Of Swans and Free Markets Capitalism


Temitope Oshikoya

Recent global events appear to expose the limits of the market intelligence economists. They espouse free markets and no government interventions in the markets and the economy. They seem to take economic orthodoxy as an extreme ideology on the same plane as taking religions to the extremes. This, at a time, that some of the global richest capitalists, including hedge funds managers, are calling to question unbridled free markets capitalism.

Their extreme irrational economic ideological disposition, however, tends to give economics a bad name. The classic textbook markets assume that markets are populated by perfectly competitive firms and institutionalized by efficient secure property rights and enforcement of reliable contracts. But alas, markets, especially in our climes, are far from perfect nor competitive; neither are property rights efficiently secured and contracts reliably enforced.

There are three scenarios that demonstrate the importance of government and roles of institutions. First is the emergence of Black Swans, Unknowns Unknowns, which are events that emerge unpredictably, that we are neither aware of nor understand. The Coronavirus outbreak emerged as a health pandemic that was not predicted to rock global financial markets, which have declined by nearly a third; with extreme volatility. A popular Wall Street’s market fear gauge index, the VIX, spiked to 85 from 14 in three weeks. A triple leveraged measure of volatility (TVIX) went from 40 to 1000 in the same period.

Businesses and supply chains are being disrupted, while demand is being depressed at the same time. China’s industrial production and fixed asset investment are estimated to have fallen by 14per cent and a fifth respectively. It is estimated that US unemployment rate could reach 20per cent. As the engine of growth for the global economy falters, the impacts will be felt far and wide, especially in Africa and Nigeria. Global commodity prices that low-income economies depend on are collapsing. Oil prices have declined to the mid-20s, a 17-year low, with significant fiscal and budgetary impacts, and causing exchange rate depreciations. African economies also have less reliable health infrastructure and systems to cope with the pandemic. While health-care systems in developed countries are being over stretched by the pandemic, many African countries have limited health infrastructure capacity to cope.

Fortunately, economic pragmatism is prevailing over extreme free market capitalism ideology. The Coronavirus black swan event is challenging the free market orthodoxy. In abnormal times, such as we are now, there have been clarion calls for governments to intervene to address the health pandemic, stabilize markets and address economic disruptions. The key global central banks are slashing interest rates and pumping liquidity to prevent financial markets freeze and instability, encouraging banks to keep lending afloat to businesses.

On the fiscal front, governments are scrambling to save lives, the financial markets and the economy. The US is preparing over $1 trillion or 5per cent of GDP to bail out industries ranging from leisure, hospitality, health industries, airlines, and send checks to consumers as transfers and paid sick leave. It is estimated that close to $4.5 billion of liquidity would likely be provided by the US Federal Reserve and the fiscal authorities in the US, combined. Britain is pumping $300 billion or 15per cent of GDP as fiscal stimulus, while the government promises to take care of 80per cent of national wage bill. Governments, all over the world, are not folding their arms and expecting that markets will solve all the emerging problems.

How about the White Swans–Known Unknowns–things that we are aware of but do not fully understand? At this point, the virus is now becoming a Known Unknown – the world now knows more about the virus, but we still do not know how it will fully play out. In financial markets, white swans are more common as economic vulnerabilities, financial excesses, and policy uncertainties build up leading to financial crises.

Even here, government do have roles to play through efficient macro-prudential regulations.

Perhaps of more importance in normal times are the Grey Swans of Known Knowns—things that we are aware of and understand. A central tenet of economics is that incentives including market implicit prices are essential to changing behaviour of businesses and individual agents. However, economics often take for granted legal framework, institutions, and customs that shape markets and economy.

Markets are constructed by laws and underpinned by institutions; they can take many forms, which explain, for example, different capital markets in different countries. We know that government and institutions play key roles due to market failures arising from externalities, public goods and market imperfections. In Africa, the economies–Ethiopia, Rwanda, Senegal and Tanzania– that have sustained high growth rates of above 6per cent over the past decade are those with strong governments and effective institutions. Yet, our free market intelligence economists behave as if these are Unknown Knowns—things that they understand but are not aware of.

At these abnormal times, economic policy decisions demand economic pluralism and pragmatism, not some dogmatic ideology propounded by market intelligence economists, who seem to be overconfident about the roles of the free markets, while underestimating and ignoring the crucial roles of governments and institutions in a mixed economy. In a situation of crisis, policymakers are at a cross-road, though: there is a cost to not aggressively addressing emerging problems immediately, but they also need to act in such a way that long-term moral hazards are not created within the economy. This requires a balancing act.

More than ever before, the lessons of this pandemic include appreciating the importance of building efficient and effective public institutions and infrastructure in health, education, research and development systems to support innovation and productivity for sustainable economic development.

In particular, the digital economy–Telemedicine, Genomics, EdTech, Fintech, Ecommerce, and E-cloud will end up being the biggest beneficiaries of this pandemic. But they also require investment in energy and fiber optic infrastructure, for which governments remain important facilitators and regulators.

·Dr. Temitope Oshikoya has background in economics, finance and law.