In October 2008, I wrote an article about Lehman Brother fallout and in it, I quote "In 1993, the much respected Alan Greenspan went before the US Congress to testify in his capacity as chairman of the Fed that the government should leave the credit derivative market to its own devices as it serves to transfer risk from those who cannot afford to carry it to those are willing to take the risk for a price.". Being a free market advocate, 2008 has been a year of much unlearning and humbling acknowledgement that free market is not all that perfect and to coin Adam Smith's famous "Invisible Hand" as the be all and end all in terms of market pricing except that he also have a caveat on the hazards of monopolies undermining the greater good of mankind. Milton Friedman in his book "Free to Choose" strongly advocated that "markets always work and only market works" and therefore doubt "government intervention" could ever serve a useful purpose.
All these economists are my heroes and I still do believe them to be fundamentally correct in their posture on world economics but would place the following caveats in light of the events unfolding before our eyes in 2008.
Firstly, in light of the break down of the credit derivative market bring down with it Lehman Brothers as well as AIG, I think that Greenspan could be wrong about leaving the credit derivative market un-regulated. I think there is a marked difference between market regulation and market intervention although the two seems to be similar but their differential makes its practice a world of difference. Regulation has to do with setting up rules of engagement for market participants, increasing price transparency and reducing product differentiation factors, ensuring proper market clearing and making buyers and sellers 'blind' in terms of counter-party by guaranteeing counter-party ability to full-fill the trade. This is normally done through a regulator like SEC and an exchange like NYSE. It is important to note that the regulator and exchange should preferably be two separate entities to ensure that they do not land into a conflict of interest situation. In addition, the regulator like SEC must be government controlled but the exchange like NYSE can have its ownership in the hands of the market. This is what I meant by governmental market regulation. Government market intervention on their hand is the participation of the government either directly or indirectly as a market participant. Examples of which are government ownership of enterprises that provides goods that are also provided by private enterprises. The key here is that the goods can or are already provided by private enterprise and therefore, there is very little reason for governmental participation in the market. The exception would be 'public goods' which Milton Friedman also agreed should be produced by government. Conceptually, public goods such as policing, fire safety, major infrastructure that is enjoyed by all and sundry in the economy like parks, roads, fire service,education etc and are necessary for a community to function properly.
Secondly, there is an issue of time frame by which these concepts are tenable. In most if not all cases, the economic concepts will apply in the longer run rather than in the short run. There is general consensus in the economic community that in the shorter run, there could be price disturbances and market imperfection. However, the period of such shorter term market imperfections in terms of the intensity of the impact as well as its duration could make such models untenable as the economic tsunami during such period could have far reaching social and political impact that could de-stabilize a society beyond redemption. Chief amongst the shorter run social ills like unemployment and stagflation could destroy a whole generation before time could be in time to heal it. Economists have long recognized these situations and even labelled them as business cycles. In the past century, we have witnessed a few of these major ones that like in the years 2008, 1998, 1973 and 1929. Of course there are some who will argue that such cycles were made worse by inappropriate governmental intervention for example the monetarist camp and the keynesian camp on whether pump priming and controlling money supply as key to ridding out such cycles successfully. For the free market to always work and the market is the only workable solution, we will need a solution to the issue of business cycle for which there is no common consensus on what is right and workable.
Thirdly, we come to the issue to what is the correct and equitable distribution of economic wealth and woes in a society. Gini's coefficient is commonly used to measure the dispersion of income in a society. The greater the coefficient, the greater the gap between the rich and the poor in a society. Of late, there has been a re-thinking of Gini's coefficient accuracy in portraying the state of the rich poor gap as it measures only income and not wealth but this a minor detail.
Generally, we can see that on a global basis, there seems to be little significant trend pointing to an upward or downward trend of this coefficient but we do note that for USA which is one of the louder proponent of free market that the coefficient has risen over time since world war II. It is also interesting but not surprising to note that when economies like China move from centrally planned to free market, we can see a marked increase in the coefficient as the free market economy takes shape over time. An interesting thing point to note that the coefficient for the Nordic countries has been on a downward trend and these are the countries with one of the higher effective tax rate globally. What I see missing is a correlation between the Gini coefficient and business cycle and perhaps I should take up this challenge when my circumstances allow me to. However, to me a lack of demonstrable correlation between business cycle and the Gini coefficient is worrying enough as I would expect the Gini coefficient to be southward bound in tandem with the business cycle as non-linear or a northward bound Gini coefficient would mean that the poorer shouldering a larger share of the economic downturn of a business cycle. This could actually have societal instability if the impact of on the poorer segment becomes unbearable or there is a general lack of economic equalizers in terms of either transfer payments,estate duties or equal opportunity rules in terms of access to education and employment opportunities that allow for mobility both ways across the rich poor continuum.
In concluding, I would only say that although free market might not be perfect, it is most probably the best that is available to us. The secret lies in how we fine tune this wild animal of the free market to behave in a socially acceptable to all humanity.
Safe Harbor. Please note that information contained in these pages are of a personal nature and does not necessarily reflect that of any companies, organizations or individuals. In addition, some of these opinions are of a forward looking nature. Lastly the facts and opinions contained in these pages might not have been verified for correctness, so please use with caution. Happy Reading. Peter Lye