Freedom versus free markets

Probably the most wicked intellectual subterfuge of the last three decades — and goodness knows there have been many — has been the pretence that democracy and markets are two sides of the same coin. Both have been extolled under the banner of “liberty”. “Free markets” are somehow the hallmark of democracy and they should be allowed to roam free, untrammeled by evil governments who never doing anything right. Any number of commentators, coincidentally funded by right wing think tanks, warned us that constraining markets represents an attack on basic freedoms. Such elision is, of course, rubbish; and in many cases deliberate deceit. In a market one dollar equals one vote. The more money you have, the more votes you get. In a democracy it is one person, one vote. You can only be one person at a time (except in Florida, it seems). With this in mind, I was intrigued to see a response from Rob Windt mid week about the aftermath of the Icelandic bankruptcy:

What happened next was extraordinary. The belief that citizens had to pay for the mistakes of a financial monopoly, that an entire nation must be taxed to pay off private debts was shattered, transforming the relationship between citizens and their political institutions and eventually driving Iceland’s leaders to the side of their constituents.

The Head of State, Olafur Ragnar Grimsson, refused to ratify the law that would have made Iceland’s citizens responsible for its bankers’ debts, and accepted calls for a referendum.

This, I would suggest, is real liberty at work. And it is probably an early example of what I expect will become an increasingly political debate, rather than a managerialist debate, about the direction of developed economies. As Jeremy Grantham in his fine piece pointed out mid-week, there has been an unholy alliance between corporate profits and government spending, something he said he “never saw as a faint possibility”. It turns out that business is not in a virtuous war with government; the only victim in America is the ordinary worker. One only has to see the film Inside Job to see how government and the financial system have worked in tandem, in large part because it is the same people playing both sides of the fence.

Grantham puts it down to childishness in the political arena, run by a president he calls “President No-Show”. I think it is not just a matter of maturity, it is a deeper and more pernicious political contest. At the heart of it is a question about the proper role of self organisation. Democracy is, or should be, a self organising system. So are markets. That obviously has advantages over central planning, but it also has potential dangers. The shortcomings are especially problematic in the case of financial markets, which are by necessity a system of rules. Allowing financiers to self organise the rules, means that they can do exactly what has happened — go a long way to destroying the system while enriching themselves to an absurd extent.

Thus they made up rules for everything: credit default swaps, collateralised debt obligations, derivatives on the weather, high frequency trading, more high frequency trading … you name it. Allowing that kind of self organisation is fundamentally absurd because in the end such invention of new rules rely for their validity on the underlying rules that must be set by governments and regulators (The Fed’s interest rate, the underlying cost of money, being the basic one). So when it is allowed to spin out of control, it will inevitably bring the whole system down, as it still threatens to do. Allowed to run amok, it becomes like the serpent that consumes itself.

Which is why the Icelandic example is interesting. The people, then the government, self organised and simply said: we don’t accept the bankers’ rules. “Why should they?” one might reasonably ask.

The Icelandic move is where we are heading. The rule makers in the financial system, who think they can make up rules as they go, are on a collision course with those who have to assent to the rules — the people and the governments they appoint. So far, it is mostly presented as a management problem — how can governments manage their fiscal and monetary levers — but it will become more than that. It will become a question about who has the right to set rules and possess power.

The outcome is not a foregone conclusion, even in democracies. Grantham argues that there needs to be more income distribution, a reversal of the money grab of the rich in the United States, in order to return to a more balanced form of economic growth. But that is by no means inevitable, indeed it is not even the norm. More normal is what happened in South America in the 60s, 70s and 80s where the middle classes were gutted and the rich ruled with increasing violence.  As Grantham shows, America is heading the same way — its middle class has been progressively eviscerated for about 40 years, while corporations and the rich have thrived. The history of human behaviour tells us that, unless stopped, the powerful will enslave the weak and America is heading in that direction.

One thing that is needed is an understanding of the right place for self organisation and the wrong place for self organisation. The looters in London did some marvellous self organisation, pursued their liberty to smash windows. Did that make it right? Those who cleaned up the mess also did some marvellous self organisation.

The degree of self organisation does not tell us nearly enough. We need to look at how to set the frameworks in which self organisation occurs; after all there must be frameworks if it is not to be mere chaos. The role of civil society which fed such actions as the London clean up needs to be revisited. The downgrading, or monetisation, of civil society has been one more unfortunate consequences of four decades of market worship.  And it is time to see slogans like “liberty”, “freedom”, nonsense about the “invisible hand” as the sleight of hand that they are. Such slogans may have made some sense during the Cold War, but that was last century. A seminal political contest is occurring and there needs to be a new understanding of the role of self organisation (not least because industrial self organisation along industrial-era lines will not be sufficient to deal with the problems of pollution that the world faces, they will make them much worse).

It also means, by the way, abolishing the so called discipline of economics. Disqualifying it on the grounds of its dismal history of spewing out self serving, circular arguments that have led us to assume that transactions come first and humans second, and that the civic and legal bases on which modern democratic societies depend are inevitable, a force of nature, and can be abused at will.

Comments

  1. Saying that “free markets have failed” because risk was underpriced in the credit default swaps market in 2007, is like saying the whole concept of powered flight has failed because Airbus has had problems with fly by wire systems.

    I agree completely that the banking and finance system should be “handmaiden to industry”. It is completely wrong that, of the total profits made in an economy, the share made by the finance sector should have crept up, and up, and up over decades to reach and exceed 50% of the total.

    Every time there are political distortions in an economy, there will be rent seekers looking to gain from it. I suggest that the finance industry is merely benefiting from decades of accumulated bad politics that penalise true industry. Abolishing corporate tax entirely would help – except for the finance sector.

    Undistributed profits SHOULD be the main source of finance for growth for an industry. Of course if the greedy government takes a third or more of this source of finance for growth, they are delivering the businessman into the hands of the finance sector, for money to pay for his added stock, debtors, etc.

    By all means tax profits distributed as income, as high as you like. But taxing profits before distribution is the single worst, destructive, spite-motivated tax there is.

    Another major cause of finance sector rent seeking, is urban growth constraint that drives up the price of urban land and forces anyone wanting to buy any land for home or business, to borrow a whole lot more money to do so.

    Always look for the distortions first, I say, before you go blaming “free markets”. By the way, “private enterprise” can be bad. “Free enterprise” never is. Read “The Paradox of the Statist Business Man” by Theodore Forstmann.

    http://www.cato.org/pubs/policy_report/pr-ma-pa.html

    • This has nothing to do with taxation.

      Financial instruments like ‘CDS’ are essentially ‘bets’, so should be counted as a potential liability, and not as an asset!! The product should not be markted as a ‘AAA bond’, yet that is EXACTLY what they’re being sold as before the GFC. There is a heavy element of fraud involved, but however nobody got arrest, nobody got charged, and nobody went to jail.

      Something is seriously wrong with the system.

      • You seem to have massively missed my point. I never said CDS’s were assets. I agree with you that they are little more than bets. But has a crime been committed when a “Totalisator Agency” accepts too many bets at too long odds and then can’t pay out when the wrong horse wins the race?

        The rest of my post, on corporate tax rates, was nothing to do with CDS’s. I was merely commenting that the higher corporate tax rates are, the more “finance” a growing business will be forced to find FROM THE FINANCE SECTOR. Because the government has gutted the main source of growth finance – its profits. So the finance sector benefits from high corporate tax rates. I bet there is a correlation between the introduction of corporate taxes, and significant raises in their levels; and finance sector profitability in the years following.

        I also bet there is a correlation between the onset of “urban growth constraints” and finance sector profits increases.

      • I’m glad we’re in agreement that CDS should not be regarded as an ‘asset’. Then why did it happen? This occur because the financial industry was allowed to write their own rules under ‘mark to market’. Even worse, when the price of the ‘asset’ dropped, the financial market rewrote to rules to suspend ‘mark to market’. This is the crux of the original post : self regulation of financial market is not working out. We need an independent body to regulate the financial system for the benefit of everyone, not for just the bankers.

        If you look at the period from 2000 to 2007 in the US and Australia, corporate and personal tax rate went down, and the financial sector grew in siz, so you can argue there is an inverse correlation with lowering tax rate and increasing financial sector profit!! (which I don’t think is correct).

        The underlying rationale is simple : when interest rate is low, you can make easy money from financial speculations. The US Fed lowered interest rate to 1% after 911 to make it cheaper to finance the war in Iraq. The war should be funded by a temporary tax revenue increase instead. That was the decision which doomed the US and the world economy for the coming decade. Concurrently having low interest rate, tax cuts and a costly war is a deadly mix.

        I agree with the remark on ‘urban growth constraint’, especially artificial ones imposes by governments. This is an area where the government have been captured by vested interest. Changing it won’t be easy though, as the the majority of the population refuse to acknowledge the link between ‘not in my backyard’ and ‘unaffordble housing’.

  2. Isn’t the fact that the Icelandic government didn’t step in to prevent companies from failing an example of the free market?

    Icelandic banks and their European investors made stupid bets, lost and then went bankrupt. That is a free market system.

    The US system where companies made stupid bets, lost and then the government stepped in to backstop them surely isn’t the way it is supposed to be in a free market.

    You can criticize the influence the “too big to fail” banks have with Washington (I would) but it seems to me that a lot of the issues here are because companies haven’t had to suffer under a free market, not because they have.

    • Iceland’s bank didn’t go ‘bankrupt’. They were nationalized, and all the debt were transferred to the Iceland taxpayer. (Look up Icesave). What happened afterward is the Iceland citizen voting in a referendum saying “we’re not going to pay”.

      • Did the government get the approval of the people to nationalize the banks including taking on the banks foreign liabilities? The referendum seems to say no.

    • The corporatist state depends on corporatist funding or that new nonsense – public funding.

      For start a ban on politic donations from any one other than an individual and even those donations should be limited to personal labour and a small $ figure per annum.

      Trade unions, corporations, trade associations, community groups must all be completely banned from making financial or in kind contributions to political parties.

      Pollies and poltical hacks can sniff a buck from a distance, if the only source are voters they may start to take some interest in them and we might just return the favour!

  3. Personally, i know of very few libertarians that actually want no govt – just a smaller one that does not have the extent powers of determination and intervention that they currently do.

    Mind you, it’s also hard to compare the success or not of “free market” notions, when they have basically only been tested extensively in the context of governmental systems that are mutually exclusive with their “free” function (and, note, that by “free” i do not mean “unrestrictied”, due to the problems of human nature!).

    When “free markets” are assessed within the over-acrhing paradigms of 1) Central Banking, 2) Fractional-Reserve-type (non 100% reserve), and 3) Fiat Money systems – what I like to call “The Three Pillars of Our Unjust and Unsustainable Economic Global System” – then the “free markets” will appear to fail…

    And fail they might anyway, due to Fallen Human Nature, but much more so guaranteed by grossly-excessive Central Planning and arbitrary (control-based) money systems (the Three Pillars I describe, above), as, I assert, the combination of such a system with Human Beings in their natural state, will render ANY (yes, I assert, ANY!) sub-system unsustainable, such that it will always fail eventually.

    Honestly, i’m of the opinion that Fallen Human Nature on its own will ruin anything, but when it is supposed to operate within the confines of such a Three Pillar System as I described above, the negative consequences will always be more severe.

    My 2c

    • “Personally, i know of very few libertarians that actually want no govt – just a smaller one that does not have the extent powers of determination and intervention that they currently do.”

      The problem with that is if the government doesn’t have that power then the corporations will and we know from history that they will use it in ways that doesn’t benefit the populace. Don’t forget that corporations are a construct of the government as well. The only way that I can see the libertarian way working is if corporations are not allowed to exist to help create a level(ish) playing field.

  4. I agree with the posts so far. The problems we are seeing are not a result of free markets, they are the results of a banking system that get special privileges from governments and central banks (compared to other businesses), yet have no checks on their behaviour. The solution is not to regulate the banks, the solution is to take away the special privileges.

    Aiming to reduce the income gap between the rich and poor is not only futile, it’s just plainly the wrong strategy. The aim should be to make the poor richer, even if it means the rich get richer too.

    We shouldn’t be worried about some people being bigger winners than others. We should be worried about people who want to rig the rules of the game so that they always win.

      • Sure, but I don’t see government regulation offering a solution. Regulation makes the cost of business higher, so any area that is highly regulated to create “competition” just makes it more difficult for small players to enter the market.

      • countering Monopolies requires both the application and freedom to apply true Entrepreneurialism.

        IMHO, one of the problems with “entrepreneurialism” these days is i) people’s lack of appreciation of what it really is and what it is not; ii) people lack of creativity (closely tied to Conforimism to the predominant paradigm); and iii) people’s lack of patience (ie. achieve something basically in one big step, rather than in a number of progressive steps, such as building capital and stability as one progresses….i like to call it “Incremental Capitalism”, and is an aspect of what i call “True Entrepreneurialism”)

        My 2c

      • I disagree that monopolies ever form without the involvement of Government. Look at the protection given to the banks, look at the rise of the monopoly utilities, Telecom/Telstra…

        All monopolies are spawned from Government protection.

        I suggest Bork http://books.google.com/books/about/The_antitrust_paradox.html?id=N7NXTbF8_MkC

        or Thomas J. DiLorenzo
        http://mises.org/daily/436

        A free market works – people just need to give it time. The reason why interventionist get such public support is that they can promise immediate public benefits with policies such as imposing price controls ect…

        As someone that began my legal career with a focus on competition law – it amazed me how many times policy makers and judges were willing to declare “market failure”. If the market doesnt produce the outcome people expect – they presume the market failed.

        An example of this would be the calls to regualte things such as ATM fees and Mortgage Exit fees..

        The market for mortgages and ATM services work just fine…its all the stupid regulations and policy structures (as pointed out by Burbwatcher above) that cause markets to ‘fail’

        Governments fail – markets dont

  5. Great piece, SoN – thanks!

    I agree with the comments above re. big banks and the folly of the finance industry, but it’s not just financiers who are to blame for the decay of free markets… The political process is now riddled with rent-seekers, with their stock in trade being ongoing fear campaigns (“this will cost jobs”) and their preferred currency being Government handouts.

    Free markets have evolved from “survival of the fittest” to “survival of the fattest”. Something needs to change.

    • Economist Ben Rogge wrote a book in 1979 called, ‘Can Capitalism Survive?’. He argued it would not survive because the intellectuals hate it. The intellectuals then go on to teach the heirs of the very rich. Joseph Schumpeter was of the same view.

  6. Interesting article, I certainly concur with the call to abolish economics as a discipline!

    The self-organisation angle is interesting, nature being the classic example, which works pretty well unless we start buggerising around with it. I’d argue we have a certain degree of this already. Over time natural systems evolve such that the biggest, strongest, slowest growing organisms survive, and diversity drops away as you get fewer and fewer bigger species (players). These bigger species (players) dominate, and it takes an almighty disturbance to shake them up and allow room for other smaller, faster growing species (players) to start to thrive. Sounds like a market to me… except that post-GFC, the big got bigger, so (insert deity name here) only knows how big a disturbance we’re going to need to change our current trajectory.

    • I think economics could be considered a subset of fiction – the requirement being the willing suspension of disbelief (who ever met a rational economic agent? This figure doesn’t look like me or anyone I ever met. But this disbelief needs to be suspended for economic theory to work).

  7. Also good reads:

    “Scratching By: How Government Creates Poverty as We Know It” By Charles Johnson

    http://www.thefreemanonline.org/featured/scratching-by-how-government-creates-poverty-as-we-know-it/

    “What About the Poor”? by Barry Loberfeld

    http://archive.frontpagemag.com/readArticle.aspx?ARTID=31997

    It is misguided politics that is the biggest cause of lack of social mobility, and usually the State’s “generosity” is captured by people who are NOT poor. One suspects that “liberal” left politicians are more anxious about maintaining voter constituencies for themselves, than they are about actually making people socially mobile.

  8. ceteris paribus

    Another great post.

    A much fairer, safer and simpler market for capital investment is needed. But the status quo, by its very definition, is “the organized”.

    I find these philosophpical meta arguments on the frameworks for money, markets and society are inherently more interesting than details of business and markets themselves.

    Also interesting are societal matters of macro public finance (MPF)- tax, income security (e.g National Disability Insurance, Retirement income policy, Worker’s Compensation policy), trade, international aid (both emergency and developmental), Consumer Credit Protection, Business competition policy etc etc.

    More of it.

  9. Great article…until…”abolishing the so-called discipline of economics”…what the?! This article is a piece of economic analysis! Economics, like politics, is a spectrum, not a fixed set of beliefs. Don’t forget Karl Marx was an economist.

    • Actually, I think he was a philosopher that fell into economics as a part of his studies in philosophy. But I do get your point. It is not the idea of economics that is at fault, but the way it doesn’t question and test its own theories the way a proper science does. It only takes a cursory look to see many faulty assumptions that it makes that any basic examination would expose.

  10. Those in power rely on the ignorance of the masses.

    The masses have been fooled into thinking that government spending can solve their problems.

    In actual fact government spending (past a certain necessary level) lines the pockets of those in power, and impoverishes the masses.

    The masses only realise this when their poverty becomes obvious.

    There is no solution to this, it is all part of the natural order, a direct outcome of human nature.

    One of the tasks of Economics is the study of these phenomena. From this we can expect an understanding.

    Where Economics has failed is in its attempts to fix something that cannot be fixed. In the process it has prostituted itself to those in power. Keynesianism and Monetarism play directly into the hands of the large creditors who now wield such enormous influence. The symbiosis of these strands of mainstream economics has served only to magnify the duration and size of the natural economic cycle.

    Both strands fail in both their descriptive and prescriptive forms. This doesn’t mean the end of Economics, but hopefully it will mean the end of these strange bedfellows.

  11. Being a libertarian I gotta agree with most of the commenters here. I don’t think it’s free markets that are the problem, but the quality of the regulatory framework in which they operate. Which means the quality of the government policies and institutions they create. We’ll never have perfect systems but rather evolving ones which change and improve over time. TheGFC showed us the free market cannot price high order derivatives sensibly whilst we have always known the free market will over-leverage itself in the good times (we just keep forgetting). The reinstatement of the Glass-Stegall act, some regulation on LVRs for home lending, changes to tax treatment of real estate assets, tougher regs on higher derivatives and maybe having central banks include asset prices in CPI calcs would go a long way to improving the Wests system of liberal, quasi-free market democracy. SoN is right in that last century saw the triumph of capitalism over collectivism, however that doesn’t mean we have the perfect system or that governments can stop trying to improve it through better ideas and policies

    • +1 QC

      The system now is broken, but I don’t know how it will be fixed. One issue should be to address political funding, and it should be only allowed from central revenue; not from companies, individuals,etc.. That would clean up the system I would hope. Politicians should be banned from lobying government when they leave office. There is too cosy a relationship with regulators and banks, and that needs to be changed.

      I look at the fallout of 2007/8, and very few were held responsible, and likewise after the dot com bubble. We have markets that find new ways to bend the system their way. I don’t see that much of the problems have been resolved, and I can’t see goivernments are too keen to change the system that keeps them in power.

    • The system is now different. It relies on futures (betting) rather than even guesstimates of real value. I think this means volatility – there is only sentiment now.

  12. I think that the main problem facing democracies and free economies is the growing concentration of capital and power which in itself is anti-free market and anti-democratic. When there is a large number of competing small players with conflicting interests they will keep one another in check. In the extreme where an area is monopolised by a single entity it will set the rules.

    Modern investment banking is at the core of corporations growing bigger as they orchestrate and finance mergers and acquisitions. The whole model of publicly own companies where capital growth and market share is more valued than profitability and efficiency favours concentration of capital and we end up with TBTF institutions which threaten the stability of economies. Large corporations kill competition and stifle innovation. They successfully lobby governments and influence regulations to their advantage. This happens at the same time as governments also become too big and try to control too many aspects of economies by direct interventions.

    To paraphrase Francis Bacon:
    “Money (and power) is like manure, of very little use except it be spread”.

  13. Stratfor this week has an excellent article on the divergence of the interest between the ‘economic elite’ and the general population.

    http://www.stratfor.com/weekly/20110808-global-economic-downturn-crisis-political-economy

    Now take this quiz on ‘Making Sense’ on PBS.

    http://www.pbs.org/newshour/rundown/2011/08/wealth-how-does-the-us-slice-the-pie.html

    The current economic and political system is not producing the country which their citizens wants to live in. The chart is pretty shocking. There will be some really serious problems ahead.

    • > Stratfor this week has an excellent article on the divergence of the interest between the ‘economic elite’ and the general population.

      Governments of the World unite against your citizens 🙂

  14. I don’t think that markets should be free, but they should always be available at a reasonable price.

  15. “Saying that “free markets have failed” because risk was underpriced in the credit default swaps market in 2007, is like saying the whole concept of powered flight has failed because Airbus has had problems with fly by wire systems.”

    Exactly. Bankers and wall street will always “game” the system. What was the govt. thinking when it started allowing investment banks to take deposits, or offering preferential treatment to institutions like Fannie Mae and Freddie Mac?? Free markets don’t work without some kind of leash, but it’s silly to pretend the govt. didn’t take it off with their perverse decisions which permeated moral hazard throughout the entire system. It’s hard for banks to get large enough that their failure would pose a systemic risk if they weren’t able to do whatever they wanted.

  16. please dont blame the free market for the inbred system in the western world over the last half century where the growth of large govt/corporatism has been the dominant force…

  17. Would love to hear from anybody as to when a “free-market” (free from the meddling influence of governments or powerful corporatist interests) has ever existed for a sustained period in human history.

    • well theres never anything 100% free market or central planned but the best examples are first few decades of Meiji Japan, UK and US in the 19th centuries and Hong Kong..

      • you also have to realise the vast history of human society has been tyranny, war, slavery, barbarism etc etc and what we are experiencing the past few centuries is an exception not the rule

      • Indeed. So, is Hong Kong our model for a “free” market as people idealise it ? Not trying to be derisory, just trying to understand what people are realistically hoping for when they talk about a “free” market alternative to the current state of affairs

      • if you look at Honk Kong under British rule you will note that they had complete free trade, very limited govt and the economy thrived despite how resource poor Hong Kong is (besides a harbour port). They still had govt but its intervention and role in society was minimal, i cant remember the %GDP of govt spending but from memory it was circa 3% of GDP.

        And it wasnt the opressed dystopian nightmare where the wealthy took advantage of the rich, people voted with their feet and came in droves from nearby neighbours.

      • the question to pose to those left leaning members of the blog is… where has socialism or collectivism worked.. ever??

      • I don’t think socialism or collectivism can work any more than “free” markets can work, but then I am essentially pessimistic about human nature.

    • Nowhere. The same for socialist collectivism.

      The question is about which rules we want and who they serve.

      The big question is the kind of society we want – this goes well beyond the managerialist way of thinking.

      It also means a recognition that systems can act in perverse ways – becoming impediments to the ends they were meant to achieve. Eg bureaucracy is a poor way to deal with complexity; such as the needs for persons to find worthwhile work.

  18. Capitalism does not mean one dollar equals one vote.

    Capitalism has nothing to do with the electoral system.

    What is being described is cronyism.. corporatism.. where large corporations exercise influence through regulatory capture and through successful lobbying of government institutions.

    Under capitalism, there would be no bailouts. There would only be liquidation.

  19. from http://ranprieur.com/
    …”in medieval Europe a new niche appeared, in which you could become powerful by manufacturing luxuries and managing commerce and finance. And this niche was filled, not by the most adaptable nobles, but by the most adaptable peasants! The nobles could not see the opportunity because they were too invested in the old system.

    Now, of course, the titled aristocracy are obsolete, and commerce and finance rule the world. But this system too is dying. What we call “the economy” is based on selling toys to the masses, and collecting exponential interest on debt. Both were made possible by using up nonrenewable resources, now mostly gone.

    So, what new niche is opening up? One answer is: we’re going full circle back to peasants. Soon, someone who has converted their whole yard to food production will be better off than someone with millions of dollars in stocks”…

    • Part of the medieval story is also the establishment of ‘free cities’ where the citizens weren’t subject to the same kinds of taxation.

  20. One of the features of the free market that free marketeers forget, is that free markets are supposed to result in low profits, i.e. the lowest profit necessary to continue in business. A properly functioning free market is supposed to result in a race to the bottom for prices of goods and services. There are two important points to be deduced from this.

    1. Profits above a minimum level indicate there is something not free market-ish happening. Either information is being hidden, someone has a monopoly, or the seller is being protected from competition.

    Those are pretty much the only things that can cause excess profits. You can see the hidden information problem in the mortgage loans debacle or in used car salesmen turning back odometers. (From my lawyering experience the government doesn’t go after the used car dealers either.) You can see the monopoly issue in patents, copyrights, which are government enforced monopolies. (I’m not saying we shouldn’t have them I’m just saying we need to call them what they are. But for the United States Patent enforcement system I would be able to buy an exact replica of an iPad2 for maybe half the price.) You can see the protection from competition in every type of governmental regulation, from subsidies for corn producers producing ethanol, to licensing requirements for hairdressers.

    2. The second point is that anyone desiring to make above normal profits must find a way to cheat on the free market by doing one of those three things.

    Put differently, what free market economics teach us is that the American Dream, i.e. becoming rich and famous, can only be achieved by hiding information, obtaining a monopoly, which for people other than Jed Clampett or Tiger Woods means obtaining a government enforced monopoly, or getting the mafia or the United States government to protect you from competition.

    These are all things that Adam Smith and Milton Friedman recognized. That’s why they understood there was a very important role for government in protecting the free market, not protecting businesses but the market, but they also understood that the quickest way to profit was by getting the government to protect you from the free market.

    • “One of the features of the free market that free marketeers forget, is that free markets are supposed to result in low profits, i.e. the lowest profit necessary to continue in business.”

      I don’t think that an economic profit (which is what you are talking about) equals a low profit. The profit has to cover the costs and the risk associated with doing the business. High risk investments will be adequately compensated and large profits will still be made.

      However, I agree with your general point and it comes back to a similar argument that a previous post made about cronyism and rent seeking.

      Steve Keen had a good analysis showing that FIRE sector profits as a proportion of GDP rose prior to a financial crash such as we are going through. I thought of that when commentators were talking about the health of the Oz economy and the strength of CBA recent profit.

      • I would agree re: low profits, to the extent that a “mature” market will generally have a commoditised level of profits, with “higher” profits coming from successful and relevant innovation, quality, differentiation to fulfill and enhance the basic needs of that society (ie. “unique and beneficial” non-commoditised entrepreneurial efforts)

        My 2c

  21. One of the important principles of democracy is division of powers. Often forgotten by government who wish to control the judiciary and bureaucracy (this happened in Australia, supported by BOTH major parties, when the bureaucracy was made responsible to the minister not the people). I think division of power needs to be extended into the economic sphere not just the political.

    I hope that you are right and that this does lead to an awakening of politics – both majors work in the managerialist mindset (with a major dose of economic rationalism thrown in).

    I think self organisation requires that people see they belong to a group going somewhere worthwhile and that their behaviour can make a meaningful contribution to getting to this valued place. The professionalisation of politics is directly contrary to this – and we will all suffer the consequences as people are disengaged from their (potential) community.

  22. There are lots of ways of looking at these issues.

    A good starting point is to recall why even a small measure of democracy was instituted in the first place – and that was to limit the power of the crown to impose taxes, control commerce, take slaves, raise armies and imprison or execute dissenters. Sovereign discretionary acts came to be limited by the need to obtain consent (from the Parliament) and to review (by the Judiciary).

    Gradually, the electoral franchise was extended and of course the judiciary has achieved a great degree of independence from both the executive and the legislature.

    So the fundamental ideas of democracy are:

    to limit the use of power;
    to make the exercise of authority subject to review by those who are NOT in power; and
    to either discharge or renew the writ of those who WISH to have in power.

    It is a system built on obtaining informed consent, without which authority will very soon lose its legitimacy and therefore also its efficacy.

    This is still the basic model. At its heart, it has always been about finding pragmatic solutions to the recurring tensions between the public interest in general and private interests in particular.

    We have evolved a system in which private interests are protected by a system of legal titles and other property rights – which include the opportunity to carry on all the kinds of commerce – and yet which are also subject to limitation. For example, while we are free to engage labour, we are not free to “indenture” workers indefinitely.

    This is different in degree though not in principle to the need to limit the discretion of the Crown. It is just part of the process of finding optimal solutions to one enduring problem: we all have to live together, and have many shared interests. And yet our society as much as our genetic make-up requires that we also act as “free” individuals.

    In a sense, we are not “free to be free.” Our society will only function if we have and can meaningfully exercise personal freedom. Accordingly, a code of personal rights has evolved to define what kinds of things any person may be free to do. These rights have certainly changed over time and will change more in future. There are limits to these rights, however, and there are two main ones as I see it.

    First, a person (or a group of people, or a corporation) may only exercise their private rights if they do not impinge on the rights of other individuals. These can be thought of as inter-personal rights.

    Second, the rights of any person (or a group of people, or a corporation) in relation to society as a whole are subject to the same kid of limitations as we apply to the rights of the Crown. These can be thought of as infra-social rights. That is, the public interest will prevail when there is conflict between the private and public interest.

    This applies to all kinds of issues. In a complex, dynamic and technically sophisticated society this is just to be expected. Since nearly everything we value and – at the deepest as well as most trivial levels – rely on is a consequence of the social structure in which we live, the sustainability of the social structure itself is always the single most important factor.

    For example, we have very well codified private property rights, but this does not mean private rights will always be sacrosanct. Private property rights are protected only to the extent that they support the workings of the social structure. This principle applies to all kinds of things – from the resumption of freehold land to build highways, the regulation of safety standards, the construction of public sanitation systems, the regulation of access to the radio spectrum, the prevention of monopolistic domination of markets, the issuing of currency, the definition and commercial use of intellectual property and so on.

    We are collectively in a constant inter-active process of discovering and calibrating the zone within which private rights can be exercised in a way that is consistent with the vitality and sustainability of the social structure.

    In the framework I have summarized here, private rights are defined and protected because it is optimal for both society as a whole as well as for the individuals that compose the society.

    We could also say the existence of private rights is necessary for our system to operate. But in itself, the exercise of private rights alone is not sufficient for the healthy functioning of society. The exercise of private rights must also be consistent with the protection of the rights of other individuals and with the protection of the general public interest.

    Finding the geometry of these forces is what politics, law and economics is about these days from my point of view.

    • David, the public interest is always what a government can use to restrict personal rights. Right now Labour are saying Abbot is causing sovereign risk by supporting farmers, but if you look back to the Fraser Institute reports our sovereign risk started to wane when Rudd started the ETF. There is no clear answer IMO

      • ahhh the old public interest line to serve the self interest… politicians are selfless you know

      • It is not always easy to reach agreement about what the public interest consists of in relation to any given issue, but that doesn’t mean the public interest does not exist or cannot be discerned.

  23. El Zorro Dorado

    A very good and interesting post…and you’re right about the wicked subterfuge. But what about the role of media in all this? The culture of spin and superficiality of values in the coverage of the media ( Grantham and a few others are the exceptions) allows for the glib, easy claims by the powerful to gain credence and acceptance at broader societal levels. It also conceals the progressive corruption and dysentry within over-ripe western democratic governments –allowing accumulation of unbridled or extreme ( for a democracy) levels of power in informal or formal extra-government groups.
    Markets have not been free ever; but the degree of manipulation by their big players, exchanges, and by regulators is now ludicrous –the checks and balances are anything but. They work for the priveleged few. In this respect they approximate the democracies of today in that privelege and wealth have replaced suffrage as determinants of the policy direction. We have allowed this erosion of values and usurpation to happen, possibly because of lazyness and the illusionary wealth of a debt-based society, and probably because we are continually lied to by those in power –and a key element in this subterfuge is the media. Like the atmosphere that persisted in Rome as it cartwheeled ‘south’, we have been too distracted by the games and fireworks to question the ever-consistent, but ever so slight erosion of the fundamental rocks on which our systems and our markets rest.

  24. Notions of capitalist and collectivist structures are essentially theoretical in nature and largely disregard critical social theory – the effect of introducing both logical and illogical people in to the workings of the model.

    Where this really starts to bring the whole thing unstuck is that these models also describe a fixed point in time – a static state, when reality tells us that all systems are organic; they change over time, as do the participants within them.

    There is no such thing as a free market, and even if there were, it would not remain so for long. The same goes for collective regimes. Systems are perverted by the power and influence people can exert over them in order to extract advantage for an individual or collective relative to other individuals or collectives.

    The real questions are, at what point in time is the system ceasing to serve the society it is entrusted to serve, at what point in time do the participants realise this and take action, what measures do you use to decide this, and what do you change to correct this? To my mind, Iceland is a great modern example of a populace, who using their democratic rights, has declared that the system is broken and is no longer serving them. For the rest of us, provided we have the illusion of personal freedoms and an acceptable standard of living, we are unlikely to cry foul. Heaven help those in countries with the capacity to suppress public empowerment.

    To my mind, wealth concentration and social stratification are probably two of the key indicators that “the system” is rapidly approaching maturity, and to a certain extent, has ceased to serve the best interests of those it was enshrined to serve.

    History is littered with examples of how concentrated wealth and social inequity have caused a stirring of the forces of change. On our current trajectory, we will arrive at a flashpoint someday also. Hopefully what follows will be a truly better system and not simply the eventual removal of the last vestiges of representative democracy we cling to today.

    • “There is no such thing as a free market, and even if there were, it would not remain so for long. The same goes for collective regimes. Systems are perverted by the power and influence people can exert over them in order to extract advantage for an individual or collective relative to other individuals or collectives.”

      That is something that a lot of people miss. They don’t think in terms of time.

  25. “free market” is utopia, same as communism. Any discussion about good or bad things in “free market” economy is pointless, because “free market” cannot exist. What we call free market is some obscure mechanism used by powerful to exploit others (including nature).

  26. When existing systems are challenged, people reach for the classics. What would Marx, Keynes or Elliot do to save us?

    But if you believe modern media and computer trading have skewed our markets and politics, it might be wiser to look to someone with the relevent skills for inspiritation.

    Why not try Pierre Omidyar who is the guy who founded ebay?

    His system allows me to confidently buy a pair of socks from someone I will never meet. It has a rating and feedback system that allows me to judge risk robustly. Past performance for delivery and accuracy are available for review. Questions can be asked. There is problem resolution and the option of escrow. There is a real incentive for all players to preserve their ratings. And it all works in a high volume environment with real world pressures.

    What would the NBN proposal look like if it was being offered on ebay? What would any of the recent inquireys or costings (pink bats, Qld floods, CO2 scheme) look like if the reputation of the originators was tracked and disclosed? The basic mechanisms of electioneering, new policy proposal and review would have to become a bit more evidence based.

    I also think modern automotive product engineering has a lot of tools and insight to offer. Fixed time frame and budgets, new technology and incomplete test data are routine, not exceptions.

    So send Pierre to Toyota for a couple of years before you appoint him world Chairman.

  27. “such invention of new rules rely for their validity on the underlying rules that must be set by governments and regulators”

    Why must the rules be set by the govt? The validity of rules would be based on what the market allows or does not allow. There is no need for govt rules for every financial instrument!

    There are rules mandating the use of ring agency ratings in various regulations. How did that work out? It resulted in corporations (and people) abandoning their own risk assessment procedures and relying on the rating agencies. Unintended consequences, massive mis-pricing of risk.

    The mandation of rules actually leads to a lot of these complex structured securities, as many of them are created to circumvent the existing set of rules.

    Would the market have accepted the MBS issues, CDO’s etc had they used their own risk assessments? who knows, but the evidence suggests that investors who actually looked deeper saw those securities were turds.

    My view remains that govt interference and rules are the root cause of TBTF and the other issues we are seeing right now. Most of the TBTF entities have been bailed out at some point, they should have all failed before they became TBTF.

    One of the beauties of a free market (or as close as you can get) is that the beyond a certain point corporate behemoths become inefficient and cant compete with agile, smaller companies. Excessive rules and regulations (and corporate lobbying) create such high barriers to entry that the small, agile company is priced out of entering.

    If you look at the IT industry, its the best example of a close-to-free market and the evolution of a market. A small start-up has the ability to rise and take on the giant corporates, and there is very little govt imposed regulation compared to finance (its mainly industry standards). The biggest issue seems to be the patent system, which actually stifles competition (without patents, innovations build on existing technologies; with patents innovation is stifled to all but the patent holder).

    this post is getting too long so i’ll stop my rambling now, i could post all day about this.

  28. I loved the article and the comments.

    However I do take issue with the continual deriding of collectivism (which I see as a philosophical value) and socialism (which I see as economic realisation of the philosophy).

    Collectivism is a value system to which humanity owes a large portion of its existence. We will always need to keep a hand firmly on this if we are to progress as a species. I can’t see anything positive coming out of eroding this as a value.

    Socialism is an equally important value that I think we are better off embracing than ignoring. Society will pay for its injustices one way of another, and its more efficient to do this at a time and in a manner of your choosing rather than reactively.

    But socialism simply dictates THAT you help, not HOW you help. In the same way that you can look at aspects of capitalism and say “we’ve been doing it wrong”, the same can be said of socialism. Capitalism and socialism aren’t in any way mutually exclusive. The biggest barrier to effective social policy is not properly understanding human nature and the real root causes of the problems that you are trying to fix.