In Capitalism Without Romance, Jeffrey Friedman provides both the best explanation for the financial meltdown I have seen yet and one of the most compelling cases for competitive capitalism that I have ever read, all in one short article.
The article explains how capitalism is completely misunderstood by liberals and conservatives alike and why the current economic situation poses fundamental risk to our economic future unless we get the story of capitalism right.
Friedman explains how with all good intentions, bank regulators passed an obscure new financial regulation in 2001 that strongly encouraged banks to favor mortgage backed security over other types of assets, thus concentrating systemic risk and creating an unsustainable bubble in those derivatives.
He goes on to dispel the myths that capitalism is about the magic of the market, the invisible hand, self interest, greed or all the other fallacies associated with it by liberals and conservatives alike. Fundamentally, capitalism is about the competition among ideas. No matter what motivates them, the market ends up forcing economic actors to compete with the best ideas and the best ideals in their fields, or be left behind.
The problem with socialism, corporatism or over regulated markets of all kinds is that competition gets lost, ideas don’t face pressure from competitive alternatives and the dictates of a powerful few end up putting entire systems at risk, as happened with the recent global financial crisis.
Its hard to convince a regulator, politician or CEO of a monopolistic enterprise that while their ideas may be good ones, there’s also a possibility that they aren’t the best solution and maybe we shouldn’t be putting huge systems under their control with no competetive alternatives. The temptations of concentrated power are too great.
The reason Silicon Valley is so successful is the intense competition, the relatively unregulated market for the products and services it produces, and the high tolerance for risk and failure that attracts and concentrates the best people, the best ideas and the best resources. People and ideas are experimenting and competing intensely and the constant churn of what Schumpeter called the “creative destruction” of capitalism assures that only the best ideas succeed.
The way things are done in Washington is quite another story. Folks in Washington don’t favor real competition. But if they realized that their proper economic role should be assuring a fertile environment for competition to thrive, perhaps politicians and regulators would better understand that the stifling nature of their dictates are fundamentally contrary to their intended goals of a strong and vibrant economy.
The old cliche is true, capitalism is the worst possible economic model in the world – except all the other ones.
Hopefully the path won’t be too painful as our governing leaders relearn the failures of socialism. Hopefully in the not too distant future we will elect leaders who will set aside naive and unattainable notions of equality of good outcomes and instead embrace the equality of opportunity. History has proven that most critical factor to social and economic progress is the real and fair competition among ideas – the real definition of capitalism.