An extra hazard lurks in the turmoil that has engulfed the global financial system. It’s the notion that the crisis repudiates market capitalism. Governments everywhere must resist the political temptations of this misjudgment.
The idea that capitalism’s validity died along with various financial luminaries sprouts from two intellectual seeds. One of them is latent socialism. The belief that the state should play a central role in the economy, including outright ownership of core assets, will always have some support. So when capitalism yields unsavory consequences, a blind turn in political support toward its reciprocal is natural, however unwarranted.
Confidence failed
Capitalism, though, hasn’t failed. What failed is confidence in a financial system choked by bad housing debt, some responsibility for which rests with statutory distortion of lending practices in the US and elsewhere. Capitalistic vigor, in fact, has so far kept economies working despite seriously constricted credit.
The second source of challenge to capitalism’s legitimacy is confusion about the role of regulation. Deficiencies in regulation are only too evident in the current crisis, beginning with disparities in the US between treatment of investment and commercial banks and extending to reporting requirements, especially as they pertain to the assessment of risk. To acknowledge that the financial business needs more and better regulation, however, is not to surrender any intellectual ground in capitalism’s defense.
Capitalism doesn’t mean the absence of regulation. To the contrary, capitalism needs regulation. It depends on the free operation of markets. At the same time, it creates incentives for its practitioners to usurp markets for parochial gain. As with any system involving human beings, markets have rule-stretchers and cheaters. Recent economic history bears multiple scars of market malpractice, with Enron just the signature fiasco—until, perhaps, now.
Just as capitalism does not mean the absence of regulation, a tightening of regulation need not portend socialism. But regulation needs boundaries, too. Generally, it should confine itself to the enforcement of market freedom. It shouldn’t make economic decisions. Regulation should set and police rules aiming at maximum transparency, ease of entry, equivalence of opportunity, and prevention of market control. Given the complexity and speed of modern markets, that’s a tall order. If exercised with reasonable success, moreover, it’s quite enough.
But the ideal of regulation confined to boundaries defined by function and activity is easier to describe in concept than to put into practice, only in part because self-restraint doesn’t comes naturally to regulators. This is why regulation in most political systems cycles between too much and too little.
The danger is that governments worldwide will respond to the financial crisis as the US did to politically unsavory energy prices: with imprudent regulation. A fundamental change occurred with enactment of the Energy Policy Act of 2005, which made fuel choice an item of government business. America’s energy destiny, now increasingly linked to favors from the government, has been up for grabs ever since. America’s energy consumers and taxpayers thus have fallen subject to growing economic peril.
Conditions—for both energy and the global economy, which are, in fact, linked—can only worsen if financial jeopardy spawns a new round of aggressive economic regulation. Governments, especially that of the US, will feel obliged to prevent a recurrence of the credit collapse. They’ll succeed only to the extent they concentrate on enhancing market flexibility, freedom, and transparency. They’ll fail if they resort, as the US has with energy, to restriction, manipulation, and retribution.
Way out: growth
The only way out of the current crisis is economic growth. Core ingredients of growth are freely flowing capital and adequate supplies of affordable energy. Both essentials are compromised at present—capital by the credit seize-up, energy supply and affordability by any government action that distorts markets.
In both cases, governments have important restorative roles to play. But they must remember what history makes clear: that market capitalism is the best and most sustainable route to economic growth. The solution to urgent economic problems, therefore, is not to restrict or abandon market capitalism. The solution is to improve it.
