THE article that my learned colleague, Tendai Biti penned on October 18, titled “Free markets root of global financial crisis” triggered a fierce rebuttal from Rejoice Ngwenya, who went on to romanticise liberalism and neo-liberalism.
In his article of October 24, Ngwenya writes, “the market has built-in mechanisms for self-correction” and that “for those that value freedom, innovation and enterprise, the presence of government in their daily lives is a negative force”.
Nothing can be further from the truth. Ngwenya’s philosophy is clearly premised on the Washington consensus which held that good economic performance required liberalised markets, financial stability and getting prices right. Once government got out of the way, private markets would allocate resources efficiently and generate robust growth!
However, this view neglects fundamental issues. Making markets work may actually require regulation and policies that promote the smooth functioning of those markets. Other cardinal considerations that militate against unbridled markets have to do with equity, empowerment and egalitarian development. It is therefore important for development policy to seek complementary strategies that can advance these goals simultaneously.
The Washington consensus emerged from the experiences of Latin America in the 1980s. At that time markets were not functioning properly, partly the result of dysfunctional public policies. GDP declined for three consecutive years and budget deficits were high and the spending underlying them was being used not so much for productive investments as for subsidies to the huge and inefficient state sector.
At first deficits were financed by borrowing – including very heavy borrowing from abroad. Bankers trying to recycle petrodollars were quick to lend and low real interest rates made borrowing very attractive. After 1980, real interest rate increases in the US restricted borrowing and raised the burden of interest payments, forcing many countries to turn to seignorage to finance their deficits. Predictably, the result was very high and extremely variable inflation (of course by normal standards, not Zimbabwean standards).
The focus on inflation which was at the time the central macroeconomic malady of Latin American countries, provided the backdrop for the Washington consensus but led to stabilisation policies that were not conducive for long-term economic growth and detracted attention from other major sources of macro-instability, namely weak and unregulated financial markets. To that extent I subscribe to Biti’s strong views on the culpability of free markets in regard to the recent global financial crisis. Growth will remain volatile as long as financial markets remain at a tangent. Thus governments should pay adequate attention on the financial sector to avert bank and credit rationing failures.
What happened on Wall Street most recently is not a new phenomenon. As Stiglitz correctly observed, in the 19th century most of the major economic downturns resulted from financial panics that were sometimes preceded by and invariably led to precipitous declines in asset prices and widespread banking failures. Financial crises have happened in the past, especially in the US and will continue to occur as evidence shows that they have become more frequent and more severe in recent years.
The importance of building robust financial systems goes beyond simply averting economic crises through bailout schemes as is currently the practice in Europe and the US. Stiglitz likened the financial system to the “brain” of the economy. He said that it “plays an important role in collecting and aggregating savings from agents with excess resources today. These resources are allocated to others —— such as entrepreneurs and home builders —— who can make productive use of them. Well functioning financial systems do a very good job of selecting the most productive recipients for these resources. In contrast poorly functioning financial systems often allocate capital to low productivity investments. Selecting the projects is only the first stage.
“The financial system must continue to monitor the use of these funds, ensuring that they continue to be used productively. In the process financial markets serve a number of other functions, including reducing risk, increasing liquidity, and conveying information. Left to themselves financial systems will not do a very good job” andÂ “problems of incomplete information, incomplete markets and incomplete contracts are all particularly severe in the financial sector, resulting in an equilibrium that is not even constrained Pareto efficient”.
Therefore to Ngwenya, there is no such thing as free markets. Markets have to be intelligently directed and regulated to achieve desired socio-economic outcomes. That is the role of the developmental state so much espoused by Krugman, Sen and Collier. Liberalism can never be the antidote to solving financial and economic cycles such as the recent global financial crisis, which are primarily the result of market failures.Â Â
Turning to Biti, failure by free markets to achieve global financial stability does not imply wholesale government intervention is the panacea. Intervention, though necessary, is not sufficient to ensure global stability. Economic history is littered with examples of failed state-led development strategies. The East Asian financial crisis of 1997 debunked that myth (although for others it is the opposite). For many years the Asian Tigers had been touted as star economies on the back of state-led growth strategies.
Linked to this, the experiences of the former communist countries —— the Soviet Union, East Germany, Poland, Hungary and Bulgaria, to mention a few, exposed the serious shortcomings of state intervention. While government intervention is noble (World Development Report, 1997), it has to rid itself of the excess baggage of price controls, price distortions and huge budget deficits. Moreover, the state has to reinvent itself and avoid economic predatory policies, corruption, and other vices such as personal aggrandizement, rent seeking and asset stripping which have become the footmarks of failed states. Â
Zimbabwe has arguably been in the throes of a devastating financial crisis since 2003 as typified by cash shortages, bank failures and low productivity credit lending —— the result of an inimical economic environment. For us in Zimbabwe, what happened at Wall Street might after all turn out to be a picnic. And all that we can conclude from our own experiences with the crises in the Zimbabwean financial sector is that over-regulation and not the lack of it could be partly to blame. In economic development, the catch lies in striking the correct balance between market forces and the role of the state. Dogmatic approaches won’t work. In this regard, the experiences of China, as we know it today, are instructive.
By TapiwaÂ Mashakada ; An economist and the MDC’s deputy secretary-General