Was Laissez Faire Responsible for the Economic Crisis?

It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

– Adam Smith (Wealth of Nations, 1776, Vol. I Chapter II.2, p27)

The recent economic crisis showed that we live in a global economy. Economies across the globe are connected so that ups and downs in exchange rates, stock prices and product prices impact every corner of the earth. But, was the recent global crisis caused by the breakdown of the free markets? Can markets be sustained only by the state? This sentence assumes Laissez Faire. No country is even close to it.

The laissez faire philosophy does not support government intervention on matters related to the economy. This obviously implies minimal regulations and taxes and private ownership of property. Laissez faire does not support wealth redistribution. Wealth redistribution involves taking capital from the productive sectors and injecting it into the less productive ones. This forced economic egalitarianism, kills innovation and the incentive to work hard, thereby destroying productivity. Take the former Soviet Union. Its people are brilliant – no other country has chess as a spectator sport. And yet when its rulers tried to make all of us its people they destroyed the country but equality was not achieved.

Even if wealth redistribution leads to the establishment of equality temporarily, this situation would soon collapse. Every individual has different motivation levels, skill sets and qualities. Therefore, their economic choices are bound to differ. Furthermore, economic inequality is essential for people to select their own actions, without any external influences.

Coming back to the crisis… Markets always go through the process of correction. Sometimes the correction is miniscule and at other times it is huge. What happened with the busting of the housing bubble in the US was a market correction. Who caused the bubble? The government rescued Fannie Mae and Freddie Mac and pumped in billions of dollars into the economy. But the US is still reeling under economic pressure. Fannie Mae and Freddie Mac were formed with a charter and special privileges and functioned as an arm of the US government to promote house ownership. They incentivized banks to lend by purchasing all mortgages from the lender banks with no regard as to the capacity of the borrower to repay. Banks merely did what the US government them to do.

The same happens in countries across Asia. Whether it is India, Nepal, Bangladesh, or the rest of SAARC countries, banks are used for political purposes. Government will instruct lending to privity sector – means that lending is directed to areas where the party in power can gain the most. In India it is farmers and businessmen who carry favor and patronage with the political establishment. Bankers are never free to make sound business decisions. In Nepal, political interference results in loans which otherwise never be given. So why blame the US alone.

When next time you think about what caused the monetary crises – remember banking and finance is by far one of the most regulated, centralized sectors of all governments. It is not lack of controls but the regulation and the interference which caused the crises.