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Will the Recession Be Free-Market Capitalism’s Downfall?

May 15, 2009 07:30 AM
by Anne Szustek
As the world struggles with gloomy economic conditions, some free-market proponents are re-examining their views. But are such crises of conscience anything new?

The Banking Sector and the Free Market: Deregulating Deregulation

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Federal Circuit Judge Richard Posner, author of “A Failure of Capitalism: The Crisis of '08 and the Descent into Depression,” explains in a Wall Street Journal opinion piece that the banking sector is at the “heart” of capitalism. Without it, companies are harder pressed to expand and consumers are less free to pursue their goals, material and otherwise.

When interest rates are low, as they were during much of the first half of this decade to mitigate the effects of the 2001 recession, people have more access to money—and thus are more likely to spend it. For this reason, housing prices surged, in turn inspiring people to turn toward real estate and the rising stock market as apparently safe investments.
This line of thinking jibes with monetarism, a theory touted by “Chicago school” economists, adherents of hands-off capitalism who see regulating access to money (often by adjusting interest rates) as the way to revive a sluggish economy or cool off an overheating one. They also advocate deregulation of the financial industry, an approach largely adopted by the U.S. government for roughly the past three decades, and which Posner and others argue paved the way to the subprime mortgage crisis and the current recession.

In the April 28 edition of his Salon column, Andrew Leonard points an accusatory finger at the “Chicago school” of economics. He believes its laissez-faire approach to financial sector oversight helped foster today’s economic conditions: “Nice triumph for deregulated capitalism, boys!”

Background: The Chicago school of economics

Hyde Park, the neighborhood on Chicago’s South Side that’s served as home to President Barack Obama and the University of Chicago, has often been seen as a spawning ground of liberal elitism.

But as some pundits may forget, the University of Chicago is also the birthplace of several schools of thought that conservatives hold dear. The law school—where Obama, as well as Wall Street Journal guest writer Posner, are officially on the faculty as senior lecturers—is known for its stance against legislating from the bench. As for the U of C’s economics department, its mere mention is synonymous with neoclassic economic theory and by extension, the father of the “Chicago school” of economic thought, Milton Friedman.

Friedman graduated from college during the Great Depression, powerful motivator for developing tonics for economic crises. He thus accepted a scholarship for graduate-level economics study at the University of Chicago. He ultimately received his PhD from New York’s Columbia University but returned to the U of C to develop his economic theories, which championed free markets as well as monetarist policy, which, as previously mentioned, advocates adjusting the supply of money flowing through the economy to stave off deflation. He famously likened this to dropping money out of a helicopter, a metaphor since echoed by current Federal Reserve Chairman Ben Bernanke.

Historical Context: Hard times lead some to question capitalism

Capitalism has come under scrutiny during previous periods of economic turbulence. A Time magazine article published April 21, 1980, when the country was mired in stagflation (a period of high inflation with low or negative economic growth), quoted Chrysler chairman Lee Iacocca as saying, “Free enterprise has gone to hell.” At the time, Chrysler was benefiting from a government loan that successfully kept the automaker afloat.

Meanwhile, the Eastern European Communist bloc was suffering even deeper economic woes, with lines of people waiting for meat and triple-digit inflation on some consumer goods.

The article concluded,  “Plainly, capitalism is not working well enough. But there is no evidence to show that the fault is in the system—or that there is a better alternative.”

Opinion & Analysis: Finding the middle ground

From that perspective, the economic policies of the 1980s, espoused by Friedman and largely adopted by the Reagan administration, were not “an abject failure,” writes The Economist in response to Salon columnist Leonard’s allegations. “We have not lost 30 years of wealth, and living standards have increased for billions of people since the 1980s,” which includes many who were living behind the Iron Curtain some two decades ago.

Those believers who are now questioning the theories of the Chicago school do not advocate complete government control of the banking system—just that some parameters need to be instituted. In an interview with U.S. News & World Report, Posner said, “I’ve always been a strong supporter of deregulation, and I should have said deregulation in everything but banking.”

The question is how and what to regulate. Posner writes in The Wall Street Journal that when considered on a global scale, regulation could deter foreign investment in the United States, as it would lower risk and thus potential returns. Nevertheless, he argues that substantive action rather than a complete hands-off approach is necessary to combat this recession.

In the same piece, he refers to John Maynard Keynes, the father of monetarism’s chief opposing school of thought, who said that in order for the economy to bounce back, confidence must as well—a position that most economists, regardless of their theoretical allegiance, would probably agree with.
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