Legal Commentary

Is the Goose that Laid the Golden Eggs Severely Wounded? Becker

By becker

Will this financial crisis mark a substantial retreat from the world's movement during the past several decades toward a competitive market system? Many journalists and others have been suggesting that this crisis will lead to much more active government involvement in the economy, and even induce a return toward government ownership of many companies in the non-financial as well as the financial sector. In my opinion, what will happen to the worldwide support for competition and privatizations, freer trade, and market-based economies depend greatly on how the American and other major economies fare during the next year or longer.

The US and much of the rest of the world appear to be headed for, if not already in, a recession with falling GDP and rising unemployment. It is possible that this recession will be steep and somewhat prolonged. The extreme example of a major depression is the Great Depression of the 1930s, where real GDP declined sharply for a few years during the early 1930s, and where unemployment grew from 3 percent in 1929 to 25 percent in 1933. Unemployment was still at the remarkably high rate of 17 percent in 1939 prior to the outbreak of World War II. By contrast, American recessions since 1959 have been so mild that in no year did real GDP fall by much more than 1 percent, and yearly average unemployment rates peaked at about 10 percent. This unemployment rate was approached in both 1982 and 1983 as the Fed squeezed inflationary expectations out of the system with interest rates that sometimes exceeded 20 percent. Still, real GDP only fell a little between 1981 and 1982, and then rebounded in 1983, even though unemployment was still high in that year.

As I have said in several recent blog discussions, and in my Wall Street Journal article of October 7th, I do not expect the current crisis to develop into a major depression. I do expect that most governments will place any worldwide recession that develops, even a severe one, in the context of the sizable world economic developments during the past 40 years not mainly in the US, but in Europe, Japan, China, and most other countries. Even a couple of years of declines in GDP and relatively high unemployment will not overshadow the remarkable economic achievements during these decades. These include unprecedented growth in GDP in formerly poor to very poor countries, such as Japan, South Korea, China, India, Malaysia, Chile, Spain, Portugal, and others. Growth in mainly market-oriented developing economies swept away dire poverty from hundreds of millions of families in Asia, Europe, and South America. This sustained growth also led hundreds of millions of others into middle class status, where they could afford to buy cars, well-equipped homes, television sets, cell phones, computers, and other goods that not long ago were considered well beyond the means of the typical family in all but a few countries.

Yet, even with a recession of the type I expect, there will be increased regulation of financial institutions. These could include requirements of minimum levels of capital to assets for investment banks and hedge funds, government insurance of money market funds, and greater oversight of all types of financial institutions-in prior postsI have supported versions of these changes. Although there may be other regulations and controls, I would not expect the US federal government to hold on for long to its preferred stock interest in various investment banks. I have not supported such government equity interests, and it would be a grave mistake if the govern continued to maintain such ownership. Indeed, the government's influence over Fannie Mae and Freddie Mac contributed in a significant way to the housing bust by encouraging these institutions to make many worthless sub prime loans, although clearly other important forces were also at work in the housing bust.

On the other hand, if I am wrong, and there is a prolonged and deep worldwide depression, not simply a recession, the retreat from capitalism and globalization could be severe, as happened during the Great Depression. Many countries would increase their tariffs and other trade barriers to reduce the competition to domestic production from imports. Nationalization rather than privatization will be in favor as governments take over ownership of many weak companies. Regulation of executive salaries and other wage and price controls will become much more common. Competition will be stifled as governments encourage companies to coordinate their pricing and other policies, and change laws to make it much easier for unions to organize workers. These are not attractive prospects.

Few people have sympathy for the hedge fund managers and others who made hundreds of millions, and sometimes billions, of dollars during the boom years, Still, middle class and poor families would be hurt the most by unwise government policies and attacks on the foundations of a competitive economy. Policies that frighten entrepreneurs and discourage them from accumulating private capital and investing in innovations will hurt most of us, but especially workers in various companies.

Full post as published by Becker-Posner Blog on October 19, 2008 (boomark / email).