The Economist: Capitalism at Bay during the Financial Crisis

When Scottish businessman James WilsonJames Wilson founded The Economist 165 years ago, it was on the premise that the solution to the problems of “uncertainty and insecurity” that beset capitalism was economic liberty.

In its editorial dated October 16, the mouthpiece of capitalism expresses concern that “economic liberty is under attack and capitalism, the system which embodies it, is at bay.” Britain has nationalized much of its banking industry and the American government has promised to put $250 billion into its banks. Other governments are re-regulating their financial systems. After all the chaos caused by lack of regulation and financial discipline, the state is assuming a bigger role in controlling the private sector.

As may be expected, The Economist opposes the command economy. It claims that over the past 50 years “capitalism has proved its worth for billions of people. The parts of the world where it has flourished have prospered; the parts where it has shrivelled have suffered.” Crises are a part of capitalism. The world should “learn how to manage it better”.

In the short term defending capitalism means, paradoxically, state intervention. “The global bail-out is pragmatic, not ideological. If confidence and credit continue to dry up, a near-certain recession will become a depression, a calamity for everybody.”

The Economist believes that the line between governments and markets will in the short term move towards the former. The public sector and its debt will take up a bigger portion of the economy in many countries. But in the longer term a lot depends on how blame for this catastrophe is allocated. This is where an important intellectual battle could and should be won. Capitalism’s defenders need to deal with two sorts of criticism.

The weaker, populist argument that Anglo-Saxon capitalism has failed may have entered the minds of policy makers from Beijing to Berlin. Arguments for market solutions in, for instance, health and education will be made with less conviction, and dismissed.

The Economist claims that “far from failing, the overall lowering of barriers over the past 25 years has delivered wealth and freedom on a dramatic scale. “Hundreds of millions of people have been dragged out of absolute poverty…The free movement of non-financial goods and services should not be dragged into the argument—as they were, to disastrous effect, in the 1930s.”

The Economist accepts the arguments of those analysts who oppose deregulation in finance, but it does not favor the regulation of the economy as a whole. “This case has much more merit. Finance needs regulation.”

The real problem was that some banks “seemed to assume that markets would be constantly liquid. Risky behaviour garnered huge rewards; caution was punished. Even the best bankers took crazy risks.”

Yet the failures of modern finance cannot be blamed on deregulation alone. The macro economic condition that set up the crisis stemmed in part from policy choices: the Federal Reserve ignored the housing bubble and kept short-term interest rates too low for too long. “The emerging world’s determination to accumulate reserves, especially China’s decision to hold down its exchange rate, sent a wash of capital into America. There was something of a perfect storm in which policy mistakes combined with Wall Street’s excesses.”

Besides, heavy regulation would not inoculate the world against future crises. In Japan and South Korea crises occurred in heavily regulated systems. “What’s needed is not more government but better government.”

Indeed, history suggests that a prejudice against more rules is a good idea. Too often they have unintended consequences, helping to create the next disaster. And capitalism, eventually, corrects itself

Sadly, says The Economist, another lesson of history is that in politics economic reason does not always prevail—especially when the best-case scenario for most countries is a short recession.

Also, if the bail-outs are well handled, taxpayers could end up profiting from their reluctant investment in the banks. If regulators learn from this crisis, they could manage finance better in the future. “Capitalism is at bay, but those who believe in it must fight for it. For all its flaws, it is the best economic system man has invented yet.”