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The Return to Regulated Capitalism

By H. H. Makhlouf, PhD

Guyana Journal, October 2009

The essence of capitalism is the predominance of the private sector in economic transactions. It is associated with private ownership, entrepreneurship, wealth creation, innovation, the profit motive, individual responsibility, and risk-taking. In the meantime, unfettered, unregulated capitalism is identified with greed, wide disparity in incomes and wealth, and unmerciful periodic adjustments in which high unemployment and bankruptcies are only two of their negative cyclical consequences.

Recognizing the positive side of capitalism, Joseph Schumpeter, whom the Economist magazine described as “the prophet of capitalism”, indicated that “the capitalist process, not by coincidence but by virtue of its mechanism, progressively raises the standard of life of the masses”. However, he was also hard on business people by describing them as “monomaniacs, obsessed by their dreams of building private kingdoms and willing to do anything to crush their rivals” (Economist, 9/19/2009). Robert Shiller, who is a professor of economics at Yale University, similarly observed that “the idea that… capitalism would invariably produce the good outcomes was a wrong economic theory regarding how capitalist societies behave and what causes their crises. That wrong economic theory fails to take account of how the animal spirits affect economic behavior.” He further commented that the idea that unregulated capitalism would always produce the best outcomes was wrong.”

The financial crisis that began in the United States in the autumn of 2008, and threatened the collapse of the global financial system, is partly blamed on the deregulation of the financial and other major sectors in the economy. Although some economists have warned for a number of years that the behavior of the largely unregulated financial institutions, and the accompanying housing sector bubble, would have bad consequences, such warnings were unheeded on the basis that market imbalances have traditionally corrected themselves. Thus, policy-makers were not prepared for this crisis, and governments struggled to find solutions before things got too much out of control. Economic rescue measures were quickly adopted to save the financial sector and reduce the severity of the economic downfall in the United States and its major trading partners. This was followed by economic stimulus plans that aimed at saving major industries from collapse, reducing the rate of job loss, and increasing consumer confidence.

This crisis that sent shock waves throughout the world has raised more questions about the negative side of capitalism, and the proper role of government in regulating business. Economists started to wonder about the future of capitalism, and ways to reform it. The decades long movement toward economic liberalization lost support. Economic observers, like Martin Wolf of the Financial Times, have gone as far as saying that from the start” liberalization contained the seeds of its own downfall”.

Also commenting on the current crisis and its causes, Sir Martin Sorrell wrote: “It must be said plainly that capitalism messed up - or, to be more precise, capitalists did. We - business, governments, consumers - submitted to excess; we got too greedy. Life was easy in the late 1990s and early 21st century. With a seemingly benign interest rate regime, and cheap goods from China keeping inflation at bay, all you had to do was go into the office - moderation was out”(Financial Times, 5/12/ 2009).

With less regulation, the financial sector mismanaged risk, and focused on short-term profits. Global imbalances, caused by major deficits in the U.S. trade balance and national budget as well as the accumulation of huge reserves in export-oriented economies like those of China and Japan, brought about increases in capital inflows in deficit countries. This, in turn, drove interest rates down, and encouraged financial institutions to assume foolish risks in lending and other financial transactions. In addition, as stated in a Financial Times editorial, “Easy money, geared up by leverage flood(ed) the financial system through innovative products. This simultaneously pump(ed) up asset prices and obscure(ed) their speculative nature, with euphoria usurping the place of analysis.” (5/12/ 2009)

As governments started to provide conditional financial support to financial institutions and ailing companies that have been described as too big to be allowed to fall, it is now commonly believed that the age of deregulation and laissez is over. In fact, economic historians see similarities between what is happening in reaction to this current recession and financial crisis, and what took place in the aftermath of the Great Depression of 1929. That depression “transformed capitalism, and the role of government for a half century, even in the liberal democracies”, reminds us Martin Wolf. Some still fear, however, that once the economic recovery takes roots, banks and large corporations would go back to their old reckless practices, and the governments of the United States and other leading economies would give in to pressure from those who have traditionally stood in opposition to government regulations. Laissez fair still has its supporters who associate government involvement in business with socialism.

In their recent meeting in Pittsburgh, Pennsylvania, leaders of the top 20 economic powers (The Group of 20) have agreed, however, to a set of principles that would hopefully guide public policy after the world comes out of this severe depression and financial crisis. In these principles they have called for tighter regulation of financial institutions. They have also pledged to work toward the elimination of excessive trade and budgetary imbalances, curb excess in granting corporate and banking executive bonuses, and adopt measures to increase consumer savings. Furthermore, they have decided to conduct peer economic policy reviews in order to avoid future shocks similar to what the world has gone through in 2008-2009. If adhered to consistently, these decisions could prevent a return to the status quo ante that brought the world economy close to another Great Depression.

About the Writer:
Dr. H. H. Makhlouf is the Chairman of the Department of Management, Hospitality and Graduate Studies at the University of the District of Columbia.