The problem started in the United States of America where, propelled by sheer greed, financial institutions made loans to people to purchase homes without due regard to the financial circumstances of such people. The loan transactions were implemented through sophisticated but dubious arrangements involving major commercial banks, investment banks, specialized financial institutions and big insurance companies. Millions of people acquired homes whose costs were way beyond their economic situations.
In the beginning those in the chain of lenders made huge profits and the real estate business became the fastest growing industry. Financial institutions from Europe and elsewhere jumped on what can only be called “the American greed train”. However, after a few years, homeowners could no longer afford their monthly loan repayments. Since repayments constitute the foundation on which the sophisticated financial arrangements were built, the system weakened as repayments dwindled. It finally collapsed as many of the institutions in the lending chain became insolvent and their financial engineering prowess could not save them. Some of them went bankrupt, others were bought over, and various governments are stepping in to salvage the situation to avoid the total collapse of the entire economy. What we are witnessing is the price of financial greed.
Some questions arise: Where were the various governments when greed was flourishing and unsustainable financial transactions were been aggressively promoted? What in any case should be the proper role of governments in managing the economy? Does the current global crisis indicate that the market economy (the so-called capitalist system) has failed?
The principles underlying the market economy are sound. The problem is not with the market economy as such; it is with the fact that the market economy has for long operated in a moral and ethical vacuum. The present global crisis has arisen primarily because the moral and ethical foundation of the market economy has been undermined; restore the ethical foundation into the market economy and you will have a prosperous and sustainable economy. Adam Smith in his 1776 seminal book entitled “The Wealth of Nations” defined a limited role for the government, leaving everything else to individual citizens and groups of individual citizens. Specifically, he identified three duties of government: first, government has the responsibility to defend the territorial integrity of the society; second, government should ensure liberty for all, and maintain law and order within society; and third, government should provide such infrastructure that cannot be profitably erected and maintained by an individual or a small group of individuals. In short, governments have no business doing business! Surely, experience has taught us this; think about NITEL and MTEL in relation to the new privately owned GSM telecommunications companies.
The principle of the market economy is quite simple and eminently sensible. It is the idea that if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. No exchange would take place if one or both parties stand to lose. Thus, if all economic activities are based on voluntary exchanges, all the participants in the economy will benefit. In Adam Smith’s conception, the market economy operates in a free society, a society of “perfect liberty” (his words) in which each person is free to work for his/her self-interests as he/she perceives them. He was convinced that the natural behaviour of free people was the best way to ensure that goods and services were produced in adequate quantity and quality and distributed in the most efficient manner.
What is almost invariably missing in the discussion and application of Adam Smith’s conception of the market economy are the conditions he took for granted. A quite obvious condition is that buyer and seller must have alternatives. If there is only one food producer in the town, the person who needs food must buy at the price dictated by the producer or starve to death. Thus, Adam Smith would consider it foolish to speak of market forces or “the invisible hand” where genuine competition is lacking. Related to this is the need for buyer and seller to have a level playing field for negotiation. It follows that the true market economy has to have a regulatory mechanism which ensures that items being exchanged are what they are purported to be and that everyone is able to receive the right amounts of rewards in both quantity and quality for every effort invested, not less and not more.
The market economy moreover presupposes a society of “perfect liberty”, in which people must be free to pursue their legitimate self-interest and in doing so they must not interfere with the right of others to pursue their own self-interest. There must, therefore, be mechanisms in place to ensure that individuals, as they exercise their Free Will, do not interfere with the right of others to exercise their own Free Will. This is to say that there is a definite role for the government in the market economy; the legislative and executive branches making and enforcing laws to protect the integrity of the system (competitiveness, individual freedom of action, fair rewards, transparent operations including honest accounting, etc.) and the judicial branch adjudicating. Therefore, the market economy should be characterized more by right regulation than by deregulation. Capitalist countries such as the United States have hitherto overemphasized deregulation at the expense of right regulation. Most governments have been guilty of not putting in place appropriate regulations or have not effectively enforced existing ones for various (often political) reasons. Thus, what they have practised cannot be rightly described as the market economy! It is anarchic economy, which must come to ruin, and is coming to ruin.
Another implicit assumption of Adam Smith was that in seeking their self-interest people would behave ethically and with conscience. With respect to the ethical factor, it should be noted that Adam Smith was a Professor of Moral Philosophy at the University of Glasgow. In those days and for a long time, the subject of economics was seen as something like a branch of ethics. He published a revised version of his famous book entitled The Theory of Moral Sentiments in 1790, about 14 years after his landmark treatise on the market economy. Adam Smith never supposed that human beings are driven solely by self-interest in a material sense but presumed that for most people “self-interest” would include “spiritual interest.” He presumed that they would reckon with the natural law that “whatsoever a man sows that shall he reap”. In other words, Adam Smith took for granted that people would exhibit the values and virtues of Christianity (the predominant religion and cultural influence of his place and his time).
The importance of higher values and virtues in the market economy remains undisputed. Professor Amartya Sen won the 1998 Nobel Prize for Economics in part for bringing ethical considerations into economic analysis. He asserts that a major deficiency of contemporary economic theory arises from interpreting Adam Smith’s view of human beings as being exclusively self-interested in a material sense. This theoretical deficiency in turn leads to bad policy recommendations by economists and a bad name for the market economy.
by Stephen Lampe