Published: March 2009
By:
Delaena Kalevor
MBA Candidate | Class of 2009
William E. Simon Graduate School of Business
University of Rochester, Rochester, NY
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 a few weeks ago? 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 name sake and benefactor 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, stay tuned!
What’s your opinion? Has the recession affected you or your country? Do you agree with British Premier Gordon Brown’s assertion that we’re in need of a new system of economics? Obamanomics, anyone? It’s a world of opinion folks…what’s yours?
Delaena Kalevor
MBA Candidate | Class of 2009
William E. Simon Graduate School of Business
University of Rochester, Rochester, NY
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 a few weeks ago? 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 name sake and benefactor 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, stay tuned!
What’s your opinion? Has the recession affected you or your country? Do you agree with British Premier Gordon Brown’s assertion that we’re in need of a new system of economics? Obamanomics, anyone? It’s a world of opinion folks…what’s yours?
Excellent piece, Dela. You're a business person so I don't expect you to argue otherwise, lol. What is also interesting is that some people in Ghana are asking for a domesticated stimulus package. Why do we feel like we should follow everything America does? Like McCain, I don't really understand the economy but doesn't the current crisis indicate there is something inherently wrong with the system as we've known it? If the economy is still this bad by December I think we would need something other than capitalism especially with all the greed that comes with it.
ReplyDelete..greed leads to efficiency, but if left unchecked...well, hell...the rest is history...
ReplyDeleteWhile a market based economy is the "best" know system that has proven to spur prosperity and development, FREE market system as evident by the recent financial crisis can be a bane. There should be nothing like a FREE economy. There must be some level of responsibility and accountability. The "self -interest" if unchecked leads to greedy and corruption.
ReplyDeleteThe reality of the freedom of any market is a pipe dream which lives only in the figment of our imaginations. DK, I think greed leads to inhumanity in its smallest dose... greed mangles and disfigures the human face of any market system and transforms it into a monster which will prey on others first, then eventually on itself... The current economic tail spin and all its attendant causes and consequences is an example par excellence...
ReplyDeleteWe are where we are right now basically because of unchecked freedoms. Capitalism has become more than an economic system--it has become a means for the inordinate pursuit of wealth. So i agree with Kofi that this isn't an either or proposition. We need middle range systems that will be sensitive to local contexts and the greater good rather than in-ward looking or self serving models. DK, greed leads to efficiency? I’d have to apply to the Simmon School to understand that. Like anhilaire said, while competition is always good, greed in any form should never be tolerated because one Madoff is simply enough for the world.
ReplyDelete.."greed"..does lead to efficiency. I added a caveat (if left unchecked). self interest is a fundamental human trait that must exist for capitalism to work. If it weren't for patent laws to protect the fruits of years of R&D, no one would conduct research which has obvious benefits. certainly if it is left unchecked people become too ingenious and that is what we're seeing today. these laws exist in free market economies to safeguard this...as to whether going forward it is the best social system is highly debatable...i guess time will tell...
ReplyDeleteI’d actually put the word 'disingenuous' in that fourth sentence. “self interest is a fundamental human trait that must exist for capitalism to work.” This statement is not even close to true. Not all human traits are good.
ReplyDeleteIt’s almost like saying “every mistake is a new style” thereby justifying everything. You can’t justify selfishness, gluttony or self-indulgence. competition ? sounds fair. But why should citizens take the hit when those fat thickheaded insensitive cats make all the bad bets. Like they say: “Wrong is wrong even if it helps you”
..self interest might be wrong, but it is certainly necessary for capitalism to work. it's all about incentives and how the influence human behavior. evidence in support of this is overwhelming.
ReplyDeleteI'm not arguing about the humanity, goodness or morality of capitalism. many people actually believe capitalism is evil and immoral. my point is capitalism has so far proven to be the best system to create wealth. and this has been amply proven.
as far as citizens taking the hit..i don't disagree with you. the root cause of this crisis was the lack of savings culture, the housing bubble, bad lending standards, and the sub-prime market (which by the way began because of the Community Reinvestment Act). so unnecessary government interference in free markets is always a bad idea..and so is the bailout..the government should rather allow the markets to function and hopefully savings will increase and things will self-correct...again, time will tell...
I think capitalism is here to stay but it is up for scrutiny from now on. Free market economics sounds good on paper and in models described by the giants of economics like Adam Smith. But as our very first Econ 101 teachers will tell us, models are just models. I think what is currently happening is a result of the models of capitalism not holding up. That does not mean though that the model of capitalism is not valid. We have seen what has happened with other systems that have been adopted by countries for example Ghana back in the day as described by the author. But things like regulation might be required to counter the Utopian world of models.
ReplyDeleteIncentives, self-interests, prestige...although some people might think these things are not the best of qualities in humans, they are part of us as humans are they are here to stay. The best we can do is to use them in the system that they work best in, capitalism, to better ourselves as well as others.
If still not sold on capitalism, I guess it is best to think of it as the next best thing of all the systems out there.
Thanks for Econ 101...good try. It's too easy...regardless of your beliefs you have to admit that accepting capitalism just because we can't think of a better system is just acting lazy. Why so many different interpretations?The hypocrisy of capitalism is second to none but as usual we glorify everything "the white man with blue eyes" does.
ReplyDelete..well, i guess we need to think of a better economic system, one that not only creates value but is also sensitive to the needs of lower income groups and is more humane...stay tuned...
ReplyDelete