Sunday, March 25, 2007

The Commanding Heights

I watched The Commanding Heights (TCH) earlier this week and I figured that, per Joe's request, I would post a comment. It was great. I was actually teary eyed more than once while watching it. I don't suspect that anyone would be too surprised by my evaluation. It did support many my preexisting beliefs. I found the perspective on post-communist Russia to be particularly interesting and informative.

I think we could use a lot more of this sort of media. Although TCH portrays a world in which the ideas of liberal economics have triumphed, I feel that that triumph is more practical than political. That is, I believe that many governments were forced into accepting more market oriented policies because command economies had been such a debacle. But I'm not so sure that liberal economics has gained any sort of ascendancy amongst the minds of the ordinary people of the world.

I fear that should the economic winds change, people are as ready as they have ever been to embrace socialistic policies. Not to put too fine a point on it, TCH paints a picture of a grand cycle going from the economically liberal beginning of the twentieth century, through an period of government dominance, and back to the modern era of world markets, and I suspect we might well repeat the same errors in the coming century that we did in the last. This would, of course, be tragic.

Really, as an American on the ground, do you see the weight of public opinion as being in favor of free market policies? In particular, amongst the free market sentiment that you do see, is it there for the right reasons? It seems to me that socialism is still far stronger than liberalism in terms of underlying public support. It is simply a far more intuitive system. Though I may sound like some sort of conservative crank, I think that we have to acknowledge that the overwhelming majority of educators and educational institutions in the U.S. still guide students toward a preference for socialism and planning over markets and individual freedom. We must simply face the fact that organization and government intervention are the products of genuine popular movements, and that laissez faire economics has probably never had widespread support.

Just look at the labor and (largely equivalent) anti-globalization movements portrayed in TCH. Do we, at any time in history see any similar movements in favor of liberalism? No, not really. I guess the American Revolution is about as close as you get. Socialism just makes for way better slogans. People want to hear that their problems are caused by the greed and evil of the rich and powerful, not that scarcity is an inevitable phenomenon and that economic limitations hold with the force of natural law. I have argued before that the drive towards communism is likely maintained by the same forces that first inspired worship of the Gods. As human beings we have a built-in tendency to interpret events in terms of purposeful action. This facility is essential to our functioning as members of complex human societies. But it also causes us to anthropomorphize and personify natural forces. Because the natural forces of scarcity manifest themselves through the market, it makes perfect sense that we blame our problems on the human faces of corporate leaders and government officials. Though such scapegoating is satisfying, it is dangerously counterproductive. We have to recognize that when oil prices, for instance, become unpleasantly high, it is not because oil producers are greedy, it is because the relationship between supply and demand has changed. We can try to deny this fact by imposing government controls, but such a lie hurts no one more than ourselves.

All right, I'll stop jabbering about free markets. If you've watched TCH you probably already have a pretty clear idea of what I'm talking about. But I do still want to comment on instabilities in the modern financial system. This is a very significant aspect of the third part of TCH. These are a very challenging problem. The solution is not at all clear. My opinion is that what we need is, in fact, a greater degree of deregulation. This is totally opposed to what most economists would suggest. But I'll say it nonetheless.

I think that governments go way to far in guaranteeing stability in their banking systems, and that we need to make it much easier for banks to fail. You see, I believe that the operation of central banks brings about a system of risk pooling in which the possibility of failure is aggregated. There is no doubt that it is possible to do away with the risk of individual bank failures by creating a centralized guarantor, but to me it seems equally clear that such a system does not eliminate risk. It merely spreads it. But this spreading means that risk is externalized, so it is entered into far more often. It means that risk goes unrecognized, so it is underpriced. And it means that the realization of risk is quickly contained, so systemic purges of risk are much less frequent. Overall, the result is that the economy ends up containing way more risk than it could have ever supported prior to bank cartelization. In a way this is good. It allows much more lending to take place, and so we have lower interest rates, and hence more development and entrepreneurship. But it is bad in the sense that the economy builds up huge amounts of risk.

Just as the containment of moderately sized forest fires allows the buildup of large amounts of fuel mass, thus increasing the possibility of huge uncontrollable blazes, so the containment of moderately sized failures in the credit system makes much more dangerous failures more likely, if not inevitable. So what I'm saying is that we need to do away with the belief that we can control risk. We need to accept the fact that risk is an inherent result of our inability to foresee the outcomes of economic decisions. Given that recognition, the best solution is to break economies into smaller cells capable of failing individually and thus making failure more common, more recognizable, and more contained.

I think that today there is more unrecognized risk in the world economy than most people could possibly imagine, and that a systemic world economic collapse is more likely than most would like to think. It is in this risk that I see the possibility that the recent trend toward economic liberalization will be undone. If we do see a global economic catastrophe, few will choose to blame it on governments doing too much to safeguard economic stability, and many more will interpret it as a predictable failure of under-regulated markets.

I'm not sure that disaggregation is possible from where we now stand. Risks that have been taken cannot be undone, and disaggregation would almost certainly bring about immediate painful realization of this fact. And even if the central banks of the world were to cast risk back upon subunits of their economies, it would not undo the recent creation of a world derivatives market, which is essentially a privatization of the role of risk aggregation. This market may truly be a market failure: a making of poor decisions that could not be subjected to the strictures of market forces until it had become to big to stop without immeasurable harm being done. But it is too late to do anything about it.

In summary, TCH is very encouraging, and made me feel very warm and fuzzy. But I for one am afraid that the trend that it illustrates might be short lived. I may be wrong. I certainly hope that I am. But if I'm not, the tragedies of the twentieth century could well be revisited in the twenty-first.

No comments: