Free Market: Hey, government! Would you like to intervene?

I do not mean to sound satirical with the title, as if a foe is trying to invite a long-time rival to a social outing. The truth is free market has always been at odds with government since free market capitalism had been championed by Adam Smith in the early days. But recent financial climate, particularly some significant events currently unfolded in United States have fundamentally shifted our opinions and possibly shattered some long-held beliefs as well. So it is worth revisiting the argument on free market and the roles of government.

It is like a vindication to the economic policies strongly advocated by Joseph E. Stiglitz and other critics of free market, they have always been the leading voices of a balanced approach of free market with effective government intervention. Particularly Dr Stiglitz who has elaborated extensively on how rapid deregulation, privatization, unfettered trade and capital liberalization have brought massive economic turmoil in developing countries and formal communist states.

Two recent events in the financial market are widely believed to be major development in the history of US economy. Because the champion of free market needs heavy government interference in the bailout of Bear Stearns and the takeover of Freddie Mac with Fannie Mae. It is a heavy blow indeed to those who always believe free market will always work efficiently when motivated by individual incentives. Unfortunately the recent financial crisis reveals that is a flawed theoretical assumption because it overlooks individual incentives may lead to massive misallocation of fund. As evident in this crisis induced by mortgage financing disaster, creditors lent indiscriminately during property boom even though borrowers might not be credit trustworthy. Without proper lending regulation in place, excess profit motivation went unchecked. When massive defaults and foreclosures happened, it precipitated the meltdown of financial market.

What is striking is that it happened in a mature economy with sound infrastructure in place. If US simply could not sustain an unrestricted free market model, I doubt if developing countries could without government involvement in creating sound market policies, infrastructure and global competitiveness. Even if they could, historical accounts will remind them sometimes through their own painful experience that they really should not. This is exactly the reason why they stand firm despite barging amount of criticism mostly from developed nations in the most recent rounds of WTO talks, for putting up protectionist measures on their nascent industries.

The shifting tone will be even more visible in the future, it is not about whether nations should or should not liberalize their markets, neither it is about how fast they should, but the lingering question will be the level of government intervention necessary in the process of market liberalization to make it truly work. Finding that balance will likely to remove much pain.