In Defence of Free Markets

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by Alasdair Macleod, GoldMoney:

Why is it that no one defends free markets, and socialism, despite all the evidence of its failures, comes back again and again? Unsurprisingly, the answer lies in politics, which have always led to a boom-bust cycle of collective behaviour. Furthering our understanding of this phenomenon is timely because the old advanced economies, burdened by a combination of existing and future debt, appear to be on the verge of an unhappily coordinated bust. But that does not automatically return us to the free markets some of us long for.

Cycles of collective behaviour

Throughout history there have been few long-lasting periods of truly free markets. Contemporary exceptions are confined to some small island states, forced to be entrepreneurial by their size and position vis-à-vis the larger nations with which they trade. The governments of these islands know that the state itself is not suited to entrepreneurship. Only by the state guarding the freedom of island markets and the sanctity of property rights can entrepreneurs serve the people in these communities and create wealth for all.

This is not the normal condition for larger nations. Before the Scottish enlightenment which nurtured David Hume and Adam Smith, the benefits of free trade were barely understood. Since then, the wealth created by free trade and sound money has nearly always been the springboard for detrimental change. Sometimes a political strongman, like Mao or Lenin dictates to the people what they can and cannot do. Alternatively, a leader courts popularity by taxing heavily the few for the alleged benefit of the masses. This is the model of welfare states today. Debasement of the means of exchange is an extension of these socialising policies, furthering the transfer of personal wealth to the state.

To understand why free markets are more often than not unpopular, we must put them into a context of human behaviour. In this regard we can stylise a cycle of collective behaviour into three characteristic phases. The first is a lawless condition of no secure ownership of property rights; in the absence of enforceable law the means of possession are necessarily violent and uncertain. It is the natural condition of tribalism and pre-civilisation societies. It is the condition to which humanity returns when the cycle completes.

The second phase is the consolidation of property ownership, with enforceable laws to define and protect it. Out of the chaos that fails to advance the condition of the people comes order, and with it the aggregation of the means of production. Capital in all the forms necessary for production accumulates, and being scarce, is used most efficiently. The backbone of this phase is freedom for the individual to dispose of his or her resources at will. The pace of improvement in the human condition is governed by the level of accumulated wealth and technological innovation.

The third phase is the abandonment of free markets in favour of state control. The state, whose primary function in economic terms is to act as provider and facilitator of the law, increasingly supresses commerce by extracting escalating levels of tax. Taxes are imposed to redistribute wealth from those that earned and conserved it to those that did not. The state takes control of money, issuing its own currency which it can print at will. The damages to the economy are covered up by all the artifices available to the state.

The state regulates. The state confiscates. The state deprives its people of their freedom. The state’s demands become so insatiable, so counterproductive, so impoverishing that the economy collapses back into the first phase of the next cycle.

That is our theoretical cycle of collective behaviour. Out of chaos is created progress. Out of progress lies the course to destruction. The best of these times is the free markets of the second phase. No one defends them.

Empirical evidence of the cycle.

The assembly of German states into a unified nation in 1871 gave credence to a new socialising phenomenon, whereby Bismarck, Germany’s first Chancellor, promoted the state as a socialising entity, superseding free markets. He was the first politician to create a welfare state, introducing accident and old-age insurance and socialised medicine. Shortly after unification, in the mid-1870s Bismarck abandoned free trade and introduced trade protectionism.

His policies echoed the principles of the German Historical School, which drove intellectual thought in the Prussian administration. The Historical School rejected the classical economics of Smith, Ricardo and Mill in favour of a controlling state, backed up by analysis of historical events, hence the name. These lessons were applied to the changing conditions at that time. Workers were moving from the land into new factories, and it was the German establishment’s outdated response to an entirely new social phenomenon.

The creation of a new German socialising state and the denial of economic liberalism inevitably led to the founding of Chartalism, the state theory of money, which stated that only the state has the right to determine the currency used by the people. Georg Knapp published his State Theory of Money in 1905. He handed Bismarck the key to unlock constraints on state spending. The state was then able to consolidate its potential, both in its bureaucracy and military armament. We all know what happened: it fed into to the First World War and in 1923 resulted in the collapse of the currency.

It is worth reflecting that a cycle of events occurred taking ordinary Germans to full state socialism from a freedom to improve their personal circumstances. The start of it was promising, with the introduction of the Zollverein, a customs union between independent German-speaking states. The roots of the Zollverein were in the 1830s, consolidated and formalised in 1861. It preceded the formation of a greater Germany in 1871. It was the gateway to political union, and statist economic management.

It is a doppelganger for the development of the European Union today, but the underlying point for EU-watchers is that it was a cycle of events, taking a nation through the erosion of laissez-faire to full state domination of economic activity and monetary affairs.

In Germany’s case, the political consequences of the First World War and the collapse of the currency were not the end of the story, or the cycle. The rise of extreme fascist socialism finally led to the destruction of the German state in 1945. The return to free markets under Ludwig Erhard’s guidance followed his appointment as Director of the Economic Council for the Occupation Zone and completed the cycle.

Cometh the hour, cometh the man. Soviet-occupied Germany was not so lucky. Erhard had to ignore the instincts and orders of his fellow American and British military committee members, who were stuck in a bureaucratic militaristic frame of mind. In July 1948, without consulting them, Erhard abolished all rationing and price controls. Almost instantly, shops reopened, food became available, the suppressed mood lifted, and people began to rebuild their lives. By way of contrast, victorious socialist Britain continued with rationing until 1954, when meat rationing finally ended.

The evolution in Germany from free markets through increasingly destructive statism and back again to free markets had taken nearly eighty years from unification in 1871. Russia suffered a similar, though initially more dramatic, socialist change from relatively free markets. Instead of a progressive introduction of state control and loss of personal freedom, it was sudden and absolute. After three years of civil war and using a ready-made Marxist template Lenin seized and consolidated control. Both Lenin and Stalin his successor were ruthless in their suppression of freedom. Tens of millions were deemed to be enemies of the state, which included those who merely disagreed or of the wrong race. They were executed or sent to the gulags. That suppression lasted until the soviets had impoverished their people to the point where there was nothing left. In 1989, after seventy-odd years the USSR finally collapsed.

The German and Russian experiences tell us in their own ways that because the beneficiaries of free trade fail to defend it, free trade does not last. Anyone reading about life in Vienna before the First World War would be struck by the widespread prosperity, freedom and artistic flowering of the age, which was destroyed by the war and a subsequent collapse of the currency. It is unfashionable in our socialist times to defend those pre-war years as good times.

I personally grew up with the free-market prosperity of Britain’s African colonies; a prosperity that benefited not just the better-off Europeans but indigenous African and Asian communities as well. That was destroyed by political imperatives, the call for independence from British rule by those who had benefited from the free markets they set out to then destroy. Fully-functioning free-market economies were replaced throughout Africa by corrupt elites that still steal their way to personal prosperity.

It is no accident that post-independence African leaders embraced socialism as the justification for their actions. They argued that the European landowners had seized property which was in the communal ownership of the tribes, and that a newly-independent state had the right to seize it back. But they ignored the fact that before the arrival of Europeans there was no ownership nor property law to define it. Occupation was by force. It is a no more than a common socialist justification for the state to acquire for itself private property.

In only fifty years, free markets had taken the ordinary native in the African heartlands from ignorance of the wheel to the age of jet engines and skyscrapers. Never before have tribal communities witnessed such rapid social change. We forget the appalling conditions and routine cruelty that existed before the introduction of western capitalism. Those conditions are best summed up in a quote from Tacitus, writing about the German tribes in 98AD: “It seems feckless, nay more, even slothful, to acquire something by toil and sweat which you could grab by the shedding of blood.”[i] He could have been describing the cattle raids that still occur today in Kenya’s Northern Frontier District and Laikipia.

Nearly two millennia after Tacitus described tribal Germania, in Africa similar disorder reigned before white settlers developed the land. To escape a subsistence stasis that had seemingly existed for ever, disorder had to be replaced by the white man’s order. Through the introduction of capital and property ownership, free markets allowed the whole population to rapidly improve its condition.

Without these crucial ingredients there can be no progress. Socialism unwittingly returns civilisation to an unenlightened state by encroaching upon, then abolishing, both property ownership and the accumulation of capital. The economy is hindered in its progress, until it withers on the vine. A nation then returns to its pre-capitalist state of lawlessness, corruption, brutality and widespread poverty. Once again, cattle raiding and similar actions become the means of ownership.

But if this repetitive cycle is so obvious, why does humanity fall into the same cyclical trap time and again?

The psychology of denying free markets

Cycles of human behaviour require a build-up of human prejudice until it becomes unsustainable. One human prejudice which is little examined is why establishments frequently stick to their convictions while denying reasonable debate. As we have seen, much of the answer is that a version of self-serving economic dogma becomes central to the credibility of statist policies. We see it today with our post-Keynesian economic establishment driving economic and monetary policies, while denying the superiority of unfettered markets in these matters. Anyone who challenges the unreason of the establishment’s economics will risk personal vilification and be side-lined.

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