A Conversation on Laissez-Faire Economics (In Light of the Recent 'Occupy' Movement)
This is a question that comes up frequently, and the answer I gave is, I think, a decent one. I’m curious what all of you think about this issue, because the economy is probably the biggest issue/problem in our nation today. The ramifications of our economic policies over the next few years will be HUGE, and shouldn’t be taken lightly.
Some authors I read suggest that the limitless free market, globalization, etc. is the very root of all those problems you mentioned (power-tripping economic institutions only concerned about the bottom line, blah blah). While other authors blame the government for interfering with the perfect free market. Whatchu think?
I think the best response to that question is to use the recent economic crisis as a microcosm. What caused the doldrums that we’re in now? The answer, though you wouldn’t think it to watch the news, is so simple that a complete (economic) novice can understand it!
The short answer is that the housing bubble collapsed. We call bubbles bubbles because they’re artificial- in this case, home prices didn’t reflect the actual worth of the properties in question- they were driven up above a sustainable level. This in turn provides an incentive to people to purchase more home than they can afford (either a more expensive home than they would have bought otherwise, or multiple homes) in the expectation that the price of those homes would continue to go up, and that those homes could then be sold for a profit.
Of course, with so many people flooding into the house market to do just that, there was suddenly a plethora of homes for sale, and nobody left to buy them, because prices had risen so high. Think about hour hometown- how many new neighborhoods were built in the last 10 years or so? And how many of those still have dozens of houses for sale? The boom turned to bust.
Now that wouldn’t ordinarily be an issue, but the particular thing about this bubble is that it was almost universally purchased on credit. People took out huge loans, often with no money down and no equity, and for exorbitant interest rates (albeit with a low ‘teaser’ rate at first). Defaults, and bankruptcies, came in droves, decimating the financial sector.
The situation I described above is essentially uncontested- that is, for all intents and purposes, a watered-down version of what really happened. But let’s look a bit more closely at each individual step, and provide some scope to this whole issue. We have to ask ourselves, “what caused the bubble in the first place?” The answer to that is a bit more complex, but is still relatively easy to follow.
President Clinton, in the 1990s, decided that an initiative to allow all Americans the opportunity to buy their own home was a good use of government authority and resources (remember, we had a surplus at the time, thanks to much-maligned ‘Voodoo Economics’ in the 1980s). He put pressure on the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) to loosen their standards for the mortgages they purchased from lenders (Fannie Mae and Freddie Mac purchase loans with government money that other institutions make and compile them into securities that are traded publicly- the secondary mortgage market).
This had the effect of giving banks the incentive to loosen their standards as well, since they knew that any loans they made would be purchased from them by Fannie Mae and Freddie Mac, essentially meaning that the banks could make essentially whatever loans they wanted, to whomever they wanted, and not assume any of the risk when those loans went bad.
One of the worst abusers of this was Nationwide. I’m sure you remember their commercials before this crisis, declaring that they could extend a home loan to anybody, regardless of credit history and income. And every bad loan Nationwide made went straight to Fannie Mae and Freddie Mac.
When Fannie Mae and Freddie Mac offered their securities to the market, they were rated at the highest levels- and why wouldn’t they be? Not only are mortgage-backed securities historically very secure (because only people with good credit were historically issued mortgages and therefore paid them back), but they were backed by the Federal Government (who are required to prop up Fannie Mae and Freddie Mac no matter how insolvent they are). So businesses who usually have nothing to do with mortgages began investing in mortgage-backed securities.
Because loans were easier and easier to get as time went by, more and more people were competing for the same number of homes, thereby driving home prices skyward at an alarmingly high rate. However, since most of the people purchasing new homes were people who couldn’t afford a new home (but who were still getting loans anyhow, thanks to Fannie Mae and Freddie Mac), payments began to be missed, and (eventually) mortgages went into default. Suddenly, not only was the Federal Government on the hook for billions upon billions of bad loans (through Fannie Mae and Freddie Mac), everybody who bought mortgage-backed securities found themselves holding worthless pieces of paper.
The bubble popped. House prices dropped radically, meaning that people who bought houses with the intention of selling them for a profit found themselves forced to sell for thousands, sometimes tens of thousands, of dollars less than they paid, causing even more financial strain. And the spiral continued.
Who is to blame there? The answer is clear, and I’m sure you’re already seeing it: the Federal Government. If they hadn’t interfered in the mortgage market (something they have no Constitutional authority to do) through Fannie Mae and Freddie Mac, house prices would have remained stable and at a level that truly reflected their market value. It was the Government’s artificial inflation of house prices that caused the bubble to begin with.
Apply that vis-a-vis the entire economy. It is the Government’s intervention in the banking system through the Federal Reserve that causes inflation (inflation is NOT, despite what we often assume, inevitable- in fact, up until the creation of the Federal Reserve, a dollar one year actually bought MORE the next year). It is the Government’s interference in farming (subsidizing particular politically-favored crops and even paying farmers NOT to farm) that drives food prices up. And so on, and so on.
The Government needs to get out of the economy, and fast, or we’re going to wind up just like the Soviets did.
Do we really want more of the status quo?
“I’m still curious about the first part of my question… What would you say to someone who argued that the free market NEEDS reigning in (by someone, but not necessarily the govt), because by its very nature it values capital above the well-being of its workers, and will slowly but surely stifle personal freedoms in the name of maximum economic efficiency? All things that run contrary to the democratic principles on which our country was founded…”
“I would say that such a scenario is unlikely at best.
Clearly, a basic regulatory structure must be in place for anything productive to happen (e.g. John Locke’s social contract theory)- in this case, a government which respects individuals and personal liberties and enforces transgressions against them such as theft (including fraud, larceny, et al), injury to one’s person or property (assault, murder, vandalism, et al), and so forth, and that upholds and enforces contracts.
The ramifications of such a simple system are huge. For one, it gives every person the rights of a free agent; it gives every person the right to determine for him or herself where and how to labor, where and how to spend, where and how to live, and so forth.
And, by the way, it isn’t the free market that needs reigning in- the free market is just another way of saying ‘an economic model where the government doesn’t interfere with commerce.’ There is a difference between ‘interfering with’, which is what happens today, and ‘providing a basic framework for’, which is what I described above.
You are correct in saying that it is in the best interests of an entrepreneur to provide a good or service as profitably as possible, but incorrect in saying that in pursuit of this end, a worker’s welfare is necessarily degraded. Historically, the people who were abused by employers were people whom the government treated as, at best, second-class citizens (the lower class, children, woman, etc). In a society which upholds every individual’s liberties equally, it is extremely improbable that any employer would mistreat its workers- they would just leave, and work elsewhere. With a lack of labor, profits would collapse instantly.
Some laborers, however, might accept arduous conditions or harsh employers in exchange for a larger-than-average salary. If so, it is the place of neither the government nor anybody else to interfere with the voluntary agreement of one free agent and another, so long as no other free agent is directly harmed in the process (e.g. two free agents couldn’t collude to defraud a third).
What people stereotypically think of when they imagine an free market is the image of robber-barons (who weren’t really, but I digress) oppressing their workers and cruelly siphoning money from the poor to enrich themselves. But such a scenario simply couldn’t happen in a truly free market. So long as options exist; and they always do; people will do whatever is in their best interest- entrepreneurs, companies, and citizens alike. In doing so, they reach an equilibrium that is impossible to create any other way. The end result, of course, is prosperity.
For a modern example, I could point to Google. Google’s offices are plush and extravagant; they have gyms, spas, parks, and more for their workers. Nobody compels them to do all of this- they do it of their own accord. Why? They want to hire the absolute best programmers, clerks, accountants, etc. that they can, and they know that every incentive they can offer will make them more lucrative. They are competing for skilled workers, and they understand that an expense paid to lure the most skilled will pay off with larger profits in the long run. More and more technology companies are following Google’s lead, putting together packages of their own (salary, fringe benefits, and other compensation) to try to get the most skilled workers that THEY can.
Even unskilled workers benefit to some degree in a free system. Sure, no McDonald’s has a spa for it’s workers. But if you compare what we would consider a horrible job to have (what parent HASN’T warned their child to do their homework lest they grow up to be a ‘burger flipper?’) is leaps and bounds better than what an unskilled, inexperienced worker would have been able to find several hundred years ago. And if you don’t like McDonald’s business practices, you can either accumulate experience and find a better job, accumulate skill and move up the ladder, or shop around to another burger joint that fits you better. Heck, you can even combine all three strategies!
The so-called American Dream- the idea that anybody can, with enough hard work and enough ingenuity, be successful in life- depends on a free market. A free market is the only system that provides that opportunity.
The primary opposition to the free markets seems to be that, while it creates winners, it also creates losers. People don’t get the job they want. Businesses fail for a variety of reasons. The system, in short, is not perfect. But then again, no system is! The alternatives, centralized planned economies and the much-discussed-never-explained ‘third way’ have flaws of their own- the former makes everybody a loser, and the latter allows a government to choose who wins and who loses artificially (this is the system we now have).
If nothing else, a free market has the virtue of being, well, free. And when you’re free, your successes are your own, and your failures are your own.”