The wealth of nations in retreat?

Much has been made in recent weeks of the need to address financial market upheaval with policy. New policies and powers have been proposed, and unprecedented authority is being transferred from private markets and private entrepreneurs to policy makers, regulatory agencies, and the U.S. Congress. Much increased levels of government participation and ownership of the means of production—a move away from capitalism and toward socialist economic systems more typical of European economies now seem inevitable. According to policy makers, a number of social activists, and many industries coming under government protection/regulation themselves, free markets have been repudiated as inadequate, unfair, and problematic. The age of the government-managed economy in America is here, it seems.

Did this occur because we have discovered that the laws of demand and supply no longer hold (that prices no longer direct economic choices appropriately), or that incentives (correctly understood) don’t really matter, or that decision makers ignore marginal changes (in favor of all-or-nothing changes) when responding to tax rates, prices, revenues, costs, or other measures? None of the above. But a failure to know and understand these basic principles of economic thinking, and to appreciate and protect the fundamentals of a sound economy, can lead to all sorts of arguments to abandon markets, and to advocate government control of private decision making, resource allocation, and production.

I offer a list of the fundamentals of a sound economy that hinges on private property rights, private ownership and control of the means of production (capitalism), a fair and impartial judicial system, and what I have dubbed the Lockean ‘prime directive’, from Locke’s Second Treatise on Government: “the highest law is the good of the people” (“solus populi suprema lex”). Locke, as an adherent of natural rights, argued that the divine right of kings (government) was logically insupportable, but was in any case superceded by the natural rights of man, which proceed from the divine. Locke ultimately argued that natural, God-given rights could not be subject to usurpation by the claims of secular government. His treatise was pivotal in the reasoned argument for the rights of Englishmen to revolution against the English crown and its claims of supreme authority. This set of institutional basics protects political and economic freedoms alike. You cannot dispense with them in one sphere without compromising another.

So how is it that we in the U.S. have recently come to the brink (or beyond) of surrendering individual choice to ‘collective’ choice, private ownership to ‘public’ ownership, of market-directed production to government-directed (read: state legislatures and U.S. Congress) production, and of market pricing to government-approved pricing and punishments (setting the ‘acceptable’ pricing bounds for wages, products, imports, exports, and resources)? Economically, we are very poorly educated, and many people seem to have decided that we should fear markets, and rely instead on the wisdom of our governors (broadly construed).

We have arrived here for multiple reasons, I guess, but among them are certainly: 1) a lack of sound economic education on the part of the general public, 2) an appropriation of language by political interests, especially of key terms like shortage, and incentives, from the realm of economics, and 3) the failure to teach logic and the method of sound logical argumentation as part of a sound basic education. The widespread choice to replace formal instruction in logic with critical thinking exercises —embedded across the curriculum in lieu of a separate study—does not necessarily a logical thinker make.

This has profound implications for popular understanding of policy-relevant economic discussions. Sound decisions demand the ability to connect the dots: from policy history to economic present (the Fed’s home ownership mandate), from regulatory policy to market performance (energy policy past and present), from economic promises to future tax policy (Social Security), and for our understanding of how markets operate (regulation in banking and financial markets).

For an example of the problem, consider how ambiguous the term ‘incentive’ has become in policy use. The market meaning of an incentive is a situation in which individuals face a changed market price or circumstance. The new situation is a motivation (read: market incentive) to adjust their behavior. In the political scenario, “incentives” is the name given by policy-makers to what are usually tax-financed bribes, created by government, to lure business to some politically valuable location.

Conflating the market definition of an incentive with the political definition of an incentive encourages ambiguity between market and policy events. The successful bribe will have very definite economic and market effects, but is not a market phenomenon. Worse, misleading terminology harms citizens’ ability to comprehend proposed policy, and to make logical, reasoned choices. Unintended consequences, often negative, are then blamed on the free market rather that the regulation and legislation. This is part of what we see in the junk mortgage market implosion. Without the government and Federal Reserve, the moral hazard, the opportunity for fraud, and the huge number of overextended/unqualified borrowers could not have grown to the degree that occurred. Economic conclusion: markets were highly regulated, such that many unsound practices were actually encouraged or mandated. Populist and political conclusion: free markets are not only not self-regulating entities, they are a menace to the economic well-being and stability of our economy. The recommended fix: either get the government out of the financial and mortgage industries (on the one hand), or dramatically increase government ownership, oversight, and control of these enterprises. The way you understand the problem makes all the difference.

Rather than condemn markets, I argue that we should look to the policy sources of recent economic ills, from the Federal Reserve to the U.S. Congress. The rush to take control of key financial and productive industries and assets, to fix the (supposed) inherent flaws of the market, to stabilize and stimulate the economy, and to spread the wealth from more productive citizens to non-productive or less-productive citizens is evidence of yet another misapprehension: the nature and causes of the wealth of nations.