Redrawing the Boundaries

• Author: Roger Bootle
• Position: Managing Director of the London-based consulting firm Capital Economics
• Pages: 34-35

Page 34

Rethinking the role of the state and markets

Economists should be used to shocks. When the Berlin Wall fell, there was little on the stocks about how to make the transition from a totalitarian state with a centrally planned economy to a democratic society with a market economy. In the years that followed, a whole new aspect of the subject was developed-and many brilliant careers were forged.

A similar act of reinvention is needed now, in light of the current financial market turmoil. It is not that many people in the West-and, let's hope, not that many economists- will want a shift to central planning and extensive public ownership of businesses, but the boundaries between government and the markets are now back in the melting pot.

In a sense, we have been here before. But that makes this all the more disturbing. The events of the 1930s brought a revolution in economics-but not before they had ushered in a period of political revolution that led to untold human misery.

Lessons learned

It is impossible to give a summary of the lessons of the 1930s that will please everybody. But this is my attempt at a distillation. First, economies can get stuck in a state of depression from which individual actors, whether people or companies, can find no escape. The state is the only agent in society capable of working for the collective interest on a suffi cient scale. Moreover, this is its duty-first to try to prevent a depression and then, if it occurs, to get us out of it.

Second, the financial markets are different. Huge uncertainty and long time horizons make the markets subject to wild swings of sentiment and herd behavior. Because of the importance of the financial markets for real economic activity, they cannot be left to their own devices. They require intervention, management, regulation, and restriction.

Revolution and counterrevolution

This Keynesian view of the macrorelationships between markets and government broadly held sway in most Western countries throughout the postwar years until the 1980s. But then a counterrevolution overturned it. In the intellectual world, the driving force was Milton Friedman, who argued fervently that markets were rational and effective. Governments, by contrast, were ineffi cient and often irrational. What's more, they weren't even always...