The Hindu Business Line : Policing capitalism

As never before in recent times, capitalism is under fire – with the one big difference that there is no challenging ideology, socialism having been disposed of almost two decades ago with the collapse of the Soviet Union. Communist China is as capitalist as they come, salvaging whatever little pride it can by calling itself a People’s Republic.

The test of an economic doctrine is if it enhances living standards, especially of those in the bottom rungs of the income and social scale. In this respect, capitalism has been a thundering success. Russia, East Europe and China have seen an explosion in growth, lifting many of their citizens into affluence comparable to the US and West Europe.

In purchasing power parity terms, China is not so far behind the rich countries in per capita income.

Despite the current global crisis, few, therefore, would dispute that capitalism is the way to go.

The search is for ‘capitalism with a human face’ (or as some Britons put it, ‘compassionate conservatism’). Is it a realistic hope? What are we actually looking for? Ethical capitalists? Effectively regulated capitalism? Very important questions whose answers will shape the future of economic activity and society.

Ethical capitalism is a contradiction in terms. When buyers and sellers meet in a free marketplace, both want to transact at the best prices for them individually.

Transactions in free markets are only apparently between equals. Inevitably, in many situations, the seller has more information than the buyer.

George Akerlof, the Nobel Prize winning economist, dramatised this point with the analogy of the used car market, in which the seller has definitively more information than potential buyers. Shorn of a lot of high-flown theory, the conclusion is that outcomes in free markets may not be optimal, leave alone fair. Markets could even breakdown, if buyers perceive the cost and risk of their disadvantage to be too high.

The macro-economic costs of sellers deceiving buyers in the vast majority of product and service markets are low. However, financial markets are different.

Everyone knows equities are risky (although many may object to investment bankers knowingly selling ‘lemons’ to unwary investors). But what about debt? It is generally supposed to be safe, especially if backed by credit ratings. That has now been given the go-by, with ostensibly ‘AAA’-rated securities turning out to be no better than junk.

Collapse of regulation

The origin of the present crash is more because of the collapse of regulation and self-regulation, with the world’s major central banks, especially the US Fed being the culprits. Risk management was thrown to the winds in the mindless search for profits and bonuses.

The world’s big banks, insurance companies and hedge funds got caught up in their own game.

Ethical capitalism? Forget it. It doesn’t exist and can’t be created.

The issue is if we can devise a regulatory system that spots potential crooks, fraudulent financial schemes and risky financial products and institutions early enough.

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