In Monday's Moneybox piece about the Long Term Capital bailout, I wrote, somewhat skeptically: "Now, it's possible to explain almost everything that's happened in the global economy over the last year as evidence not of the failure of markets but rather of what happens when markets aren't able to operate freely." On the Wall Street Journal's op-ed page the next day, Nobel Prize-winning economist Milton Friedman wrote, much less skeptically, "The present crisis is not the result of market failure. Rather it is the result of governments intervening in or seeking to supersede the market."
It's always nice when someone lives up to expectations so perfectly. As for Friedman's piece, it's an unsurprisingly well-stated argument for doing, well, nothing. However well stated the argument is, though, the piece as a whole is unsatisfying precisely because it suggests that nothing that could happen in the real world could ever change Friedman's mind about anything. Certainly what's happened to the global economy in the last year has at least made plausible the idea that the movement of capital is different from the movement of goods and services, and that the essentially unimpeachable arguments in favor of free trade may not be quite so unimpeachable when applied to capital flows. But Friedman dismisses this argument in a sentence, and never even touches on the impact that speculation has had in devastating emerging-market economies.
Now, of course, it's very difficult to distinguish between capital and goods and services, since goods and services derive their value, in part, from their convertibility into money. And there is a strong case to be made that capital controls are doomed to failure, both because they isolate nations from the global economy by making foreign investment unlikely and because they lend themselves to corruption. But it's simply willful blindness to deny that "hot money" has played an essential role in destabilizing tottering economies and, more importantly, that it has been the key factor keeping those economies from returning to growth. Yes, Thailand, South Korea, Malaysia: These countries were living beyond their means and eventually had to pay their bills. But the contagion that has spread across the emerging markets is hardly evidence of rationality on the part of investors.
Along these lines, the most curious line in Friedman's piece is this: "Emerging markets need external capital, and particularly the discipline and knowledge that comes with it. ..." But what does "discipline" mean here? If it means simply that emerging-market economies will have to listen to external capital's dictates, then it's tautological and trivial. If it means, as Friedman wants it to, "efficiency" and "rationality," then it doesn't seem to describe the past few years very well. The real estate bubble in Hong Kong, the giant factories in South Korea, and the overbuilding in Thailand were all funded by external capital. And how much "knowledge" or "discipline" did Long Term Capital impart to the countries it invested in?
This isn't a call for central planning or for the resurgence of something like Japan's MITI. There's no guarantee that a group of government planners would make any better choices than foreign banks do. In no small part thanks to Milton Friedman, economists have spent the last 20 years reaffirming the virtues of free markets. That's been to much good effect. But the battle against central planning has been won. Now it's time to abandon the pretense that markets always function perfectly when left alone, and to think about the possibility that sometimes doing something is better, and more effective, than doing nothing.