The political and economic history of the past quarter century has been dominated by an ideology that sought to roll back big government and placed a fundamentalist faith in the notion that markets are self-correcting, allocate resources efficiently, and serve the public interest well. These ideas had also underpinned the infamous "Washington Consensus" bouquet of policies - privatization, liberalization, balanced budget, capital account covertibility, independent Central Banks, and inflation fighting to the exclusion of all else - that was the basis of many of the policies of multi-lateral institutions like the World Bank and IMF.
This ideological thrust, influenced by the free-market and neo-liberal ideologies of economists like Ludwig Von Mises, Friedrich Von Hayek and Milton Friedman, started with the Thatcher and Reagan administrations of the early eighties. Now, almost forty years later, after a series of market failures, the curtain appears to have definitively come down on this experiment. The blind trust on the self-correcting abilities of the market has completely disappeared from the mainstream, and there are loud calls to bring back the much-maligned Government.
Today, it is widely acknowledged that there are too many market failures, lingering on for too long, for the government to not intervene. Here are five areas where Government is making a big comeback
1. Financial Markets - It is now official - the big bang of financial market reforms of the nineties has failed, and failed with disastrous consequences. In the aftermath of the bursting of the sub-prime mortgage bubble, moral hazard concerns are thrown out of the window and bailouts are the norm. Bear Stearns, Northern Rock, Fannie Mae and Freddie Mac, the list of bailouts is impressive an continues to grow. It is estimated that the sub-prime losses and bad loan write downs will easily cross $1 trillion.
The unregulated financial markets have done an excellent job in repeatedly distoritng incentives and misallocating financial resources, thereby building up bubbles, first in tech stocks and recently in housing mortgages. It is feared that there are more bubbles in credit card debt, education loans etc, which are waiting to erupt in the US financial market.
These recent events have starkly highlighted the massive failures of the unregulated financial markets. It is clear that there are too many and too complex conflicts of interests and moral hazard concerns, and markets cannot account for them. Unregulated financial markets are designed to privatize gains and socialize losses. Financial markets have become too large and integrated, intertwined with the real economy, and dominated by behemoth investment banks, that problems in one institution invariably affects the others and threatens to drag the real economy down.
2. Social Security in an age of widening inequality - The rising food prices and inflation, and the clear inability of governments to control them, has exposed massive numbers of people, especially in the developing world, to issues like food security. A decade back, opinion makers were basking in the glory of a world economy that was growing as though there was no end. It was even proclaimed that we had entered an age of prosperity!
Even in that bastion of limited government, the biggest social security debate is about health insurance, and there is an increasing convergence of opinion about a single-payer, universal health insurance. It would not be an exageration to argue that health care insurance and social security reform have been one of the two or three major issues in the ongoing US Presidential campaign.
The recent rise in foodgrain prices and inflation, has adversely impacted the poorest and most under-privileged. In such situations, it is imperative that governments step in and provide basic minimum social safety cushions to these poor people. Such times are therefore strong reminder of the continuing importance of social safety nets. Sample this debate about wage insurance.
3. Environment - In the past quarter century, neo-liberal economic thinking had scorned on any proposal for raising taxes. In keeping with the belief that the tax payers knew best how to spend their taxes, tax cuts had become the order of the day. Today we have widely co-alescing opinion among major economists that carbon taxes should be introduced to control emissions and thereby prevent global warming.
There is across the board support in all countries that carbon emissions should be capped and then reduced, either through the European style cap-and-trade system of emission permits or through carbon taxes.
4. Global trade - The post-WTO era of globalization and off-shoring, coupled with the impressive trade assisted global economic growth over the last 15 years, had instilled a widespread belief that free trade could be the magic pill to eradicating poverty in developing world. Trade barriers were pulled down and tariffs were lowered on an unprecedented scale, and the vision of a "flat world" dictated trade policies.
The massively subsidised agriculture exports from US and Europe have had the effect of devastating agriculture in many developing countries, especially in Africa. Agriculture investments have declined and the results are to be seen in the rising foodgrain prices.
This has now given way to misgivings about whether free trade has created deep distortions in the global and national economies. Free trade and globalization are now being blamed for everything from widening inequality in the US to rising commodity and energy price inflation to displacement of labour in Africa. It is now widely acknowledged that trade needs to be regulated. This debate has been discussed in this blog here and here.
5. Fiscal Policy - Demand management policies are back. We only need to witness the almost across the board clamour for fiscal stimulus to prop up a diving US economy. Despite the not so encouraging outcomes from a first round of fiscal stimulus in te US, a second round of fiscal stimulus is on the horizon and appears to enjoy bi-partisan support. After a brief flirtation with Friedman and self-correction, it has now become universally accepted that governments need to step in at times of market failure, so as to pump-prime recessionary or failing economies.
In addition, there are economic cycle problems like rising energy and commodity prices, that have highlighted market failures which demand government intervention. For example, it is argued that governments will have to proactively participate in addressing the issue of food and energy security, and in finding alternative energy sources. Barack Obama, the leading presidential contender in the US, has proposed imposing a windfall tax on oil companies and use the proceeds to fund research in alternative energy technologies.
Many influential economists have called for government intervention to address the issue of widening income inequality in the US. Numerous studies have blamed the erosion of countervailing checks and balances as the primary reason for this widening inequality and have warned of serious consequences if the decline is not stemmed. This debate has been discussed by this blog here, here and here.
In all these aforementioned areas, market failures affect the poor and underprivileged very adversely. Further, for too long, the brunt of market failures was borne by the poor and the rich had been spared its consequences. The difference today is that the extent of market failures have become too large to be confined to a small portion of the economy and is adversely affecting the entire economy.
Update 1
The FT has this comment describing the increasing tension between politics and the market, and the global trend towards increasing role for government. Particularly scathing is the doubts expressed about the present state of financial markets by former Fed Chairman Paul Volcker, "Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the market place."
The article also highlights the growing influence of the "libertarian paternalism" school of behavioural economics that Cass Sunstein and Richard Thaler's new book, Nudge, promotes. This view of Government as Platonic Guardians, approves of governments nudging citizens to act in accordance with (pre-defined) public policy goals.
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