The US bailout – was Hayek and Friedman wrong afterall?

Posted on September 26, 2008. Filed under: China, Communist, economics, USA |

A frustrated and dejected Hayek had once returned to his home country of Austria, leaving the Chicago school of economics alone to fight for the acceptance of their theory of the superiority of “free market forces” over that of centralized or planned/controlled economies which were constantly being intervened in or needed intervention by the Government or financial regulatory authorities. Hayek’s eventual rehabilitation started with the fascination that the Iron Lady had for his interpretations, and of course the Iron Lady’s success [perhaps with a heavy dose of Lady Luck smiling through the success in the Falklands war – or was it not so much an “accidental” war after all?] in deregulating most of the UK’s economic sectors. Friedman was the face of “free market” in the USA, the focus of intense vilification as the “devil’s advocate” who thought nothing of the heavy human cost of “reforms”, and the man who visibly flinched at the abuse hurled at him from the galleries while even receiving the Nobel Prize.

The association of the Latin American dictatorships with these reforms were not a help to the Hayekists. The Chilean example would be a permanent blot on the Hayekists, because of the fascist methods of torture and liquidation of political opposition, especially those who could be  represented by the authorities as “leftist”. European countries who recently appear to pander to “leftist” demands to “equate anti-Islam” with “fascism”, never uttered a single word of censure against the Chilean regime in defense of the Chilean “Left” then.  This was consistent with their behaviour when similar barbarities were being carried out on “Leftists” in the middle-Eastern Islamic countries. The only European country to have opened its mouth on humanitarian concerns about the atrocities in Latin America, appears to be the post-post-Franco Spain, still too deeply agonized and guilt-ridden over its spectacular achievements on the human-rights front under Franco. However, utilization of or experiments with spontaneous market forces to revive stagnating economies had started not only in the USA under Reagan following Thatcher, but unknown and unpublicized in the western media, had been going on in the “Communist” world surreptitiously. Communist China had never really fully given up on markets, with records showing existence and encouragement of local markets from the beginning of Communist power. With the admirable strategic and tactical flexibility shown by the Chinese communists as always,  the CCP showed its grasp of economics quite early – when it used a combination of markets and hedging against real commodities to slash down on inflation. Subsequently it retreated quickly as and when necessary from disastrous experiments with centralization, and did not believe in continuing on an error because of pride or ideological commitment.

In contrast to Keynesian theory, which at least gave a crucial importance to the role of the Government spending in jump-starting a stagnant or crisis ridden economy, and was taken up with enthusiasm by FDR leading definitely to the recovery from the Great Depression of the 30’s in the USA, a simplistic reading of Hayek indeed gives the impression that Government intervention only leads to further chaos.  There are two important objections to this simplistic reading of Hayek.  When Hayek is talking of leaving markets forces to adjust themselves, he is talking of small departures from equilibrium – this is the reason, where there had already been cumulative large departures from equilibrium, the adjustments were extremely costly in human terms. The US case is the case of a large departure. But then inevitably the question arises as to how large is “large”?  And this is where the second objection comes in.  Hayek was essentially formulating his theory in the framework of national economies, and to a certain extent we still cannot completely come out of the implicit conditions in Hayek’s theory. The fundamental problem is because our mechanisms of financial and economic accountability is still tied primarily with the political boundaries and institutions of the nation state, whereas financial capital is no longer national.  Global capital now flies where it senses profit, with very little of the actual market forces being integrated between the source and sink of this capital.

Taking the very simple example of the US mortgage crisis, which probably resulted at least partly from the ruthless exploitation of endemic vulnerability of non-dominant racial and ethnic and social groups in having access to resources, to pump up prices and profit rates. This not only creates a fictitious commodity in economic terms, [a value which cannot be supported in reality by a real commodity of utility – especially peculiar commodities like land or buildings which do not generate new buildings or lands on their own, unlike other material input into industrial processes] but also definitely needs increased money supply. Now in the older framework of national economies, this increased money supply and therefore inflationary pressures could have been controlled by tightening the national money supply itself. However in the strange modern world economy, money supply itself cannot be controlled within the national economy itself, as finance capital flows constantly in and out  of the national economy. The nations have no real control over the global money supply, and the crucial equilibrium factors of a tight money supply, free movement of labour and other factors of production [as would have more or less naturally been obtained for a “free market” system within a single “national economy”] are practically absent in the international economic exchanges between national economies.

Exceptionally high prices for basic housing could only be sustained if there was unusually large financial capital on the money supply side not really balanced against the productive capacity of the national economy and  development of monopolies and cartels in the housing provider market also with the help of excessive accumulation of finance capital in the hands of a few – both conditions not conducive to a Hayekian “free market” self correcting mechanisms.

There are two components to solving this problem over the long run – (1) go for a solid, international fully integrated monetary regime not constrained by national boundaries, but subject to overall control of money supply, backed up by a freeing of the crucial market forces of free movement of labour and technology (2) include a basic social security net that still is consistent with encouragement of performance and the role of incentives. Even in the USA, the land of “opportunities”, the ideas of “microcredit” or “community land trusts” should not be “untouchable”!

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