Monday, April 6, 2009

Economics: Beware of Fundamentalism

TORONTO, ONTARIO - Pretty much everyone agrees that the main flaw of communism is that it did not account for human nature, that human beings are fundamentally self-centered and greedy. While communism might work quite efficiently on paper, in practice, individuals do not necessarily do what they are told society needs them to do, withholding resources for the their own use or not doing assigned work, and those assigned to make decisions for the society could become especially corrupt in assigning resources to their own friends and family rather than what would actually most benefit the society as a whole.

Proponents of capitalism have long claimed that their system was superior precisely because it was centered around self-interest. In a market environment, people would have to act in their own self-interest and be greedy, resulting in innovation, and this would lead to advances that would result in economic growth and the advancement of society. Thus, there is a supreme irony that what has occurred that is making some people question the veracity of capitalism now is that it didn't properly account for human nature. In the absence of regulation, people withheld information and over-sold various financial instruments, leading to a distortion of the market, and the very greed that made communism unworkable and was supposed to make capitalism work instead led to a global financial crisis.

Of course, this doesn't mean that capitalism is fundamentally flawed and needs to be abandoned for something else (and I'm still waiting for a serious suggestion for those making such claims as to what exactly would replace it). Instead, it points out that the real enemy here amounts to fundamentalism--those that believed so strongly in the core beliefs of free-market capitalism that they were blinded to the realities around them. They believed so strongly in eliminating regulation to create a free market that they did not realize that the lack of regulation had actually resulted in a market that was far from free. In order for a market to function properly, there has to be accurate information about what is being sold at what price so that the purchasers can make a decision that is in their self-interest. Some will buy cheaper products of lower quality, while others will buy more expensive products of higher quality, but nobody should buy more expensive products of lower quality; the market should force the prices on those products to lower, or if there is constricted supply and these products are necessary to meet overall demand, then the prices of the higher-quality products should rise higher than the lower-quality products.

What the fundamentalist needs to understand is that when human beings are involved, the establishment and maintenance of a truly free market actually requires regulation. If not for regulation, people will be greedy and withhold or distort information--pretending that bundled sub-prime mortgages, for example, were of no more risk than normal mortgages, or that milk was really pure when it was actually contaminated. Proper regulations--not regulations that constrict the market, but those that make it transparent and reliable--actually make markets more efficient and allow them to do what they are supposed to do.

Fundamentalists refused to believe that human beings would destroy communism, so sure enough it was destroyed. Fundamentalists are now refusing to believe that lack of regulation contributed to the current financial crisis and are calling for further deregulation. If allowed to prevail, capitalism might face a similar fate as communism--but fortunately they don't appear to be prevailing.

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