The ongoing financial meltdown has raised voices lamenting the failure of market economy and prophesying its end as a viable system for achieving prosperity. But there is nothing failing about the basic market principles or their capacity to deliver economic growth: property rights, price mechanism, efficient contract enforcement, or fair competition remain as valid tools for development as ever. Instead, what the current crisis illustrates is the failure to provide appropriate regulatory and institutional incentives that would responsibly guide the behavior of market actors.
While overregulation is harmful to the economy, regulation per se is not the same as excessive interference of governments in markets. In fact, it is the very essence of how markets are defined in the first place. In an advanced economy, complex exchanges (say, credit default swaps) cannot self-regulate because the incentives to do so are simply not there. The parties benefiting from the exchange are too far removed from the greater economic risks of their actions to fully incorporate those risks into their investment decisions.
A modern economy is more than Adam Smith’s pin factory. The essential principles remain the same, but the larger system rests upon a complicated framework of man-made rules. There is one crucial lesson here often overlooked by developed and developing countries alike: the quality of political governance is inextricably linked with the quality of economic performance because it is the political system that defines economic rules of the game.
If we want to assign blame for the current crisis, it is much more the shortcoming of governance than the failure of market economy. Government policies can create market incentives that spur sustained growth and development – or lead to economic trouble. Democratic governments don’t always succeed in the former, but particularly in a crisis like this one, democracies are still best equipped to examine the causes in a transparent way, introduce more accountability, and correct the incentive structures.
Published Date: October 09, 2008