Free markets or government regulation?

Keeping this title in mind, it is obvious that there are a lot of different arguments on whether or not markets should be free or regulated by governments. Take the following two well known economists whom one might argue provided the world with the two most important economic theories.

John Maynard Keynes

  • Advocate of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions.
  • Argued that the overall level of economic activity was determined by aggregated demand.
  • Fought for government intervention and regulation.

Friedrich August von Hayek

  • Firm believer in free markets.
  • Argued that the efficient allocation of capital would be the most important and leading factor for sustainable and optimal GDP growth.
  • Warned of the harms from monetary authority manipulation of interest rates. With respect to interest rates, he argued that interest rates should be set naturally by the equilibrium between consumption of goods and capital stock.

Controversy surrounding the Keynesian model

Although Keynes ultimately won the battle of ideas after World War 2 (most countries nowadays follow the Keynesian model), many countries who did accept the Keynesian model experienced high economic growth and rising standards of living. Some of these countries include Europe, Japan and America. This, however, was short lived as they suddenly started to experience rising unemployment together with rising inflation; also known as stagflation. This was impossible under Keynesian law as the government should’ve controlled wages and prices.

Another disadvantage about the Keynesian model was that governments started to provide industries with subsidies. Being dependent on government subsidies made industries inefficient and unproductive as they had no incentive to work.

Daniel Yergin, author of The Commanding Heights, said the following about the dependency theory (Commanding Heights: The Agony of Reform, 2002):

“If you want high economic growth you must put up barriers/tariffs that would restrict the flow of imports to the country and help to develop and build your own domestic industry. If you don’t do this, you will be victimized by world trade.”

In reality, however, being dependant on government subsidies leads to cut backs on technology flows, investment flows and flows of know-how. With no threat of competition it makes companies lazy and uncompetitive. This means they will produce low quality products against higher prices. It now became clear that maybe Hayek’s model was better.

How Hayek’s economic model led to economic growth

India

Before the 1990s India decided to industrialize their economy in order to counter poverty. Due to the controlled environment, people had no incentive to work and this gave rise to lower productivity. By the 1990s, under the influence of the now Prime Minister, Manmohan Singh, the government started to let go of all their rules and regulation (Hayek’s economic theory) and eventually the Indian economy started to bloom (Wikipedia, 2012).

America

During 1992 America went adrift with a debt of over US$ 4 trillion. This brought a recession with it and gave rise to unemployment while industries struggled against foreign competition. Bill Clinton met with Wall Street financiers in a bit to reach a decision on what to do to safe and improve America’s economy. They came up with three actions: financial markets should reduce government spending, cut the deficit and embrace free trade (Hayek’s economic theory).

It can thus be said that in order for an economy to function well and grow, it is important to embrace free markets. The government must, however, still have some form of rules and regulations in place with regards to different policies.

In contrast with this, Ron Paul stated that he does believe in regulation, but that government regulation was to blame for the distortion of markets. According to him, markets, through interest rate changes, provide signals that must be followed.

 

“And, I believe in regulation. But I don’t believe for a minute that it’s a lack of government regulation that is our problem. It was the fact that the government had licensed the Federal Reserve to distort the market, create capital out of thin air and distort interest rates, which caused the malinvestment and excessive debt.”

It becomes clear that controversy does exist around whether markets should be free or regulated by government policies. If it helps to reach a conclusion; most countries today does accept Keynes’ theory, but they combine capitalism with government control. Governments must ensure that there is sufficient competition to keep prices low and the quality of products high. Governments must thus only regulate economic rules, but leave the market to adapt to changes in the world economy.

– AG for SuperSonicSurge

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One comment

  1. You have written a well-structured post. And have taken more of a macro perspective than most of the groups. To drive home the argument, I would emphasise the underlying reasons why markets are better. You already mention the problems of how government can distort price signals and incentives, but you have to stack up those arguments to counter the other side’s points about market failure.

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