Tuesday, January 27, 2009

A Modern Liberal and Free-Market Capitalism

Milton Friedman always claimed that he was a liberal…but, that he was a “classical” liberal. By that he meant that in terms of economics and liberty he was more like a liberal in the 18th century and the early 19th century. Liberalism shifted on him…or as Ronald Reagan said about the Democratic Party…he didn’t leave the Democratic Party…the Democratic Party left him. Friedman felt the say way about the policies and programs proposed by 20th century…and early 21st century liberals.

I am in this dilemma as well. I tried to lay out my position in my last essay, posted o January 24. In that post I claimed that I was an Information Libertarian. This meant that on the side of the cultural wars and civil rights I tend to come down with the modern Liberal…I am for openness, transparency, and liberty. However, on the side of capitalism and the role of government in the economy, I tend to come down on the side of free-market capitalism and minimal government intrusion into economic affairs. My liberalism…as it were…is split…right down the middle.

Liberalism, as Friedman argued, used to include free-market capitalism as one of its components. What happened? Why did free-market capitalism move from support on the left of the political spectrum and land on the right? Good questions.

Currently, I am reading the book titled “The Ascent of Money” by Niall Ferguson. In the Introduction to his book Ferguson makes several observations about how the world looks at finance and financiers that carry some relevance for the questions asked in the previous paragraph.

Ferguson writes: “Throughout the history of Western civilization, there has been a recurrent hostility to finance and financiers, rooted in the idea that those who make their living from lending money are somehow parasitical on the ‘real’ economic activities of agriculture and manufacturing.” He cites three causes of these attitudes:
• Debtors have tended to outnumber creditors and the form have seldom felt very well disposed towards the latter;
• Financial crises and scandals occur frequently enough to make finance appear to be a cause of poverty rather than prosperity, volatility rather that stability;
• For centuries, financial services in countries all over the world were disproportionately provided by member of ethnic or religious minorities, who had been excluded from land ownership or public office.
Furthermore, in terms of business, in general, there have been wide disparities in income distribution and this can be highlighted by the earnings of corporate executives in recent history and the increases they kept receiving over the years, far exceed what individual workers receive, the including small increases that they have received in recent years.

Ferguson goes on to say that one of the real paradoxes of the ‘liberal’ or ‘radical’ prescription for the elimination of the use of money is that one of the major constraints on economic development and growth is the LACK of financial institutions, the absence of banks…not the presence of them. And, this not only applies to nations, or regions, but also to neighborhoods and areas within cities. That is, for economic development to take place there must be some kind financial services present or development is not going to happen or be constricted.

However, Ferguson also says that “If the financial system has a defect, it is that it reflects and magnifies what we human beings are like.” For example, behavioral finance has shown that “money amplifies our tendency to overreact.” Also, the financially knowledgeable can use their talents and skills to multiply opportunity whereas those that are not can be severely hurt. Financial presence can accelerate mobility…both upward and downward. “The rewards for ‘getting it’ have never been so immense. And, the penalties for financial ignorance have never been so stiff.”

What Ferguson seems to be saying is that the presence of free-market capitalism and modern financial institutions and markets are like financial leverage…they can magnify both positive results and negative results. The way this seems to work is that ‘the few’ get very great benefits from capitalism whereas the ‘many’ end up with only meager results. That is the distribution of benefits is very skewed with smaller numbers at the top with a substantial number at the bottom.

The thing that doesn’t get mentioned as much is that, on average, countries that are democratic, capitalistic, with a great amount of liberty have much higher living standards than do countries that don’t offer these things to their citizens. The income distributions may be very skewed and unequal in the former countries but even those that are nearer the bottom are much better off than many of the citizens in these other countries. This doesn’t make the skewed income distribution right…but the fact that there are higher living standards relative to those in other countries is relevant.

The point is free-market capitalism can create wealth, it can create inequalities in income distribution, and since the inequalities can be quite substantial and magnified. Given these results, people can focus on the issue of fairness, not only of relative results at one particular time but also over time in terms of economic fluctuations. Thus, criticism can be leveled at financial capitalism because of these outcomes and because the people further down the pyramid outnumber the people at the top, discussions and debates about the validity of capitalism can be dominated or, at least, forcefully engaged in.

I would like to make three points in response to this. First, there does need to be oversight and regulation existing side-by-side in a capitalistic system…it cannot just be an open, do-as-you-will environment. This would include greater openness and transparency within the business and financial system. The capitalistic system can run better. Second, there does have to be safety nets, insurance programs, education, financial institutions to serve poor areas and other forms of help to reduce some of the risks and extreme results that can come about in free-market capitalism.

Finally, the government must not be too active in attempting to fine-tune the economy. The government can set up incentive systems that drive people and businesses to take excessive risks and make unwise decisions. The most recent eight years is a case-in-point. Through its monetary and fiscal policies the Bush43 administration created an environment that incented executives to take on more and more risk, to assume higher and higher leverage, and to bring new and untested innovations into the market place. The financial…and economic…system became more and more fragile. The collapse came. And, who got the majority of the blame…the executives running these institutions…those running the government escaped without the fingers being pointed at them at all…or, very little.

What I would like to emphasize is that small, entrepreneurial businesses provide most of the dynamism of a free-market capitalistic system, most of the new jobs created, large amounts of wealth that is relatively well distributed, and it adds substantially to the upward mobility in a country. This system thrives on information, trying new things, gathering more new information, innovating, learning, and growing. This part of the system…even the modern liberals like. It is the big, set-in-their-ways organizations, who create much of the unhappiness and the inequality.

I, of course, like this breed of entrepreneurs that exists below the horizon covered by the large, clumsy behemoth. It is also consistent with my support of liberty in the culture wars and civil rights. It is also consistent with support of the “new” in art and literature and music and life style. It is consistent with what being an Information Libertarian is all about…at least, I believe it is.

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