Matt McCarten has lost the plot

Thanks to Kiwiblog I have discovered that Matt McCarten has lost the plot ... again. In his latest rant in the Herald on Sunday McCarten says

The trillion-dollar, taxpayer-funded handout to criminal and irresponsible corporations in the United States surely puts an end to the nonsense that there is any such thing as a "free" market.

What the bailout does show that the banking sector in the US was not a free market to begin with, much of the blame for the crisis is due to this fact. Government interference with the normal operations of markets played a big role in creating the current crisis. As John Stepek pointed out in a recent piece in MoneyWeek,

This crisis has its roots in the actions of central banks. I think it's important to make this point very clear right now.

Central banks, the Fed in particular, could have popped what was obviously a rampant property bubble before it got too big. They didn't. As Roger Kerr wrote, correctly, recently

What caused this bubble? A prime source was easy money - the Federal Reserve cut interest rates in response to the dotcom cash earlier this decade and kept them low despite inflation pressures and the surge in the prices of housing and other assets.

Moreover, the Fed’s 1998 rescue of Long Term Capital Management and its response to the dotcom crash led many to believe in the so-called ‘Greenspan put’ - the expectation that the Fed would bail out troubled financial firms, especially large ones. This arguably resulted in imprudent borrowing and lending

Also there were the incentives created by legislation, the 'anti-redlining' laws, being one example. Such regulations set out to stop lenders refusing loans to people who happened to live in a poor part of town. That gave millions of poor people access to home loans – but at the expense of the institutions taking on riskier customers. As Kerr puts it

Another factor was political pressure on banks to lend in the name of ‘affordable housing’ (sound familiar?). As a Brookings economist put it, banks “had to show they were making a conscious effort to make loans to subprime borrowers.”

Then there was the implicit government guarantee on Fannie Mae and Freddie Mac. Seemingly insulated from all harm, they became reckless - a nice example of moral hazard. They constructed a giant pyramid of debt on a very small base of capital. Again, as Kerr has written

Another very important contributor was the implicit government support of Fannie Mae and Freddie Mac, the two huge corporations that back nearly half of the $12 trillion mortgages outstanding in the United States.

This was a train wreck waiting to happen. The government backing undercut private lenders and encouraged risky practices.

McCarten goes on

Right-wing ideologues have bullied us for three decades that the only way for growth and prosperity is to have unregulated free markets, guided by some mystical force called the "invisible hand". After the meltdown in the US this week there has been a deafening silence from these sages.

There is much evidence that well functioning free markets are a big factor in growth and prosperity. Herbert Grubel concludes that

This paper uses the Economic Freedom Index to show that greater economic freedom does not have a cost in terms of income levels, income growth, unemployment rates, and human development, as has been the conventional wisdom during much of the postwar era. To the contrary, economic freedom is associated with superior performance on all of these criteria of human well-being.

The size of government is normally associated with less economic freedom and less growth. As Gwartney, Holcombe and Lawson note

The findings of this paper show a strong and persistent negative relationship between government expenditures and growth of GDP, both for the developed economies of the OECD and for a larger set of 60 nations around the world.

To see the basic point consider the following graphs. The first shows the relationship between economic freedom and income. The relationship is positive.

The second two show the relationship between economic freedom and income and economic growth,

McCarten continues

The free marketeers' ideology goes something like this: there should be no regulation and the market is always self-correcting. If managers of enterprises make mistakes, their businesses would fold and new ones would take their place.

The problem is that without any rules the law of the jungle applies. The bullies and thugs who lie and cheat are the ones who survive. After they've gobbled up many of their competitors, they become so big and monopolistic that they can do whatever they like without consequence.

McCarten doesn't understand what a market is. Markets are, basically, a form of regulation. Markets are an institution that evolved to facilitate trade, that is, they are a set of rules and regulations that make trade between strangers possible and efficient. All markets have rules: what can be traded, how it can be traded, when it can be traded, by whom it can be traded etc. In markets the law of the jungle does not apply, that is what makes a market a market. Trade takes place not robbery.

As to McCarten's point in the first paragraph above, in competitive markets that is what happens. The problems occur when governments step in to prevent this from happening, as when it funds a bail out of firms.

McCarten then get even more bizarre. He writes

Here's how they got themselves into this mess. After the internet bubble burst, the hucksters in these institutions decided that property was the new scam where exorbitant profits could be made.

The new capitalist reward system structures their incomes around the concept of the higher the return for shareholders, the better their bonuses. Recklessness and irresponsibility in the short term made these people millions. They normally exit before they get exposed.

The problem is, it's not just in the US but in most of the Anglo-Saxon world that they're doing it. These financial barons were lending billions and billions of dollars to suspect property deals. When they ran into trouble, they would package them up with other suspect deals and sell them to another bank as an asset.

In the end, all of them were doing it to each other and receiving huge bonuses for making apparent record profits. It seems these packages were fake and weren't worth anything. What brought them down was that they were all doing it to each other.

I notice he does produce any evidence to back up these claims. I guess because there isn't any. The causes of the current situation are many and varied but as pointed out above the biggest factor were actions by government agencies. The Fed, financial regulators, legislators all have questions to answer.

McCarten ends by saying

Our politicians and business leaders need to come clean and admit that free market capitalism doesn't work and never has.

What writers in the Herald on Sunday have to come clean about it that the situation we are dealing with isn't free market capitalism. Capitalism, even in the weak form we know it, has worked better than all known alternatives, including all known forms of socialism. As Tyler Cowen has said of the capitalism, it is

... the economic system that brought about modern America, the Industrial Revolution, and high standards of living around the world.

It has been the most successful anti-poverty weapon we have yet found. As Bill Easterly has written,

Profit-motivated capitalism, on the other hand, has done wonders for poor workers. Self-interested capitalist factory owners buy machines that increase production, and thus profits. Capitalists search for technological breakthroughs that make it possible to get more output for the same amount of input. Working with more machinery and better technology, workers produce more output per hour. In a competitive labor market, the demand for these more productive workers increases, driving up their wages. The steady increase in wages for unskilled labor lifts the workers out of poverty.

The Easterly bottom line,

... profit-motivated capitalism is still the best hope for the poor.

McCarten is so strange that I honestly find it hard to comprehend that he actually believes what he writes. Does anyone believe it?