariffs to raise the prices of imported goods was the only way to make people buy Australian. The subsequent success of microeconomic and trade reforms gave Australian consumers better and more affordable choices. It would be foolish to forget these lessons only because of the current financial crisis. Economic liberalism beats all of the big government alternatives in providing the right conditions for economic growth and wealth creation.

It is also worth setting the long term record straight on economic growth. The International Monetary Fund has just revised its forecast for next year’s economic growth to -0.3 per cent for developed countries and 2.2 per cent for the world as a whole. Everything under 3 per cent global growth, in the IMF’s own terminology, is a recession. But we should not forget that this sluggish growth, painful as it may be, is just a blip in the long term success of global capitalism.

Per capita GDP grew at a snail’s pace for most of humankind’s history. But it skyrocketed from the time of the Industrial Revolution, which was also the beginning of capitalism as we know it.

The British economist Angus Maddison once calculated that the average inhabitant of the world in 1700 was only producing just a third more than the average person in the year 1. But in the following three centuries, worldwide per capita GDP increased tenfold. That this could happen is due to a number of factors, among them the end of mercantilist trade restrictions, the development of corporations and financial institutions, and above all the growing worldwide division of labour. In other words, the dramatic improvements in the global economy can directly be traced back to the institutions of the free market economy. The world’s stunning economic development in the past three centuries was not an accident but the result of global capitalism.

It is true that some countries have developed faster than others, but on closer inspection the reasons are obvious. There are now a number of empirical studies examining the effects of economic freedom on a country’s economy and society. The results confirm the superiority of capitalism. That economic freedom and economic growth are highly correlated may not surprise the supporters of free markets. But the beneficial effects of capitalism go far beyond the economic sphere. Countries with a liberal economic order also tend to be more democratic, they usually have a better record on human rights, and their inhabitants are also often healthier and better educated. Economic freedom, so the empirical evidence suggests, is as close to being a social cure-all as it gets.

And yet, even without all its beneficial results, something else about economic freedom is at least as important - that it cannot be divided from political freedoms. You cannot be “a little bit free”, just as you cannot be “a little bit pregnant”. The issue of economic liberty is part of the wider, more general question of what relationship we should have with each other and with the state. If we allow the government or its bureaucrats to tell us what we may buy and sell, and to whom and at what price, there is no logical reason why the government would not eventually attempt to decide other things for us as well.

There is a slippery slope that descends from a society that is fundamentally free towards a world where the individual is a mere servant of the state. But if we believe in human dignity, and in the principal right to make one’s own choices in life, then we have to be vigilant about all attempts to shift the power balance between the state and the individual. The current financial crisis may serve the supporters of more government control as a Trojan horse from which to mount an attack that pushes back the boundaries of the free society. The result may be a loss of autonomy that is felt far beyond the marketplace.

These are difficult times for liberals. The mood around the world is turning against them. Politicians find it easier to blame crazy economists and greedy managers for financial turmoil than to understand and fix their own mistakes.

Free-marketers still have the evidence of economic history on their side, but they will have to make their case more forcefully from now on. They face a constant battle of ideas that can never be decisively won. But they can take consolation in the fact that today’s swing to the left will not spell the end of history, let alone of capitalism.

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First published in The Sydney Morning Herald on November 15, 2008 as "This is not the end of capitalism".



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About the Author

Dr Oliver Hartwich is a Research Fellow at the Centre for Independent Studies. His paper No Particular Place To Go: The Federal Government's Ill-Conceived Support for the Australian Car Industry was published by CIS on March 17, 2009.

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