free-market has failed

Our Economy is Broken: The Free Market Experiment Has Failed

Even before the shut-downs, the economy wasn’t working for the majority of people. Our experiment in the free-market has been tested and it has failed.

Ever since the Great Recession, people have been discussing the rising inequality in Western society, but especially in the uber capitalistic North American society.  With COVID-19 impacting every industry, the inequalities have been amplified and highlighted.

Underlying health conditions aside, more disadvantaged socio-economic demographics are experiencing a higher number of deaths.  They are on the labor extremes, either experiencing more unemployment or they are more likely to put their lives on the line in jobs deemed “essential.”

We now have the space to evaluate some of the tenants and the assumptions underlying our understanding of capitalism.

I was really surprised to learn that our version of capitalism only started in the 1970s.  I was equally surprised to hear that before then companies were not solely profit-making machines.  There was a time when big companies, usually manufacturing, were considered pillars of society.  They were respected and respectful.  They saw themselves as stewards of the communities that were woven into.

Townspeople and employees saw them more like quasi-governmental or semi-parental entities.

No seriously.

Ok Boomer

That was when our grandparents or parents developed a fierce loyalty to the companies.  They wanted to get a good job at a good company and stay there until retirement.  They had the notion that they take care of work during their productive years and the company will take care of them in their retirement years.  It was a social contract.

Free-Market Capitalism

Then something happened.  Sometime in the ’70s, we embarked upon a grand economic experiment.  This longitudinal experiment is finally revealing the results.  What was this experiment?  It was our modern economic framework of free-markets.

Often referred to as the Chicago School of Economics, the main framework of the free-markets is the idea that each person is incentivized to maximize their own well-being.  As a result, they allocate (ie spend or invest) money that maximizes their benefit.  This means the overall flow of money will also be optimized. Because the use of money is optimized, then prosperity will naturally develop without intervention.

Caveat Emptor

The coronary of this main concept is the wisdom of the crowd.  While one person might not know the answer, the average of all the human actors will produce the closest correct answer.  A popular example is guessing the number of jelly beans in a jar.  You don’t know the answer, so you guess.  After 50 or 100 people took their turns, the average of the guesses tends to be rather close to the actual number.  Not exact, but it’s close enough.

This is an Efficient Market

The efficient market proposes that all information is already baked into the capital market.  You think there will be a recession? The markets already reflect that. You think a particular company has a great CEO and will steer the company to increase revenues?  The market already reflects that too.  No one person can out-jelly-bean the market.

The Chicago School also had one important clause; minimal-to-no government intervention.  Government regulation was seen to be highly inefficient. After all, the government invented red tape. They were barriers that reduced optimized results.  Furthermore, government agents (not spies kind of agents, but those who work on behalf of the Government) were seen to be utterly wasteful. Therefore, the government should only determine the supply of money in the system using monetary policy – setting interest rates.  Then the capitalists take over and best allocate it for maximum prosperity.

The Economics that We Know and Love

There is some follow-through logic to this framework too; several If-Then statements. These are things we are already familiar with. IF the price goes down, THEN more people will buy it.  IF the price of something goes up, THEN fewer people will buy it. This is the basics of microeconomics that we’ve all been exposed to either in class or at the store.

It’s easy to see why this framework is attractive.  No one likes Big Brother telling them what to do. It’s easy to rely on the wisdom of the crowd. As humans, relying on each other has to lead us to become the dominant species.  And of course, government workers are inefficient and wasteful!  C’mon, we’ve all had to stand in line in some government office for what seems like hours to fill out random paperwork, been told to bring the form from one wicket to another only to learn that we hadn’t filled it out correctly and had to go back to the first wicket!  Talk about inefficient!

How maddening!

I digress. But you can see why the concept of the free market was welcomed with open arms and widely adopted.

Experiment Results

As I mentioned, the free-market has failed.  What are the results of this experiment? It’s been proven to be incorrect.

The Whole is Not Just a Sum of it Parts.

Let’s look at the idea that maximized individual benefits lead to optimal growth.

First, if the market was perfectly efficient and rational, then market bubbles wouldn’t happen.  The theory would predict that there will be a sufficient amount of people who have the knowledge of a bubble forming and in order to maximize their benefit, would avoid it or invest in other assets.

Dot-Com Boom and Bust

If that was true, then the 2000 dot-com bubble wouldn’t have happened.  People would have seen it as unsustainable or it was a bubble or that many companies didn’t have any revenues.  For rational investors, why would they invest in a company that has never sold anything or made any profit?

They wouldn’t.

Financial Crisis and the No-Income-No-Asset Loans

How about the 2007-2008 Great Recession? That was caused by a bubble in the housing market and the associated securities that packaged mortgages up.  Why would people buy houses they knew they couldn’t afford?  Why would companies lend them money? On the other hand, why would people buy bonds that had these assets inside them if they knew they were stuffed with mortgages of people who can’t pay?

In both examples illustrates how the free-market experiment has failed.

In Defense Of

Economists still defend their hypothesis by saying it was greed or uninformed buyers.  But those defences actually prove my point.  If the market was rational and efficient, then there would be no uninformed buyers; or at least there would be the same amount on both sides to balance out.

Greed is individual actors maximizing their own benefits, but under the Free-Market hypothesis, this would lead to the optimization of the economy, not bubbles.

Mental Math

Another example of this hypothesis proving false is that humans are not maximizing machines. This we can only prove by looking at the circumstance of human behaviour.

Let’s look at retirement.  In order to maximize my benefit, I would find a way to balance current satisfaction with investing enough in my retirement to ensure that my future provides the same (if not more) levels of satisfaction.

Perhaps because you are reading this article, you are one of these people.  But I bet you know a couple of other people who aren’t doing the same.  They are overspending today and not investing enough for the future. Zooming out to an entire population, we actually see those who are saving for retirement are the minority.

The Chilean Free-Market Experiment

The purest form of this experiment was actually implemented in Chile.

In the early 1970s, a group of exchanged students from Santiago went abroad to study economics in Chicago under the preeminent economist Milton Friedman.  There is a lot of political background behind this which is too long for this article, but you can hear more about it here.

The goal of the students was to bring back these progressive economic theories and ideas to Chile and use them to improve the plight of the poor. Under Friedman’s concepts of Neo-Libertism Free-Market; many government enterprises were privatized.  This included the pension and education system.  Government jobs and departments were slashed to cut costs. Regulation and taxes were also slashed in order to “take the shackles off.”

Basically, the government got out of the way and the free-market took it from there.

Choose Your Own Adventure

By privatizing pensions, it gave control of retirement to companies.  Many companies implemented pension plans and they met the minimum requirement of deducting 10% of employee pay as a contribution to the pension.  They did not have to provide any company-match as there was no regulation to do so.  Instead, they raised the pay of the workers.

Again, this makes sense because, under the free-market theory, each employee would act in a way to maximize their own gain.  They can invest it in the pension, they can spend it on a more pressing need or they can invest in business startups.  It was up to them.

For many years, the economy did indeed grow.  The wealth of the total population in aggregate was increasing.  But it probably wouldn’t surprise you that most of the gains were accruing to the rich.  From what we are experiencing in our own experiment, this is almost intuitive, ain’t it?

But Here’s the Plot-Twist

Furthermore, now that the first generation under the privatized pensions has retired, many cracks are exposed.  First, the mandatory 10% contribution was not nearly enough.  Most pension payouts don’t cover the basic necessities.   Second, in order to even qualify for a payout, one must have contributed to the pension for 20 years.  For many people who had to leave the workforce, they do not meet this requirement.  Third, there were masses of people who did not work in stable company jobs.  They worked in mom & pop shops or they worked the gig economy. As a result, they never had the opportunity to contribute to a pension.

Now there’s no safety net to catch any of them.

View From My Future Self

You know that saying, if you find yourself in a hole, the first thing to do is stop digging?

We should probably stop digging now.

The Chilean pensioners is a look into the future of our retirement years.

I’m not against capitalism.  I’m not against the free-market. Both are good things.  I like the idea that I can vote with my money because it’s a free market.  I like that we can undertake our own endeavours and make money from our work and talents.

It’s just some of the assumptions that this free-market theory was inherently faulty.  As a result, they led to a lot of unintended consequences.  We can keep contorting ourselves to try to fit our observations into the free-market theory.

Or we can accept that our experiment has failed and come up with a new solution before it’s too late.

Join me next time when I explore how some of these faulty assumptions can be reversed and a theory that describes what actually happens IRL.

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