Saturday, September 20, 2008

The Darwinian Conservative Case Against Bailouts

The US Government's moves towards bailing out financial firms that have made bad economic decisions shows that the United States has adopted a market-socialist economy. Early in the 20th century, critics of socialism like Ludwig von Mises and Friedrich Hayek argued that pure socialism could not work because there would be no way to calculate value in a large, complex economy without market prices. Eventually, most socialist thinkers admitted the accuracy of this argument. But then many socialists responded by defending the possibility of market-socialism that would combine market pricing based on private property with central economic planning by government.

The creation in the United States of government-sponsored enterprises like Fannie Mae and Freddie Mac illustrates market-socialism in action. Backed by a government that wanted to provide affordable housing, Fannie and Freddie could act as private firms seeking profits in mortgages and mortgage-backed securities, but when the bad decisions of these corporations led to turmoil in financial markets, the government could step in with taxpayer money to cover the losses in the hope of stabilizing markets. Now, it seems an even bigger bailout will be designed to use taxpayer money to cover the bad mortgage debt in financial markets.

From the perspective of Darwinian conservatism, it is easy to see that such market-socialism must fail, because it ignores the human nature of private property, free markets, and political ambition. For conservatives, property is rooted in human nature and thus universal, although the specific forms of property reflect the customary traditions and formal laws of particular societies. For socialists and liberals, property is not natural but a purely social construction that can be deliberately changed, or even abolished, to secure social equality. A Darwinian view of human nature sustains the conservative commitment to property as a natural propensity that is diversely expressed in custom and law.

A system of private property and free markets under the rule of law channels the natural desire for wealth to allocate resources productively in a manner that recognizes the imperfectibility of human beings in their limited knowledge and limited virtue. In such a system, human beings gather economic information and make economic decisions based on their expectation that they will reap the rewards of their good decisions and bear the costs of their bad decisions. This gives them the incentive to be prudent, because they know that their imprudence--such as being foolish in undertaking too much debt and risky investments--will be punished by financial failure.

By contrast, in a market-socialist system, losses are socialized. Business managers and shareholders can reap great profits through foolish risk-taking, while assuming that they will not be punished for their imprudence because any losses will be covered by governmental intervention. This creates distortions in the economy as resources are directed to bad investments, creating financial bubbles that inevitably must burst.

Like all other human beings, political leaders are imperfect in their knowledge and their virtue. Moreover, they are moved primarily by the ambition for power. In a system of free enterprise and limited government under the rule of law, political leaders are not given broad powers to manipulate the economy, because their economic ignorance and their political ambition will lead them to create harmful distortions in the economy. Because of their ignorance, they will not know what decisions would be best for the economy. Because of their ambition, they will respond to political pressures in advancing their political careers rather than working for sound economic outcomes. In a market-socialist economy, those with great political influence can benefit from their access to power, but the economy as a whole suffers from the misallocation of resources coming from the ignorance and ambition of central planners. To deny this conclusion, we would have to assume that government planners can have perfect knowledge and perfect virtue, but such an assumption is implausibly utopian.

Such reasoning from Darwinian conservatism does not allow us to predict specific events that are determined by the contingencies of history. But it does allow us to predict the broad tendencies of economic and political life as shaped by human nature. So we can predict that if the federal government of the U.S. continues its market-socialist strategy of bailing out financial businesses with taxpayer money, the financial crisis will be prolonged, which will create an even greater demand for more bailouts, and the vicious circle will eventually bring a massive economic collapse. If such market-socialism spreads around the world, as seems likely, then the collapse will become global.

Some of the logic of this economic analysis can be found in two recent articles found at the Cato Institute website--one by James Dorn and another by Jagadeesh Gokhale and Kent Smetters.

Today's New York Times (September 20) has an article by Joe Nocera with the title "A Hail Mary Pass, But No Receiver in the End Zone." His conclusion is that the people proposing the new bailout plan have no idea how it will work or whether it will work. But political pressures force them to "do something." His final sentence is that "as much as we might hope that the government finally has the answer, it probably doesn't." The fundamental problem is ignorance. "Nobody understands who owes what to whom--or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances."

In a state of such ignorance, the only reasonable thing for the government to do is to do nothing and let the market go through a painful period of adjustment. But instead, government planners will offer rescue plans that only make matters worse, at a cost of over a trillion taxpayer dollars. That's market-socialism.

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