Is this the end of laissez-faire capitalism?

It's an inconvenient truth, to borrow a quote from Al Gore, but it's one that investors should heed, if they seek a U.S. economy capable of sustainable GDP growth and an investment stance that's correct for the age, the new era.

The truth: laissez-faire capitalism -- like orthodox communism -- has been discredited. That era is over.
If one doesn't agree, take a look at the banks. Take a look at the financial system. Then take a look at the Dow and the U.S. economy, and what laissez-faire-backed executives and management did to the nation: first, they sold-out employees, then shareholders (they sold out shareholders, their owners -- scandalous!), and now the U.S. taxpayer -- that's us -- has to pay the bill.

Pure capitalism laid bare

Laissez-faire capitalism, also known as pure capitalism or market absolutism, is basically the belief that markets are self-correcting, self-policing, and self-regulating. Laissez-faire proponents also believe the state should be minimal in size and merely an arbiter and a mild regulator: this economic philosophy has failed abysmally. For example, had the United States government done exactly what the market absolutists wanted in just the AIG (AIG) case -- not intervene to save AIG -- the U.S. financial system -- and quite possibly the global financial system -- would have collapsed. Most certainly, credit markets would have been under much more stress than they are today, and that's a lot, given that credit markets today remained constrained.

(Laissez-faire capitalism also said 'Let Lehman Brothers go bankrupt.' The federal government did, and we're still living with the consequences today: constrained credit markets. In fact, we're still trying to normalize credit markets after the damage of that mistake. Many economists believe the non-bailout of Lehman may ultimately be viewed as one of the biggest errors in the crisis management process.)

Further, AIG is just one consequence from one laissez-faire call to do nothing. That doesn't count U.S. government interventions to-date to attempt to stabilize Citigroup (C), the Bank of America (BAC), Fannie Mae (FNM), and Freddie Mac (FRE). In the case of Citigroup, does any one really believe that inaction by the Fed and U.S. Treasury would not have led to Citigroup's collapse? It's folly to think that Citigroup would not have collapsed. Now picture the financial and economic shockwaves from a Citigroup collapse.

The U.S. economy is another example. The laissez-faire policy would have recommended cutting taxes on businesses and wealthy individuals, cutting federal spending, and further reducing federal regulations. Does anyone really believe that the way out of this $2 trillion GDP hole is to just cut taxes and cut federal spending? The U.S. economy needs stimulus -- lots of stimulus -- to compensate for the $2 trillion recession hole -- not just tax cuts that may or may not be invested in domestic assets.

The future: mixed capitalism

The era of laissez-faire capitalism ended with the 1992 election of President Bill Clinton, who immediately recognized its flawed economic theories, and steered a centrist-oriented, populist, middle course that led to the longest, peacetime, economic expansion since World War II and the creation of 22 million jobs during his presidency -- the 'Roaring 90s.'

Even so, laissez-faire got a reprieve with the close electoral victory in 2000 of President George W. Bush, who successfully repealed one Clinton policy -- the tax increase that helped balance the federal budget and create budget surpluses. One can see the result from that mistake and other policy errors: massive budget deficits, a large trade deficit, no energy policy, fewer than 5 million jobs created in 8 years -- the lowest for any 8-year president -- and the U.S.'s worst recession in generations. Yes, it's true -- it's hard to believe now -- but the federal budget was actually in surplus under President Clinton: the nation was paying-down the national debt. Bush 44 altered all that. The American people saw and experienced that alteration and issued their verdict in November 2008.

Further, one of the biggest errors the laissez-faire advocates make is assuming that the problems today just concern the middle class and select workers. If they establish policies that win back the middle class, and a few workers, they'll be vaulted right back into power.

But what they fail to see is that President Barack Obama's coalition contains not only the middle class and the working class (the latter having gained almost nothing, economically, during the Bush 44 years), but also the working poor, the elderly, the disabled, and the underclass, in addition to many young voters, and liberal professionals. In sum, Obama's coalition is vast and the policies needed to address that coalition's concerns are not found in laissez-faire economics, although it's possible (but not guaranteed) that Obama may incorporate some of its tenets, if some work. President Obama will select these on a case-by-case basis, based on effectiveness.

Moreover, the problems presented by the underclass have always frustrated the laissez-faire proponents. For decades, the Laissez-fairists have conveniently ignored the fact that every other major industrial democracy has better anti-poverty programs than the U.S. "We're not Europe" was their response. For them, "If you're poor, well, then, you're poor." That stance may have been appropriate in the 1980s during the Reagan era. It is woefully inadequate today, given the nation's massive increase in wealth since then, what we know about poverty's origins, and the complexities of modern life.

And that sort of summarizes the essence of the laissez-faire stance today: it is still in the 1980s. The laissez-faire proponents prefer large tax cuts for upper income groups, local control of school districts, and favor a strong stance versus Soviet communism. But the world has moved on.

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Financial Editor Joseph Lazzaro is writing a book on the U.S. presidency and the U.S. economy.

What's your view of pure capitalism? Do you think it still has a chance? Or is mixed capitalism the future? Let us know what you think.
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