Unconfirmed Reports

You can call it Neo-Liberalism, you can call it Thatcherism, you can call it Reaganomics. By whatever name, the doctrine that free markets can by themselves effectively organise our economic resources has been dealt a mortal blow over the last few weeks.

Multinational banks, the very pinnacles of the free-market economy, have been revealed as poor economic organisers, and now they need state help. In the United States and Britain, the government is taking up substantial part-ownership of these troubled institutions.

Why this failure of the free-market system?

I would argue that the theory has failed because it takes a very naive view of human activity. The theory itself, in its ideal form, seems sound: supply and demand is indeed a very organic, efficient way to manage the distribution of resources. But it is far too ideal. Really “free” markets just don’t exist, because the people involved will always start adding in their own distortions, in an attempt to make sure that more of the resources are flowing to them. When companies grow big and powerful, they start exerting whatever pressures they can on the market so that supply and demand will be distorted in their favour. In global finance, people have exploited the extreme complexity of modern financial instruments (things like “collaterized debt obligations“) to distort values. It is not at all surprising that workers in the finance industry would create such distortions, because they personally stood to make lots of money out of the deals.

What I see here is an idealised economic model, which in practice is undermined by self-interested human actions. There will never be a pure free market, because the humans involved will always screw with it.

But what I find really interesting is: this is very similar to a key criticism often raised against the communist theory of economics. Communists believed that a state created for and by the people would organise the economy in a way that best served the people. Rather than competitiveness, a rational, centralised economic authority would be used to distribute resources so that they optimally fitted with supply and demand.

We all know by now that this communist economic theory didn’t work, and a reason often advanced for this is that it failed to account for individualism and greed. Communist states didn’t distribute resources well at all: they were marred by corruption, with individuals distorting things to their own advantage.

In both theories, the complexity, unpredictability, and sheer deviance of humans has been ignored. Humans are falsely assumed to be rational economic units.

So enough of bullshit economic theories, I say. Enough of capitalism vs socialism. We should just accept that we actually have a “mixed” economy, a practical compromise of various economic methods, both free-market and state-regulated. Ditch the theories, and create policy in a way that responds to the realities.