The Current Financial Crisis - Term Paper Example

The current financial crisis is the worst debacle we have experienced since the Great Depression. It is believed that we are now on a recovery path but its effects are still adversely affecting people all around the globe. The question that Friedman and Friedman seek to answer in their paper is what have we learnt from the crisis? They are of the opinion that what we experienced was not a breakdown of the economic system but meltdown of corporate (human) values (Friedman and Friedman, 4). The article outlines the many warning signs of corporate greed such as: the 1986 to 1995 Savings and Loan disaster in which 1,043 banks failed with a cost to U.S. taxpayers of about $124 billion, the colossal corporate scandals of Enron, Tyco International, Adelphia, Global Crossing, WorldCom and others, the dot.com bubble between 1995 and 2001 and the 1998 Long Term Capital Management (LTCM) hedge fund fiasco. Their argument is that the corporate world has been heading down a dangerous path for more than 20 years while governments, regulators and the society failed to put the necessary checks to stop the big disaster that was looming. In short they are saying that we are now facing the consequences of our actions. Adam Smith Smiths contribution to the study of Economics lay primarily on his demonstration of the interdependence of the different segments of the economy and of the policies to be followed to promote the wealth of a nation. He advocated for competitive markets without government intervention on the assumption that natural process within the economy have the ability to resolve conflicts more effectively than any arrangements developed by man. From his book we get the following famous quote: With competitive markets and an absence of government regulation, the resulting natural prices bring about an optimum allocation of resources in that consumers receive the goods they want at the lowest possible cost and maximum rates of growth are ensured (Smith, 2009, p.24) Smith essentially was saying that self interest + free markets + deregulation results in prosperity for everyone. The global financial crisis has taught us otherwise. It has taught us that unrestrained capitalism that is obsessed with self-interest and is unconcerned about the long-run, can lead to monopoly, inequitable distribution of income, unemployment, and environmental disaster (Pitelis, 113). However we cannot put the blame on Smith considering that he was speaking in the 18th century when the context of Economics had not yet experienced the industrial revolution nor were there words such as capitalism in use. Moral values were regarded highly and he believed that society could not survive among those who are at all times ready to hurt and injure one another. Modern professors have misinterpreted his ideals to students to the extent that he is thought of as an apostle of capitalism. John Stuart Mill Mill came about at a time when capitalism had begun to emerge from feudalism. Society was changing from being one centered on a ruler to one centered on the individual. Thus Mill was among those who were shifting economics away from an analysis of the monarchs interests to expansive national interests. Mill’s approach towards economics was mostly similar to Adam Smith’s in that they both viewed it as a subject that could not be looked at on its own, but as a part of many activities. Stuart Mill also advocated for free markets like Smith though in his case he accepted the necessity of certain interventions such as tax if there were sufficient reasons to justify doing so. Having had a background in utilitarianism Mill believed that that everyone needed to be equal one way or another and he therefore looked at equality of taxation as equality of sacrifice. His contribution to the study of Economics is mainly his issue with how much importance we should give to abstract theory and how much we should give to institutional-historical material. He argued that social forces such as custom could modify or even negate predictions based on competitive processes and therefore they must be considered in any discussion of competition and free markets. When we look at the global recession that was brought about by the financial crisis we could argue that if we had been keen on the changes in customs of our society, for example excessive greed and lower ethical standards we would have found a way to regulate our ‘free markets’. Moreover Mill’s belief that “the market might be efficient in allocating resources but not in distributing income making it necessary for society to intervene...” sound too familiar to our present day situation where CEOs take home obscene bonuses while pay at the functional levels of their organizations remain static. Karl Marx Karl Marx developed his economic theories on the base of classical economics. He only differed from the classical economists in the manner in which he expected changes to occur within a society. Marx advocated for revolutions rather than the small marginal changes envisioned by the likes of Adam Smith and J. Stuart Mill. He was among the first to value the importance to technology to an economy with its implications of increasing returns. Marx’s economic theories were mixed with philosophical and social analysis that it is difficult to analyze one without the other. One of the characteristics that distinguish Marxian economics from others was its approach of that it is the whole economy that determines the parts. This is opposite to the microeconomic theory that seeks to explain the whole economy through analysis of its parts. Marx postulated that one of the major contradictions between the forces and relations of production under capitalism is the periodic depressions that are inherent in a capitalist economy. This study of economic fluctuations led him to develop an interest in investment spending. He attributed the fluctuations in the total level of economic activity to volatility of investment spending. He also believed that from the 19th century onwards the gigantic increase in wealth and population could be attributed to the competitive striving to obtain maximum surplus-value from the employment of labor. This ability to convert and express this economic surplus in terms of money then led to large scale amassment of wealth and increased capitalism. Surplus-value and the rate of surplus-value are... the invisible essence to be investigated, whereas the rate of profit and hence the form of surplus-value as profit are visible surface phenomena (Marx, 1981, p.134) From the 1990s fewer and fewer economist are using Marx’s theories of economics especially with the fall of communism in Russia and its satellite states. Most pro-Marxist economists are searching for a middle ground between Marxism and Capitalism. John Maynard Keynes Towards the end of the 19th century there was increased industrial concentration and many monopolies were being created. Recessions and financial depressions occurred more frequently which symbolized failure of the laissez-faire form of capitalism. Economic thought shifted from defending free markets to advocating for increasing government participation through controls. Government intervention became ironically needed to assure the harmonious and beneficent workings of the so-called invisible hand of the market. It was within this context that John Maynard Keynes emerged with his economic theories. Keynesian economics view income as the chief determinant of both consumption and saving. He believed that a person saves more, not because interest rates have been increased, but because the gap between his total income and the amount needed to maintain his standard of life has widened. Secondly, Keynesian economics argue that the prevailing interest rate is determined by the supply and demand for money. Therefore according to Keynes monetary policy has a major role to play in curbing recessions and depressions through balancing of the levels of saving and investment by regulating the supply of money in an economy. For example when savings exceed investment, government could intervene by borrowing the excess savings and spending it on projects that would not increase productive capacity or decrease investment opportunities (Keynes, 2009, p.180). The central theme to Keynesian economics is that capitalism is not automatically efficient when left to market forces however this efficiency could be increased through government influence and intervention. Keynesian principles were officially displaced by Monetarism in 1979 as the primary influence on Anglo-American economic policy. However after the events of this financial crisis many present day economists such as James K. Galbraith, Robert Shiller, Nobel Laureate Paul Krugman and others have been calling for a return to Keynesian economics as the best way of tackling financial crises of such magnitude. Works Cited Friedman, Hershey H. and Friedman, Linda Weiser, The Global Financial Crisis of 2008: What Went Wrong? 9th March 2009. 25th May 2010. Keynes, John M. The General Theory of Employment, Interest and Money Collector’s ed. Hamburg: Management Laboratory Press, 2009. Marx, Karl. Capital Volume 3. Pelican ed. London: Pelican, 1981 Pitelis, Christos. “On economics and business ethics”. Business Ethics: A European Review. 11.2 (2002): 111-118. Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Digireads.com, 2009 Read More