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Government's Help Needed To Save Free Market

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The Tampa Tribune

Published: October 25, 2008

One hundred and sixty-five years ago, a Scottish businessman set out his plans for a newspaper. James Wilson's starting point was "a melancholy reflection": "while wealth and capital have been rapidly increasing" and science and art "working the most surprising miracles," all classes of people were marked "by characters of uncertainty and insecurity."

Wilson's solution was freedom. He committed his venture to the struggle not just against the protectionist corn laws but against attempts to raise up "barriers to intercourse, jealousies, animosities and heartburnings between individuals and classes in this country, and again between this country and all others." Ever since, The Economist has been on the side of economic liberty.

Now economic liberty is under attack and capitalism, the system which embodies it, is at bay.

Last week Britain, the birthplace of modern privatization, nationalized much of its banking industry; meanwhile, amid talk of the end of the Thatcher-Reagan era, the American government has promised to put $250 billion into its banks.

Other governments are re-regulating their financial systems. Asians point out that the West appears to be moving towards their more dirigiste model: "The teachers have some problems," a Chinese leader recently said.
Interventionists are in full cry: "Self-regulation is finished," claims France's Nicolas Sarkozy. "Laissez-faire is finished."

Not all criticisms are that unsubtle (the more pointed ones focus on increasing the state's role only in finance), but all the signs are pointing in the same direction: a larger role for the state, and a smaller and more constrained private sector.

This newspaper hopes profoundly that this will not happen. Over the past century and a half capitalism has proved its worth for billions of people. The parts of the world where it has flourished have prospered; the parts where it has shriveled have suffered.
Capitalism has always engendered crises, and always will. The world should use the latest one, devastating though it is, to learn how to manage it better.

In the short term defending capitalism means, paradoxically, state intervention. There is a justifiable sense of outrage among voters and business people (and indeed economic liberals) that $2.5 trillion of taxpayers' money now has to be spent on a highly rewarded industry. But the global bailout is pragmatic, not ideological.

When Francois Mitterrand nationalized France's banks in 1981 he did so because he thought the state would run them better. This time governments are buying banks (or shares in them) because they believe, rightly, that public capital is needed to keep credit flowing.

Intervening to prevent banking crises from hurting the real economy has a strong pedigree. Wilson's son-in-law, Walter Bagehot, recommended that the Bank of England lend generously (but at a penalty rate) to illiquid banks (but not to insolvent ones). In modern times governments of every political stripe have had to step in.

Ronald Reagan and Margaret Thatcher oversaw the rescues of Continental Illinois and Johnson Matthey. In the 1990s the Finns and Swedes nationalized banks - and privatized them again later.

This rescue is on a different scale. Yet the justification is the same. The costs of not intervening look larger. If confidence and credit continue to dry up, a near-certain recession will become a depression, a calamity for everybody.

Even if it staves off disaster, the bailout will cause huge problems. It creates moral hazard. Such a visible safety net encourages risky behavior. It may also politicize lending.

Governments will need to minimize these risks. They should avoid rewarding the bosses and shareholders of the rescued banks. They must not steer loans to politically important sectors. And they should run the banks on a commercial basis with the explicit aim of getting out of the banking business as quickly as possible (and at a profit).

From the taxpayer's point of view, it might make sense to limit dividend payments to other shareholders until the government's preference shares have been paid off. But governments need to avoid populist gestures. Banning bonuses, for instance, would drive good people out of companies that badly need them.

The politicians all claim they understand this. Of course, they have no intention of revisiting Mitterrand's mistakes, of trying to run the banks themselves, or of taking stakes elsewhere. Yet already voices (including Lady Thatcher's Tory heirs) are pushing to limit executive pay.
Capitalism is at bay, but those who believe in it must fight for it. For all its flaws, it is the best economic system man has invented yet.

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