Must markets conform to government policies?

By Christopher Lingle

HONG KONG (JP): With world markets rocked by a mood of uncertainty, it seems appropriate to seek policy responses to what appears to be a cycle of boom and bust. Two separate camps have formed to point the way ahead.

One group would have greater and more universal controls over capital markets. Another group insists that such policies would be at best ineffective or worse, could deepen the current sense of despair. The dispute reflects an interminable dispute over the appropriate role of governments in economic affairs.

The basis of this disagreement resides in the question over whether severe booms and busts are a natural and inevitable outcome of market interactions. This dispute goes on despite centuries of evidence that market forces encourage moderation and inspire a process of discovery of a stable center.

As such, markets tend to shun extremes and punish those who stray there. The evidence of these claims? If markets were not inherently stable, they would have spun out of control long ago. The fact that markets continue to be widely viewed as a mechanism that encourages growth and fosters gains in income and employment is the best indication that they are stable.

Yet many observers claim that this stability is the result of a prudent set of remedial government policies to guide markets. While governments can take steps to facilitate commercial interactions, the role is for establishing fundamental institutions and rules rather than implementing interventionist policies to guide or alter the outcomes.

In short, governments serve markets best when they install basic institutional arrangements that guarantee openness and equitable treatment of all players. Most of these institutions evolve through market interaction and co-mingle with other elements of a community, including its culture.

An examination of those emerging market economies that are suffering provides strong evidence that the underlying problems arise from a failure of governance and not a capricious market.

Ironically, government policies that were previously identified as the basis for East Asia's high economic growth rates can be seen as the cause of the region's downturns.

The one truth of the ever-evolving global market place is that change is a constant and that competitive advantage is transient.

So prescribing the role of governments in the face of new and changing global realities depends upon the interpretation of how markets work and what conditions make them work best.

Many promoters of capital controls view recent market turmoil as the outcome of a dark, conspiratorial process. It is often suggested that markets can be directed and controlled by a few powerful groups or individuals.

Some blame hedge fund managers or "Jewish bankers" or perhaps both. Such views endure despite the evidence that the market also punishes the powerful and wealthy.

An alternative interpretation of markets is that they reflect nothing more sinister than the choices of many different and dispersed individuals. If there is an enemy, it is us.

Markets are simply a mechanism that provides people the opportunity to test their talents, skills or products to discover what values others place upon them as discovered by an exchange process.

Capital markets operate in the same manner as other markets. What is different is that capital markets involving the trading of risk and expected returns instead of goods or commodities.

Like other markets, traders in stock, bonds or mutual funds include workers, teachers, homemakers as well as venture capitalists. Their actions in these markets result in a constant re-pricing of risk through repetitious purchase and sale of these financial instruments.

Limiting the free choices of people in markets involving exchange among consenting adults should only be allowed when very strict criteria are met.

Limits on economic activities are inescapably linked to restrictions on political choices or actions. People should be allowed to protect their freedoms and preserve their economic assets by having a voice in how they are governed.

The most obvious mechanism of voicing their concern is being able to vote. However, in single party states or authoritarian variants of democracy, votes may count for little.

Another option might be to "vote with their feet" and migrate.

Global capital markets represent a new option for citizens to express their support or disapproval for government policies. Open capital markets empower citizens by allowing them to place their savings in foreign currencies or internationally-traded assets. When citizens or foreign investors become unhappy with domestic policies, they can send a signal by sending their assets abroad.

Restrictions upon capital markets unavoidably disenfranchise many citizens that need the most protection. The real struggle over the efficacy of capital controls is not just between economists with opposing views of the operation of markets.

Many governments are simply loath to give up the power they have held so long over so many. So they seek to reduce the power available to their citizens to challenge the efficacy of their policies.

Unsurprisingly, many regimes that are considering restricting freedom of capital flows have a record of restricting political freedoms. Authoritarian leaders do not trust the judgments of their own citizens.

Many of those who favor capital controls are generally happy with wider aspects of control over the economy. Indeed, many have only recently abandoned support for trade protectionism in order to shift the battle to capital controls. For them, markets are simply not to be trusted.

In essence, those who clamor for market controls do not trust people acting as individuals to conduct their own affairs. This distrust of markets actually goes against the most basic precept of democracy. Governments should bend to the expressed will of the governed.

As markets have become more global, they offer an enhancement in the communication between governments and the governed. Consequently, global capital movements have increased the accountability of leaders to their own people. A strong argument for free and open markets relates to their contribution to the strengthening of political freedom and citizen's power.

The writer is global strategist for eConoLytics.com (CLINGLE@eConoLytics.com).