The Free Market Is Failing?
This Reaction to Economic Bad News Is as Old as Capitalism Itself
DECEMBER 01, 2008 by STEVEN HORWITZ
There is no doubt the U.S. economy has hit a rough patch over the last several months. As is often the case when economic problems make headlines, pundits rush to declare that capitalism is “in trouble,” or “is ailing” or even “has failed.” This reaction to economic bad news is as old as capitalism itself. It is also consistently wrong. What the pundits fail to realize is that economic problems, from the recent housing and credit crisis to things like the Great Depression, are far more often, if not always, the result of attempts to intervene into the free market rather than failures of capitalism itself.
An excellent example of this tunnel-vision punditry is E. J. Dionne Jr.’s New York Times column of July 11. Dionne argues that a variety of problems facing the economy in 2008 has led to “the collapse of assumptions that have dominated our economic debate for three decades.” The assumptions he refers to are that “Regulation is the problem and deregulation is the solution. The distribution of income and wealth doesn’t matter . . . [and] free trade produces well-distributed economic growth,” among others. In Dionne’s view, these ideas are “failing” and “even conservatives recognize that capitalism is ailing.”
Unfortunately for Dionne, it just ain’t so.
Dionne spends much of the column arguing that the current housing crisis and its spillover effects on the financial industry are the result of, in Rep. Barney Frank’s words, “excessive deregulation.” There has been some deregulation of the financial markets in the last couple of decades, and much of that deregulation has actually produced incredible benefits for the American public. Aside from the customer-service gains that have come from the legalization of interstate banking and the ability of banks to offer an array of products under one roof, the expanded range of investments that banks can take on enables them to diversify and lower their exposure to risk.
Yes, a number of banks have had problems in the last year (more below), but the number of bank failures since the 1999 deregulation has been exceptionally low.
Between 1999 and 2007 only 40 U.S. banks failed, which is substantially lower than the same nine-year periods starting in 1969, 1979, and 1989. Only two years since 1934 have had no bank failures: 2005 and 2006. If the 1999 overturning of the Depression-era Glass-Steagall regulations is such a problem, why were the eight years to follow among the healthiest in U.S. banking history? Assuming deregulation did not have a built-in time delay, this year’s banking problems must have some other source.
Those problems are almost all linked to the troubles in the housing market. Here too, blaming deregulation is at odds with some important facts. True, financial firms have developed many new tools during the last 25 years. Some of those, such as the adjustable-rate mortgages at the center of the difficulties, were necessitated by previous government intervention in markets—in this case, the Fed-generated inflation of the 1960s and ’70s.
More important, though, is the role played by institutions such as Freddie Mac and Fannie Mae, both of which are not the products of laissez-faire capitalism or any sort of “deregulation.” Those government-sponsored enterprises have artificially supported elements of the housing market that might not have been economically justified. Other government regulations, such as the Community Reinvestment Act, which requires that banks make a certain proportion of loans to low-income customers in their communities, have forced banks to take on excessively risky investments in housing. Finally, meddling politicians can cause banks to fail by spreading unwarranted concern about their balance sheets, as some have argued Senator Charles Schumer did in the case of the now-failed IndyMac Bank.
In sum, nothing in the current housing and banking troubles indicates some sort of systematic failure of capitalism that can be laid at the feet of deregulation.
Dionne also makes a passing comment about the way in which “The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era.” This claim is problematic in three ways. First, the 1920s were hardly “laissez-faire,” especially in the financial markets. The United States had a government-run central bank along with a host of banking regulations, not to mention all the other economic regulations born out of the Progressive Era and World War I. Second, the Great Depression itself resulted not from the failures of capitalism, but the Fed’s monetary mismanagement in the 1920s and 1930s, and its length and depth were caused by the protectionism and interventionism of the Hoover and Roosevelt administrations. The New Deal and World War II did not get us out of trouble; only the explosive growth generated by the freer postwar economy did so. Third, many of the very regulations that emerged from the Great Depression, such as federal deposit insurance, enabled banks to do exactly what Dionne wrongly blames on the market: profiting when they lent well, but shifting losses to others when they messed up.
Finally, Dionne’s claim, echoed by Frank, that free trade and capitalism more generally have benefited the wealthy at the expense of the poor also does not hold up to scrutiny. Frank’s concern for the “most vulnerable people in the country” is admirable, but free trade, by making cheaper imports available to lower-income Americans and by creating jobs in export industries, has done more for “the most vulnerable” than any government program.
It is also ironic that a man of the left would focus only on the vulnerable in the United States and ignore the massive increase in well-being that free trade has produced for the most vulnerable people in the rest of the world. The billions of Chinese and Indians who have risen out of abject poverty in the last decade or so are a major accomplishment of free trade, and that increase in wealth has benefited American citizens as well. The living standards of poor Americans today, measured by what they are capable of consuming, exceeds that of the average American 35 years ago. If free trade is so awful for the poor, Dionne and Frank need to explain how an era of expanding free trade has also produced these increases in the well-being of poor Americans and billions of others across the world whom they seem to think do not matter.
Once again, the pundits grab onto any bit of bad news to declare the death of capitalism, all the while ignoring the ways in which our larger-than-ever government has intervened in the market, producing the very problems they try to blame on the free market. Their misguided analysis is matched only by their continued promulgation of the idea that American living standards are declining, despite abundant data to the contrary. Even with all the government intervention, the (hampered) market continues to improve the lives of everyone, especially the poor. Imagine if the politicians and pundits stopped trying to prevent it from doing so.