Bound at Last?

Laissez-faire Capitalism and Globalization

By
Capitalism
Bound at Last? : Laissez-faire Capitalism and Globalization - Henrique Schneider

Abstract

Often, an unrestrained capitalism in association with globalization is blamed for causing the actual financial crisis. In this article, after a historical overview on the emergence and development of the term “Laissez-faire Capitalism,” the question of the truthfulness of the above assertion is examined. Although laissez-faire capitalism does not oppose globalization, it does not endorse the process of the last two decades. While laissez-faire capitalism champions economic freedoms and deregulated markets, it also stresses the aspect of accountability: the possibility of failure itself is essential for assessing risks. Globalization on the other hand made not only markets and players global, but also regulations and regulators, and thus constrained economic freedom. In particular, globalization played a significant role in diminishing accountability for the decisions of actors in the market.

Introduction

As newspapers, politicians and economists write obituaries for laissez-faire capitalism, globalization is being buried with it. Many blame the actual financial and economic crisis on an “unconstrained” globalization of free markets. At the same time, these critics link the global integration to laissez-faire capitalism. Their conclusion seems clear: the current crisis has allegedly proved globalization bad, thereby also proving laissez-faire capitalism wrong and morally unacceptable.

The main intention here is not to proclaim capitalism’s death, but rather to cast doubt on two commonly held notions: that laissez-faire capitalism and globalization are actually linked, and that laissez-faire capitalism lies at the root of the current financial crisis.

Surveying the development of laissez-faire capitalism and how its definition has been adopted and modernized over time could provide essential insights in order to answer the first question. The second will be analyzed by exploring if a basic claim is true: that laissez-faire capitalism is to blame for exploiting (rationally, perhaps) flaws in the global system, but it bears no responsibility for bringing about the crisis to begin with. The World Trade Organization (WTO) and the current financial crisis will exemplify the validity of this claim.

Without giving any definite answers, the following article hints that although globalization is intertwined with capitalism, its specific and actual form lacks some crucial characteristics of laissez-faire. As governments and regulating institutions joined the global integration to become big players, globalization expanded at least the scale, if not the scope, of possible mistakes that gubernatorial agents could make, thus working as a catalyst for the market turmoil of the past years.

Laissez-faire, from Marginalization to Dominance

1.1 Laissez-faire, MorbLeu! Laissez-faire!

“Laissez faire, telle devrait être la devise de toute puissance publique, depuis que le monde est civilisé…. Détestable principe que celui de ne vouloir grandir que par l’abaissement de nos voisins! Il n’y a que la méchanceté et la malignité du cœur de satisfaites dans ce principe, et l’intérêt y est opposé. Laissez faire, morbleu! Laissez faire! ”[1]

[“Let they do, that should be the motto of every public authority, according to which the world is civilized. . . . A detestable principle that which would not wish us to grow except by lowering our neighbors! There is nothing but mischief and malignity of heart in those satisfied with that principle, and interest is opposed to it. Let them do, damn it! Let them do!”]

The exact origin of the term laissez-faire as a slogan for economic liberalism (or a certain shape of capitalism) is uncertain. The first recorded use of the laissez-faire maxim was by the French foreign minister René de Voyer, who championed free trade, in the abovementioned statement. The term “laissez-faire” can be traced back to 1680, when the French finance minister Jean-Baptiste Colbert held a meeting with French business representatives, led by a Mr. Christophe de Le Gendre. The minister, who himself developed theories on monopolies and oligopolies, asked the merchants what he could do in order to ease their ado. Mr. Le Gendre then replied “Laissez-nous faire” (Let us do). Later on, around 1760, a French inspector of trade, Vincent de Gounrnay, appropriated the motto and made it part of his doctrine.

Let us not forget however, that even mercantilists were—by some standards—proto-state-capitalists. Of course, it was not until the works of Adam Smith, David Ricardo, John Stuart Mill, and Jean-Baptiste Say that capitalism emerged as a set of new theories about actions, ownership and markets. Capitalism refers to an economic system characterized by private or corporate ownership of capital and goods. Investment is determined by private decisions while prices, production and the distribution of goods are caused mainly by competition in a free market.

These were mainly technical aspects on how to organize economies, but political aspects soon joined the science. Capitalism (or classical political economy), as other doctrines concerning the organization of markets, is not free from values or moral views. As much as it proposes the freedom of markets and individual actions therein, it rapidly associated itself with political liberalism, which advocates the broader freedom of individuals in society. Both classical political economy and political liberalism were in favor of constraining the role played by the government. On the other hand neither aimed at totally expelling government of all realms of social relations. [2] On the contrary, classical economic and liberal thinkers assigned the government pro-active tasks, like encouraging innovation, guaranteeing patents and intellectual property and providing basic goods such as building roads and schools, as well as administering education. Of course, the discourse went on as to how to pay for these services (tolls, progressively to the income, free provision, etc.), but there seemed to be no doubt on the government’s role.

Two main questions remained at the centre of the free-market advocates’ discourse: to what extent were markets able to regulate themselves? Moreover, who should be allowed to participate in the system? Stable markets were considered the aim of all economic development; any kind of instability, such as unemployment or capital overflows, ought to be dealt with immediately. Classical capitalism took it more or less for granted that the state would be able to participate in markets and also, if needed, to leverage them. The reason for these assumptions was twofold: First, it was quite clear that the state would not retreat from its influence over its society. Second, the classical economist, influenced by enlightened ideas, thought the state to be an impartial agent caring for the overall wellbeing of the society.

Early laissez-faire capitalism, on the other hand, dismissed this belief. Recognizing the state to be as partial as every other agent, laissez-faire thinkers advocated for as little regulation as possible, claiming that markets are always able to leverage and stabilize themselves on their own. As the idea of capitalism merged with the political system of liberalism, the inner-systemic debate about what laissez-faire capitalism is, or how far it is able to go, coined a discourse of its own. Laissez-faire capitalism henceforth not only criticized mercantilism, but also classical capitalism, adventuring beyond the scope of the original ideas of Adam Smith and David Ricardo.

The laissez-faire claim of intrinsic stability of markets grounds on two models: first, in a long-run analysis of the amounts of supplied and demanded goods, which are the same at a given price; and second, in the direct abstraction from the micro level (small scale markets) to a macro level (encompassing all markets). As a baker only makes the amount of bread being sold in one day at a given price, all markets do the same—at least in the long run. Since all agents can be said to act on average in a rational way, markets always settle in equilibrium.

Throughout the history of capitalistic thinking, proponents of laissez-faire were often marginalized in the political debate. Indeed, until after World War II it played a secondary role in politics and was championed only by the Vienna Circle (Friedrich Hayek and Ludwig von Mises). Although this marginalization came to a sudden end, the question concerning the inherent stability of markets has remained unsolved. [3]

1.2 rebirth and rise

A much more pressing matter however, seems to be what laissez-faire capitalism is today. The answer is more complicated than what one might expect. In the 1980’s, the rise of Ronald Reagan and Margaret Thatcher was tantamount to the rebirth of laissez-faire. Both “tried to overthrow the big government interventionist Capitalism that they inherited.” [4] The government was now to play a minimal role in the market economy, and development left to the “natural laws of the market.”

Note that the last assertion is in itself a twofold claim—being both a political as well as a scientific one. Nevertheless, the political point can only be true with the scientific foundation at its heart. The term “natural laws of the market” stems in fact from a different context altogether. This type of expression relies on a physical conception of the world, and was shared by the Vienna Circle, a group of positivistic philosophers believing only in mathematical-physical truths. For them, science was a quest for the natural laws governing the world. It was through this group that the physical ideas spread on to the economics of the Austrian School and laissez-faire capitalism. As time went by, these “laws” were adapted and modified, acquiring certain robustness until they reached the form of social-scientific models as we see them today.[5]

Personal interest and competition are here the fundamental forces driving rational individuals to achieve social welfare while at the same time pursuing their own interests. Private property and freedom are the institutional prerequisites safeguarding the development of these personal interests and therefore, the role of the government has to be limited to the protection and reinforcement of private property and market freedom. Rational individuals seeking their own interests and competing against one another will thus ultimately lead to stability in the economy.

Any absence of this stability is a result of the government’s failure in providing or ensuring private property and market freedom. This is a two-way argument, as the government can fail in not doing enough, but fail if it does too much. Many of the problems of the so-called welfare state arise from the over-activity of the gubernatorial body, thus constraining freedom or diminishing its utility.

Unemployment serves as an example. Under laissez-faire theories, unemployment is voluntary, because rational individuals prefer leisure to the “disutility” of work. By providing social security, the state is instigating individuals to work less. As governments pay people not to work, rational agents will try to use the incentive of leisure as long as they can. By constraining the freedom to decide, states urge individuals to pursue their interests at the expense of the common body.

There is still a missing step however, in the development from Vienna’s laissez-faire capitalism to Thatcher and Reagan’s version. This link is the work of Milton Friedman and the foundation of modern laissez-faire. Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists, and modernized them in his own peculiar way. One example is an article he wrote for the September 1970 issue of The New York Times Magazine where he claimed that the social responsibility of businesses is “to use its resources and engage in activities designed to increase its profit [… through] open and free competition without deception or fraud.”[6] This is equivalent to Smith’s argument that self-interest in turn benefits the whole of society. Yet in sharp contrast to Smith, Milton based his claim on microeconomic principles as advocated by the Vienna Circle.[7]

Friedman’s academic work, coupled with its implementation by Reagan, Thatcher and Clinton, led to the new ascension of laissez-faire capitalism. According to this “modern” laissez-faire capitalism, markets are inherently stable if left to themselves. Depressions, recessions and other challenges result only from government intervention. The laissez-faire economists see capitalists as earning profits by forgoing current consumption, taking risks, and organizing production. On this account, capitalists need market freedom to operate. And as they act according to their own best judgment, they become responsible for the outcome of their actions. Only then will markets be able to provide stability.

Freedom—market freedom—longs to be absolute, even worldwide. Along this logic, free-marketers want to expand their ideas beyond the boundaries of nations. They engage in the dissemination of global laissez-faire, with globalization perceived as the adequate vehicle to do so. However, is it really so?

Globalization: Its Friends And Its Enemies

Globalization is widely attributed to laissez-faire capitalism. This is because its implementation occurred simultaneously with the enormous growth in international exchange markets and, correspondingly, of international corporations, which sometimes have greater resources at their command than nation states.

Globalization is certainly a process no laissez-faire economist will oppose. However, he will have strong objections concerning some of the actual features of globalization. Among the criticism, two pole-positions emerge: First, globalization itself should be a process in which free-willed agents act upon their best judgment. This implies that there is no need to impose globalization. If the process of freeing worldwide markets is desirable, the markets themselves will adhere to it. Second, if rules are needed at all, they will be made by the market and should not be stated ex-ante. Globalization as we find it today can be criticized along these lines, because it is not based on such freedom and because it is foremost a worldwide integration of regulations and regulators. While it may be capitalistic, it certainly is not a free market approach.

2.1 the Laissez-faire Critique

From a laissez-faire perspective, there are some additional critiques of globalization based on the general logic of the last paragraph. They address primarily international treaties, the so-called intellectual property rights, and the functioning of international agencies and organizations.

To start with, several international treaties seem to serve mainly as insurance policies for specific interests of multinational corporations and other worldwide oligopolies. The WTO, among other organizations, may open segments of certain markets, but at the same time it closes others. In addition, different national regulations still impose considerable barriers to free markets. For example, access to agriculture in Europe or investments in infrastructure in the US still remain restricted. In China and Israel, pharmaceutical, chemical and energy industries, as well as telecommunications remain state run or state planned areas. These barriers
are often sustained by WTO regulations.

Consider the beginning of the WTO, such as the Cancun and Doha conferences, where highly developed countries advocated an aggressive, three-pronged agenda: to foist a stricter system of investment rules on developing nations (including patent and copyright enforcements), to extend European-style environmental and labor regulations to poorer nations (the so-called welfare state), and to reduce restrictions on exports and foreign investment to poorer nations. What was missing was the good will of countries to make a change in their own policies, which—especially for Europe—are more or less openly protectionist.[8]

Trade is invariably part of the WTO agenda, but completely free trade, as understood by laissez-faire, is not part of it. A claim could be made that from the start, the WTO was based on the urgency of industrialized nations to find markets for their products. This would allow for the reverse conclusion: if the developed regions of the world were searching for markets, globalization was a tool to find them, and not one for freeing them. Deregulating presupposes that poorer and emerging nations might have something to sell that consumers in rich nations might want to buy. Nonetheless, there was no deregulation on the horizon.

Again, the WTO was from the start overly concerned about regulating intellectual property rights and tracking countries, which did not respect these laws. This became a high priority, whereas free trade in agricultural goods was pushed off the table completely. Even as some ministers and experts from emerging and developing countries tried to usher their demands, ministers from Europe and the US responded by telling poorer nations that they should regulate their economies more heavily.

Furthermore, liberalized markets in the developed world cracked down on alleged copyright and patent abuses in developing countries, raised wages so that workers could not “unfairly” compete with those from industrialized nations, and started enforcing stricter environmental laws.

From a laissez-faire point of view, this is extremely problematic. According to classical microeconomics, poor or emerging countries will only be able to succeed in free trade if they are free to use their comparative advantage. Agents usually offer what they do best when compared to the other choices they have (and not compared to all other agents).

The comparative advantage that poor nations have in attracting investment and producing their own goods for export is precisely their unregulated labor and environmental regimes. Given that their objective is to become more competitive, it would make little sense to legislate higher wages. This would only drive out capital and lead to more unemployment. If they stand a chance for development, what is needed is an open marketplace where they are free to compete by using their comparative advantage.

This shows quite clearly how laissez-faire capitalism approaches globalization. Based on market freedom, it locates individual property rights to the micro level. The WTO—as an example of globalization—disrespects the first and infringes the second. There is however, another problem with globalization, discussed in the following section.

2.2 GLobaLization of internationaL reGuLations

Laissez-faire capitalism is not just about the global expansion of markets, but also advocates the deregulation of them. The true aim of laissez-faire is to enforce economic freedom for all agents in the market.[9] Note specifically that “deregulation” is used in a positive sense. Whatever results from the market-ing process, it is at that certain point of time the optimal output of regulation under the constraint of the involved agents. There is no normative claim to this. Laissez-faire capitalism, at least at this stage, remains agnostic of the equilibrium’s moral qualities.

Of course, this model only works if private property is respected and market freedom ensured. Globalization through the last two decades did not advance accordingly. National and international agencies or governments took over the responsibility for regulating world markets rather than freeing them up.

Regarding the current financial crisis, laissez-faire capitalists will point out that market failures occurred because of government regulations and not the contrary; in the aftermath, fiscal packages, bailouts and stimuli only helped to aggravate the scope and intensity of the turmoil. Why was this so? The regulation of part rather than all aspects of the financial markets caused an increase in the demand for unregulated, adventurous instruments, because investors had the—correct—impression that regulation diminishes revenues.

This phenomenon is explicably due to the socialization of the investor as taxpayers. As taxes have to be paid because of laws, diminishing the investor’s wealth and profit, law and loss become associated with one another. Surely, the supply side offered what demand wanted, losing itself in extremely complicated financial products. Note however, that the products themselves took advantage of often misled central bank policies throughout the world. As central banks printed money, adapted modified the interest rates, or changed the reserve policies, the financial markets adapted to them.

Furthermore, since investors and suppliers of financial products are used to regulations, many attached the character of regulating actors to the rating agencies. As long as investment products were positively rated, the market thought they would remain secure. Because the state institutions kept silent about their relationship to rating agencies, many then interpreted this as an implicit endorsement of their judgments.

The most important mistake of the state institutions however, was to try to “save the world” from a financial crisis. In the best of intents, interest rates were lowered, fiscal stimuli were granted, tax rebates were given, and bailouts were pursued. But these measures are nothing but pure poison to markets, since all the instruments used merely rewarded the investors who had been assessing their risks poorly. They infringed the models of interest and competence because they socialized risk and dictated who should be saved and who should not.

Implementing aggressive stimuli-oriented policies also led to extreme long-run risks. For example, the risk of inflation due to drastic interest-rate cuts; a loss of efficiency and profitability in global banking due to new regulations, a possible bond bubble, the jeopardizing of budgets because of overspending and future interests having to be paid, the creation of a liquidity trap in worldwide markets, and the crowding out of private investment.

Not only the risks but also the failures are then socialized. This caused investors to assess their risks even more poorly through relying on the distribution of burden to all other agents. By rewarding the losers through socialization of their failures, the state educated them to become greedy—or even greedier than they were. Once again, the state proved that it lacks the capability of preventing economic crisis, let alone the capacity to remediate them.

Laissez-faire capitalism claims that the state is neither the benevolent dictator nor the impartial umpire. The state itself acts as self-interested and self-centered as the other market players, dealing with the same constraints, the same imperfect information and the same risks as all the others. Nevertheless, the state has two peculiar traits that make it a much worse agent compared to the others: it sets the law and cannot fail, thus escaping the limiting market forces.

Failing means being punished by customers or by suppliers, or worse still, by going bankrupt. The state however is not accountable for its mistakes. This causes it to become much more eager to commit mistakes, take oversized risks, and act without measuring the means and the ends of its actions. Lack of accountability is the primary error in state-driven capitalism. It is also the primary error of reasoning for all who think that regulation or legislation will ease the development of the worldwide markets. On the other hand, since international regulators are not accountable—in market terms—they just add to, or perhaps aggravate, the problems of the national bodies. Concerning those who urge for new and heavier regulation, two insights seem interesting. Firstly, more regulation is not a self-evident cure to the disease, and second, after each single crisis, when more regulation was enforced, this did not prevent new turmoil to occur nor did it soften the bad consequences.

The reasoning suggests a conclusion: international regulation, subdued competition and distortion of market forces are chiefly responsible for the actual economic crisis. It was not too much laissez-faire or globalization that caused the financial crisis. On the contrary, it was caused by worldwide regulation without market freedom. Is laissez-faire then free from all sins? Many of the self-proclaimed advocates of free trade use regulated globalization in order to pursue their own interests. The thinking is simple: according to the microeconomic “laws” that laissez-faire capitalism bases itself upon, free-traders endorsing worldwide regulation act perfectly rationally. In the name of their personal interests, they see their chance in constrained markets. Unfortunately, the voice for competition is then kept silent.

Bound at Last?

In this article, two questions have been pondered. The first one asks if laissez-faire capitalism and globalization are linked, while the second questions if laissez-faire and globalization necessarily lie at the root of the actual economic crisis.

In order to discuss these questions, the article first tried to show through a historical perspective that most common held notions of what laissez-faire capitalism actually is may be misguided. Laissez-faire capitalism certainly favors the worldwide expansion of markets. But it also believes that markets should be able to operate freely throughout the world, opposing thus a certain type of regulated globalization. This again means that the different market players should have the possibility to decide on their own if they want to open their markets. Second, every agent should be able to play by the same rules. All protectionist regulations will impose unacceptable barriers to free trade. Third, according to laissez-faire capitalism, free markets—not regulating bodies—should be globalized. As a conclusion to the first question then, the answer is yes; laissez-faire capitalism advocates globalization, but not the one the world is confronted with.

Concerning the second question, globalization is perhaps the catalyst of today’s crisis, but it was the lack of market freedoms that caused the actual crisis. The globalization of regulating systems is one major driver of global downturn. Moreover, supposing governmental agencies, national or international, are more suitable, informed agents is a crucial mistake. Laissez-faire economists can be blamed for adapting too quickly to the international system of state-capitalism, for calling on central bank intervention and for speculating on the system. In sum,
they can be blamed for forgetting a most important feature of laissez-faire: to always be responsible for one’s mistakes.

Is there a future for laissez-faire? Or are we bound to the new surge of state-capitalism? Economic nationalism—the urge to keep jobs and capital at home—is the ugly face of sate-capitalism and is not resurrecting; it is alive and en vogue. It is both turning the economic crisis into a political one and threatening the world with depression. Its consequences may be dire.

Most measures implemented in order to stem the crisis may actually worsen the crisis by creating more government intervention (which sparked it to begin with) and removing the accountability of those who over-played their risks by socializing the burden. Furthermore, these stimuli packages are instigating market players to enter even bigger risks, because they can count on guaranteed protection.

Perhaps world politics is marching in the direction of state-capitalism and economic nationalism. When individuals and enterprises called for more government oversight on financial markets, looming in the dark, some agents hoped for market restrictions in imports, and subsidies for exports.

Is there a way out of the crisis? Laissez-faire capitalism would suggest that there is only one way: state governments must guarantee free markets and private property, including the possibility of losing out to the markets. This has to be done in order to ease the decision making process of self-interested agents in healthy competition with each other. Is it this simple though? Yes. However, it seems to be simpler to regulate than to stand the temptation of state capitalism. Laissez-faire makes the case for individual responsibility in worldwide markets that are free at last.

Notes & References

  1. Peter Saunders, Capitalism (Minneapolis: University of Minnesota Press, 1995) p. 17.
  2. Friedrich Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960) pp. 43–56.
  3. The controversial discussion of Laissez-faire’s assumptions and undermining principles is still ongoing. For its defence refer to Arthus Sullivan and Steven Sheffrin, Economics: principles in action (Upper Saddle River: Pearson Prentince Hall, 2003); for its criticism to Carin Lee Holroyd, Government, International Trade, and Laissez-faire Capitalism (New York: McGill Queens University Press, 2002).
  4. Hymam Minsky, “Finance and Stability: The Limits of Capitalism,” The Jerome Levy Economics Institute of Bard College, Working Paper No. 93 (May 1999): p. 7.
  5. Today, instead this physicalist terminology, social science prefers models with law-likeliness. David Kreps, A Course in Microeconomic Theory (Princeton: Princeton University Press, 1990) pp. 1–5.
  6. Milton Friedman, “The Social Responsibility of Business is to Increase its Profits” The New York Times Magazine 13 September 13, 1970 retrieved 18 February 18 2009“http://www.colorado.edu/studentgroups/libertarians/issues/friedman-soc-resp-business.html.
  7. Ibid.
  8. Jagdish Bhagwati, In Defense of Globalization. (Oxford: Oxford University Press, 2005) p. 98. Jagdish Bhagwati, “Reshaping the WTO”, Far Eastern Economic Review 162 No. 22 (January 2005): pp. 25–30.
  9. This does not necessarily entail political freedom. There are countries like South Korea and Taiwan, which started as a capitalistic economy under political dictatorship and developed towards Capitalism and Democracy. Others are free markets without democratic structures, like Singapore, Hong Kong and Malaysia with de jure capitalism, and China with de facto free markets. However, some profoundly democratic societies, like the Bolivarian Republic of Venezuela and Anarchist Catalonia have been expressly anti-capitalist.
Henrique Schneider is a Vienna-based consultant working on economic and geostrategic issues. He is particularly interested in the Far East, Central Asia, the Caucasus, and the Balkans. He has studied economics, philosophy, and history in Switzerland, Germany, the US, and China. He also served as a professor in China and Switzerland before moving to Vienna to pursue international consulting.