Don’t count out the free market

ANALYSIS/OPINION:

“The report of my death was an exaggeration,” Mark Twain wrote amid rumors he was in ill health.

The same can be said about all the dire predictions of the end of free-market capitalism. Like Twain’s mistaken prognosticators, critics of capitalism around the world will be proved wrong as well.

As markets fell late last month, French President Nicolas Sarkozy breathlessly denounced unbridled capitalism, declaring “laissez-faire is finished.” Germany’s finance minister and Russia’s prime minister charged that the financial crisis meant the end of America as a “superpower.”

Not to be outdone by the Europeans, Iranian President Mahmoud Ahmadinejad proclaimed, “It is the end of capitalism.”

Yes, there is comeuppance and Schadenfreude in all this. Bringing America down a notch is a parlor game the world over. But the ideological motive is stronger. Critics of the free-market ideal see an opportunity as promising as 1932 to reverse the march of economic freedom - America’s own “brand of capitalism” - and usher in a golden age of state-run economies and regulated markets.

The problem with this desire is that reality will eventually make a comeback. The hard, cold fact that liberalized markets work better than tightly regulated ones will emerge again. “Life itself will intrude,” as the Russians say. And the world will rediscover that high taxes and stifling regulations slow economic growth and kill jobs.

There is no escaping the fact that the freer the economy, the more it grows and prospers. Year after year, the Index of Economic Freedom co-published by the Wall Street Journal and the Heritage Foundation affirms that higher levels of economic freedom are associated with higher levels of per-capita gross domestic product and faster growth rates. There may be temporary ups and downs, but in the long run, more economic freedom leads to more wealth for more people than any other factor.

Nor can we ignore the fact that it was not the failure of the free market that precipitated the financial crisis; rather, it was a market distorted and manipulated by the state - precisely opposite of what Mr. Sarkozy and other critics charge.

When the federal government heavily subsidized the mortgage securitization market, as it did with Fannie Mae and Freddie Mac, it strongly encouraged bankers to take unnecessary risks. In other words, the government suspended the normal market rules that would otherwise have exposed the risks incurred by all the bad loans.

When the Community Reinvestment Act of 1977 compelled banks to make loans to poor borrowers who could not repay them, it was not doing so in the name of the free market. It was doing so in the name of politics.

Contrary to popular belief, there has been no Era of Deregulation in recent years. Yes, 10 years ago Congress overturned the Glass-Steagall Act that barred banks from engaging in the securities business. But as former President Bill Clinton has pointed out, this change actually stabilized the current crisis by facilitating Bank of America’s purchase of Merrill Lynch.

Why does all this matter? Because if we fall for the myth that the “pure” free market is what collapsed, we will make way for a wave of state controls and regulations that will deepen the recession and likely send the great American economy into permanent decline.

Pressures to do just that are already building internationally. Mr. Sarkozy, like British Prime Minister Gordon Brown, wants an international conference to revamp, or as Mr. Sarkozy puts it, “re-found the capitalist system.” He proposes an international body to regulate financial institutions, eliminate “tax havens” and regulate hedge funds.

The last thing we need is some unaccountable international body distorting markets with risk-reducing subsidies and growth-destroying regulations. As Amity Shlaes explains in her brilliant analysis of the Great Depression, “The Forgotten Man,” unbridled government intervention in the marketplace is what made the Depression “great.” Government-imposed high wages, new trade tariffs, “class taxes” and prosecutions of big industrialists turned a stock-market failure into a full-blown economic catastrophe.

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