Let Entrepreneurs Fix the Problem Government Made

As the financial crisis intensifies, we hear ever more claims that emergency times justify government measures unthinkable a mere 14 months ago. Even some libertarians, who would cry foul if a third world dictator nationalized an industry, are calling for the government to take equity positions in major financial institutions.

Worst of all, an ostensibly conservative Republican administration is seeking to subordinate the capital markets to the whims of one man, Henry Paulson. In this Orwellian climate, genuine free marketeers need to take a deep breath and remember their principles.

Economic theory and historical practice have demonstrated beyond any doubt that decentralized free markets outperform centrally planned economies. Beyond the issues of incentives and corruption, there is the knowledge problem stressed by Friedrich Hayek: it is no use searching for just the right experts to put in charge of running entire industries, because such omniscient people do not exist. Only in an open, competitive marketplace can rival firms discover the cheapest ways to deliver superior products and services to consumers. Businesspeople make mistakes all the time, but the profit-and-loss test weeds out the bad entrepreneurs and allows the successful ones to gain more influence.

Many, if not most, policy analysts would agree that capitalism is a better social arrangement than socialism, and that free markets provide sustained economic growth showering prosperity on all citizens. Yet for some inexplicable reason, many of these same analysts lose all faith in the power of markets during times of crisis. All of a sudden, even many cynical right-wingers – let alone the liberals – believe that 535 people in Washington D.C. know better than legions of financial professionals in New York and Chicago. Yet this is just one of many contradictions in our current crisis.

For example, we are told that the housing boom was caused by cheap credit and lax oversight, where greedy lenders made it too easy for unqualified applicants to receive loans. But at the same time, we are told the limits on Fannie and Freddie, as well as the FDIC, must be relaxed, and that taxpayers must spend $700 billion in order to “unfreeze” the credit markets; that is, to get easy credit flowing to borrowers as it has been in the recent past.

We are told that the government must enact bold measures, lest we relive the Great Depression. Yet at the same time, we are told that the measures we need to take are precisely those adopted by Franklin Roosevelt in the 1930s. Indeed, this is why so many news articles over the last year have included variations of the phrase, “a government power not used since the New Deal.”

Prior to the Great Depression, economic downturns in the United States were relatively quick, typically lasting 18 months or so. The worst was the depression starting in 1893, which lingered four or five years, depending on the economic historian. It was under the New Deal – when the federal government adopted unprecedented measures to prevent business failures and to prop up wages – that a sharp initial downturn endured for a decade. When Roosevelt took office in 1933, unemployment stood at a staggering 24.9 percent. And yet, despite claims that Roosevelt “got us out of the Depression,” the unemployment rate was still 19 percent five years later in 1938.

Poor government policies, including very low-interest rates and efforts to promote mortgages for unqualified applicants, contributed to the housing boom of the mid-2000s. And after the government contributed to the problem, its efforts to fix things are even worse. For example, hundreds of billions in corporate welfare to bail out overleveraged financial institutions will only ensure that they take unwarranted risks in the future as well.

Resources were misallocated during the credit bubble, and the economy needs a period of liquidation before its normal growth can resume. Policy analysts, above all those who claim to support the free market, should tell the government to stop meddling with the correction and instead let private-sector entrepreneurs fix the mess that the politicians made.

Robert P. Murphy is a Senior Fellow in Business and Economic Studies at the California-based Pacific Research Institute and author of The Politically Incorrect Guide to Capitalism (Regnery 2007).

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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