Sunday, March 22, 2009

The market and the state: Capitalism caught between libertarianism and populism

One of the recurring themes in these blog entries is reflecting on the age old discussion about defining the respective roles of the state and the market in ensuring the efficient and equitable functioning of a modern economy. Today's entry will be yet another footnote to that ongoing conversation. I heard an interesting new way of framing this debate today from Eliot Spitzer, the disgraced former Governor of New York, who became famous in his earlier incarnation as Attorney General in pursuing crooked dealings on Wall Street, including a prosecution of AIG, which makes anything he has to say on the subject timely. Plus, he's a smart and thoughtful guy. Perhaps his prescience in predicting the sort of trouble that Wall Street (and for that matter, the nation, and the world) is going through now, and the fact that he actually tried to do something about it, will help revive his political career, laid low after the prostitution scandal that brought him down as Governor last year. We'll see.

But back to the point at hand. Spitzer was on Fareed Zakaria's excellent new CNN program, GPS, earlier today, commenting on the current controvery over AIG's executive bonuses, amongst other things, and legal avenues that the US government might pursue in recovering those monies for the American taxpayer. The whole interview is well worth watching, and, if you're reading this today, Sunday, March 22, you can catch it again at 5 pm Eastern time this afternoon. In due course, it will no doubt be archived on the show's website. Here is the link:

Interesting and topical stuff, but much the most interesting part of his discussion was on the very subject of the market and the state, on which I've been opining recently. Spitzer framed the debate in an interesting way, by saying (and here I paraphrase) that we had during the last twenty years was libertarianism masquerading as capitalism, and, if we're not careful, what we're likely to get in the next twenty is rank populism instead, that, if not nipped in the bud, will threaten the system of capitalism itself. This is a more provocative and pungent way of saying what I'd put more prosaically, that we might be about to witness another pendulum swing, from the balance tipping from the market back to the state. Or, to be more precise, this would involve a putative move from an insufficiently regulated market to an over-regulated one. On this fundamental point, I believe that Spitzer's framing of it is accurate, and, alas, his predictions may once again prove to be prescient.


Bombay Beauty said...

Yes, it is interesting and troubling how suddenly opine on what a banker should be paid. And of course in the populist political arena it's impossible to explain that sometimes you have to pay millions to attract the appropriate talent. At the same time, it is link to the question: Is is appropriate for a government enterprise to pay the same kind of salaries as a non-government enterprise? If the government wants to manage the enterprise to profitability then perhaps. But at the same time many people, even economists, are nursing the feeling that incentives were out alignment in the private market, so perhaps populism is simple the tool at hand to achieve a goal that will benefit us all.

Vivek H. Dehejia said...

BB, you raise a good point. Perhaps populism will take us back in the right direction, if we agree (as I would) that we saw excessive deregulation during the Reagan period. The notion that financial institutions will simply regulate themselves now seems preposterous, although it was widely accepted at the time. But I think Spitzer was right to point out the danger that populism may over-reach to far in the other direction, and we may once again get excessive regulations that will stifle the creative and entrepreneurial energies that make capitalism thrive. The pendulum keeps swinging!

Bombay Beauty said...

Indeed, though one wrinkle or personal take. I don't think the proximate cause here is deregulation. I'm not sure whether that is a deep cause or just a necessary condition. But I think the immediate cause was a break down of the principal-agent relationship between shareholders and bankers. I think most shareholders if they understood the kind of risks that were being taken "on their behalf" would not have approved and in a similar spirit didn't understand how banks were incentivizing their employees to double down on big risks. At the same time, it is possible shareholders did understand, but simply didn't care (=accepted the risk) when it was paying off.

Deregulation in an environment where agents have the correct incentives shouldn't be a problem. The question is why the incentive scheme broke down:

- computation complexity prevented oversight by shareholds;
- looting by agents;
- a conspiracy theory hatched by Elvis and JFK in whichever dark room they are hiding out...


Vivek H. Dehejia said...

BB, you raise a deep and important point. Deregulation was a necessary condition for the current financial crisis, but the breakdown in the principal-agent relationship between bankers and their shareholders was evidently the proximate cause. I think my overarching point, that excessive deregulatory zeal, done by politicians but egged on by economists of a libertarian stripe, is at the root of the crisis, in that they assumed that the market, left to itself, would sort itself out. As your persuasive analysis shows, that clearly didn't work, although we agree that we're not sure exactly why.