With the U.S. economy spinning dangerously out of control and with G-20 leaders scrambling for options at their recent summit, several questions have been raised about the potency and viability of free market capitalism as a sustainable means of efficiently allocating resources and creating wealth.
Former Federal Reserve Chairman, Alan Greenspan, one of the most authoritative economists of the post WW II period, admitted that he was shocked at the scale and magnitude of this recession which was sparked off by frozen credit markets. At a speech prepared for delivery before a congressional committee in 2008, he said “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity—myself especially—are in a state of shocked-disbelief.”
This raises some pertinent questions, a few of which are: Are we going back to an era of nationalization of private enterprise—given the unprecedented scale of government intervention in the capital markets? Should it be so or should the market be allowed to perform its duty of “efficiently” allocating resources? Is the market really efficient? Or, the market is sometimes irrational? Was Citigroup Inc. really worth ninety-something cents a share when it broke the buck in March 2009? Is this the end of free market economics as we know it?
In the light of all this, I present below compelling anecdotal (the experience of my home country Ghana) and empirical evidence from Adam Smith’s book, Wealth of Nations, that point to all indications that free markets is still the most potent social system for creating wealth.
On December 31 1981, Lt. Jerry Rawlings and his team of air force officers overthrew the democratically elected government of Dr. Hilla Limann. This was the second time that Rawlings had staged a military coup in two years—the first was in 1979 when he led a group of renegade military officers to oust the Supreme Military Council. This marked the beginning of Ghana’s tumultuous slide towards centralized economic planning. Rawlings and his band of idealists were angry about, what they termed, the “greed and corruption” of wealthy politicians and businessmen; thus he promised a “revolution” with his 1981 comeback.
In hindsight, Rawlings genuinely sought to bring progressive change but was in need of proper direction as he led Ghana to find its identity. He seized money, property, and businesses of wealthy businessmen and promised to equitably distribute the nation’s resources to all citizens. His regime centralized all the major sectors of the economy, including agriculture which was its backbone. My mother tells me that she had to queue for hours to buy food from government warehouses in those days. By 1984, the drought that had hit most parts of sub-Saharan Africa had taken its toll on Ghana and millions of people were starving across the country. Rawlings had to turn to the same western liberalized economies that he so despised because of his leftist inclination, for food aid. The fact that Ghana couldn’t survive the drought without food aid leads me to conclude that while centralized economies may satisfy short term goals, over the long haul, they are not sustainable for economic prosperity.
Today, it’s a new Ghana, booming with the fastest growing financial markets in Africa, attracting foreign direct investment, and recording one of the highest GDP growth rates on the continent. By 1990, it was clear that the future of the country lay in free market economics. The state-owned telecommunications, postal, electricity, and agricultural sectors were divested to private entrepreneurs. Under the Financial Sector Adjustment Program (FINSAP), the banking sector was deregulated and a stock exchange was established in 1990.
Free market economics provides the incentives necessary to drive innovation, growth and economic prosperity. It removes the “tragedy of commons” that bedevils centrally planned economies. In his book, Wealth of Nations, Adam Smith (1776), noted that a group is collectively better off, if each individual in the group strives to achieve self interest. The incentives, derived from individual success, motivate everybody to innovate and create value leading to positive externalities that benefit all. This explains why companies especially in biotechnology, pharmaceuticals, aerospace/defense, and robotics deploy billions of dollars in research and development.
But for patent laws that protect their proprietary knowledge and processes, they would not profit from their research and we would gravitate to a Nash equilibrium where no one conducts research at all. With patent laws, these firms benefit the most (for instance, the huge rallies in their stock prices/windfall corporate profits when their patents are approved) from their research, but the community also benefits (positive externality) because of cutting edge cancer drugs, anti-retroviral drugs, etc that their research produces and which save lives. This incentive to innovate, that Adam Smith referred to 300 years ago, probably explains why some small biotech firms tend to be less innovative when they’re acquired by larger pharmaceutical firms. The potency of free market economics is as true today as it was 300 years ago, from this example.
William E. Simon (1978) (63rd United States Treasury Secretary and namesake of the William E. Simon Graduate School of Business – University of Rochester) in his book, A Time for Truth, recounts his experiences as the Chairman of the Oil Planning Committee in the 1970s. He notes how the Energy Planning Office centralized the distribution and allocation of oil resources. The lack of innovation in energy exploration that resulted from government regulation of the sector resulted in a heavy reliance on imported oil. By 1973, the U.S. was importing one-third of its oil, half of which came from the Middle East.
The 1973 oil embargo from Arab countries created a gaping hole in the U.S. oil supply chain. Again, central planning proved not to be sustainable in the face of this crisis. These experiences cemented William E. Simon’s beliefs in laissez-faire capitalism. He wrote that, “there is only one social system that reflects the sovereignty of the individual: the free market.”
These examples overwhelmingly demonstrate that free market economics is the best social system in the sense that it guarantees the primacy of the individual and it creates value as a consequence. The viability and applicability of free markets have no geographic boundaries as demonstrated by the Ghana and United States examples. Finally, the concept has stood the test of time; thus, history is the best argument in favor of free markets.
In the face of the 2007-2009 global recession and the unprecedented government intervention that we’re seeing, the efficacy of this argument remains to be seen going into the future. But that is a story for another day.
Delaena Kalevor is an MBA Graduate from the Simon Graduate School of Business, University of Rochester. Excerpts from this article were part of an award-winning essay he presented to the Simon School for which he was awarded The Prince Family Scholarship for his philosophical insights into free market capitalism.
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