Regulating away improvement


The bailouts are getting bigger. The rescue of US mortgage giants Freddie-Mac and Fannie-Mae is hailed as the largest bailout in history. On our side of the Atlantic we saw the similar, but smaller, rescue of Northern Rock. All of these have common features. The companies concerned were nationalized, and their losses are now underwritten by taxpayers.  Between them their rescues have engendered a culture of bailout,which says that the public has to be protected at all costs from the consequences of failure.  It is almost as if there has been a collective loss of faith in capitalism and in its ability to take failures in its stride.

This is how capitalism works. Some firms are successful and make money. Others get it wrong and lose money. There are many varieties of failure: people might misread the market; they might become complacent and allow competitors to steal an edge; they might put too many eggs in one basket; they might fail to anticipate changing trends in the world economy and adapt to them in time. Some will make it through, but others will fall by the wayside. In the process of failure some people will lose money, and some will lose their jobs. Government might legitimately interest itself in their welfare, and in helping them cope with distress, but this is quite different from using public funds to stave off failure in the first place.

One of capitalism's great virtues is that it constantly renews itself. The failures are counted out, and the resources they managed, both financial and personnel, are redeployed elsewhere. It has evolutionary features, in that those unfitted to survive go under, leaving resources available for those better equipped. The comfort blanket of bailout which government wraps around capitalism's failures prevent that process from working. They keep going those firms and management teams which have got it wrong. 

What does it tell financial managers if they can keep the rewards of success, but expect government to step in with taxpayer help to meet any losses? People are more careful with money when they stand to lose it. They assess risks more closely, and are less reckless in their actions. In taking away the political consequences of failure, governments are blunting capitalism's ability to improve and renew itself. We are leaving ourselves with lame-duck firms that couldn't cut it under market conditions. Britain's former nationalized industries showed us just how sluggish, unresponsive and uncompetitive firms become when placed under the ponderous hand of the state.

It's time we looked hard at the bailout culture we're headed into, and perhaps gave capitalism a little more credit for its ability to fix these things and replace failure by success. Its record is phenomenally better than any achieved by governments.