Financial crises and the meltdown of national economies

A free market economy, is the other name for the American brand of capitalism, it is at cross roads for the legitimacy for the economic power because of the global financial crises which have roots in collapsing the investment banks. These banks, during low inflation and low interest rate periods between the years of 2002 and 2007 looked for new ways to make double-digit returns to boost their profits to record highs, through the spliced and diced securities of many entities that are at the heart of current crises.

Consequently, between 2000 and 2007, the credit default for various types of credit derivatives soured from $100 billion to $62 trillion, something unbelievable but a hard ground reality. Concerns were shown by top stakeholders over such a serious development but the protagonists of the free market, “like Greenspan insisted that they played an important role in spreading risk.” The Wall Street believed that risk had to be taken for growth and profitability, the two key elements of free market economies. But, what are the limits in taking risks and earning profits? They need to be defined.

The system was helped by market-friendly politicians notably Ronald Reagan and Margaret Thatcher during 80s and they had their successes. It was further supported throughout in the 90s by deregulation particularly of the financial system. One of its high points was separation of commercial and investment banking that paved way for the present crises.

Legitimacy and stake

Free market system around past three decades had proved its worth vis-à-vis other state-managed economic systems of pre-cold war era. By virtue of the gains made by Southeast Asian and a number of emerging economies notably China, Brazil, Russia and India in recent years, it earned a sort of global credibility and legitimacy as Bretton Woods institutions stayed on sidelines to ensure its credibility and legitimacy in the midst of any financial crises taking place because of it.   It had exported a subtle vision of capitalism of American brand initiated by Reagan in early 80s based on, “low taxes, light regulation and a pared-back government (that) would be the engine for economic growth. Reaganism reversed a century-long trend toward ever-larger government. Deregulation became the order of the day not just in the US but around the world,” noted an analyst. Moneyed people and governments had full faith in American economic power. That is why for decades they invested 80.0 per cent surplus savings of world in American economy. This liberal view of American economy and system and investment made in it became one of the causes of collapsing of American financial system because it enabled Americans to live beyond their means and wage wars with out feeling financial pinch.  

With the sort of financial crises that have brought collapse of American brand of capitalism, there is loss of faith in it. Its legitimacy is at stake and saving it is one of the core objectives of the American administration along with the governments of developed economies, may be with some reservations, as have been expressed by Europeans particularly social democratic states of France and Germany. That is why there has been a spree of bail out packages by the governments of developed economies and even emerging and developing economies like India and Pakistan to save the financial system in their countries based on free market.

Future course

The financial crises have been being addressed during the past few months through bail out packages by individual states and the IMF. The latter has come up with its “straight jacket” solution for developing and even some of the smaller Europeans economies affected by the financial crises. But, there is hardly any unified approach to address the core weak areas of the system. Authoritarian and   democratic capitalism are the two brands of capitalism that are in practice in China, Singapore, US, and the European states respectively.  Their efficacy or other wise is at the heart of debate but what is being set aside is how to make them more responsive to the needs of the people and avoid recurrence of the cyclic misadventure by the governments, this is because of the lack of regulatory measures and monetary and fiscal policies. Measures taken by the US administration such as nationalisation of AIGs and bailout packages to rescue the failing financial institutions and commercial organisations, in fact do not fit in the free market regime that believes in survival of the fittest.

Many analysts and economists have firm view that free market can’t do self-correction. It needs to be regulated by the government and there have to be regulatory authorities to over see if the market forces were acting in accordance with the laid down rules and regulations. It is being hyped at present that we are, “entering a new paradigm of tight money, tough regulation, less speculation and more government meddling in markets.” With the loss of credibility of the American model, it is being speculated that because of the shift in the base of capitalism and new centres emerging in Europe and Asia, they will take the initiative to modify the model in light of their experiences.

Pakistan and free market economy

Pakistan has tasted free market through high growth based on high consumption during five years between 2002 and 2007. It jacked its growth with out addressing fiscal and monetary and other imbalances in the economy and society and made economy totally dependent on external inflows that were hardly sustainable for too long. It is again that the country is in need of the IMF to put its fiscal and monetary house in order. The country needs improvement in infrastructure, fiscal and monetary environment, jacking up economic growth through maintaining a balance between productivity and demand, creating wealth through production and exports, creating opportunities for growth and employment, developing social sector and observing tough fiscal and monetary discipline. These are bare minimum essentials for a free market economy to thrive.

Conclusion

The free market economic system is deeply rooted across the world including Pakistan. Despite its pitfalls, it is capable of delivering. It, too, needs to be regulated contrary to the general belief that free markets takes care of it. The current financial crises across the world and the meltdown of national economies clearly show the importance of regulating the markets.

Source: The News, 19-Jan-09

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