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Financial Security in a Free Market Society?

Financial Security in a Free Market Society?

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January 25, 2011

Question: 1. I've read that the Objectivist view of Social Security is that individuals should save their own money throughout the course of their life and then live off that when they retire.  But what about cases where rampant inflation devalues a retiree's wealth or pension, so that their planning isn't sufficient to support them anymore, such as happened in post-Soviet Russia?  What is the Objectivist take on this?

2. Apply the following example to all markets:

There is no FDIC insurance; banks are private and issue their own money.  I am asked to do my own due diligence and examine their balance sheets, check their background, etc.  My reply?  I don't have the time to perform this action on every business I deal with and furthermore the risk (where my life savings is concerned) is too high.  Many banks fail and I cannot spend every day checking the financial viability of mine.  I'd sooner put the money in a vault somewhere.  People are frequently irrational and businesses (composed of people) are no different; history is littered with examples.  If someone is offered the opportunity to profit for a short time at the expense of the business failing later, why not?  The mortgage company is defunct but the lenders and agents who securitized debt for them already made their fees.  If you can make several million legally in a few years who cares what happens afterwards?

The end result is that mistrust is rampant and commerce nearly grinds to a halt; the only people you trust are those you can observe in your own community.  China appears highly unregulated, would I buy food products from them?  Certainly not.

Business owners are quite aware that people don't act in their rational self-interest.  That is why they invest so much money in theft protection systems (packaging, RFID wires, door scanners, etc.).  They know that to rely on the law to protect their property is to close the barn door after the coach has left.

The consumer, on the other hand, must extend a great deal of trust to participate in a transaction.  Purchase software and it will require that you sign an agreement after reading 50+ pages of legalese.  Where is your contract?  You don't have one, you must rely on your wits. Caveat emptor.  A civilization based purely on these principles will surely be a backwards one, the free flow of goods and services constricted by an atmosphere of distrust and mutual suspicion.

A police force is a regulatory agency of a kind that is continuously watching to make sure that no infractions are committed.  I don't advocate over-regulation but isn't some oversight warranted or are we to rely solely on after-the-fact intervention?  Would you live in a country where police didn't watch over the populace but only got involved once an accident or assault took place?  

Answer: The free market can provide as much security as a statist system. And statism is more to blame for economic instability than most people tend to think.

President Barack Obama has been at pains to argue recently that he supports the “free market,” at least as much as the free-spending Bush Administration did. What a laugh. Obama doesn’t even know what a free market is, and the Bushies should have been ashamed of the degree to which they abandoned the free market, too. Ayn Rand knew what it was:

When I say 'capitalism,' I mean a pure, uncontrolled, unregulated laissez-faire capitalism – with a separation of state and economics, in the same way and for the same reasons as the separation of state and church.
Ayn Rand , "The Objectivist Ethics" in The Virtue of Selfishness

If Rand wasn’t clear enough, let me state for the record that free market capitalism is a system in which no one is permitted to initiate the use of force against any other. It is a system without government regulation as we know it, and in which the government would have a sharply reduced role in society. Most important social activities would only have a glancing relation with government. Businesses would no more need to keep lobbyists in Washington to protect themselves than the Episcopal Church today needs to lobby to avoid being disestablished.

The free market can provide as much security as a statist system.

Can there be total financial security in a truly free market? No; but then, neither can there be in a beggar-thy-neighbor and rob-the-productive welfare state. The welfare state reacts to crisis by seizing the wealth of the productive to provide security for the unlucky and unproductive. But economic freedom, growth, and wealth are corollaries: the tighter the state controls the economy, the more blood is extracted from the goose that lays the golden eggs. There’s no security at all when there is no economic progress and little wealth for anyone.

Enemies of the free market argue that life without the welfare state would be radically insecure, an endless cycle of booms and busts. Because everyone would need to save for their own retirement and insure themselves against health risks and other dangers, everyone’s health and savings would be at mercy of the next corporate swindle or the next market panic. Everyone’s insurance would disappear with the first hurricane or the first dishonest CEO.

But consider: you just lost 40% of your income last year… and the year before … and the year before. “Wait,” you exclaim, “there wasn’t a market crash in 2007 or 2006!” Very true. But in the U.S., federal, state, and local government together take about 40% of your income every single year. Radically reducing the size of that government bite out of your pay might be worth a little instability in the stock market.

In fact, in a free market we could have sound markets. To get them, we would need to use market institutions and prudence to fill a role we often leave to the government now.

In saving for retirement, we would need to invest prudently and take care to manage our portfolios to maintain the right balance between risky and less risky investments. This could be made easy by companies selling savings plans and investment packages that would automatically adjust with the saver’s age and other circumstances. In fact, such products exist today. And if one simply wanted a steady cash payout, there are private annuities. There can be private workmen’s injury insurance. Various kinds of informal assistance could develop as well, like the mutual aid societies of the past.

Inflation shouldn’t be a threat to our savings, since almost all our wealth would be held in real assets—like gold, land, and stock—or interest bearing accounts. Without bank regulation by the government, it is impossible to force people to accept interest rates lower than inflation. In any case, long term inflation would be unlikely in a free banking system, since people would only want to hold and use the more reliable currencies.

It’s true that today many contracts are complex and befuddling. But they can be standardized and made simple. We would have every reason to encourage sound legal practice and patronize firms that don’t surprise us with hidden contractual terms. This is something we should work toward now, privately: it has nothing to with Congress or the President.

The safety of a system based in property rights and contract would depend in turn on a web of private interests. Insurance companies would play a crucial, multilevel role, as they do now, insuring us and re-insuring the insurers.

Against outright fraud there would still be the law. A government restricted to its proper role would still have a great effect.

Corporate raiders would look for weaknesses to exploit, doing us and themselves a service. Investors and shareholders would have every reason to demand sound accounting and financial management—unlike today, when everyone assumes the government will cover mistakes and set all the rules of business. Ratings agencies would matter more than ever, and watchdog groups like Consumers Union would probably be more hard-hitting and investigative. We would need to demand business journalism that really digs into the dirt. And who knows what other approaches might succeed. Take a look at Ebay: there, thousands of sellers are rated on their reliability by the people that buy from them. Perhaps internet rating systems could cover a much wider range of services and products. We can see from sites like RateMyProfessors.com that many services are already being rated by the public.

Against outright fraud there would still be the law. A government restricted to its proper role would still have a great effect. The courts would recognize certain types of contracts, and not others. Courts would accept certain accounting practices and not others. Courts would draw lines establishing the limits of reasonable caution and the defining reckless irresponsibility. There would remain such a thing as fiduciary duty.

If we found that some businesspeople were playing fast and loose—and we almost certainly will, sooner or later—we would have to push for reforms of business practice. But our push would be cultural, economic, and educational, not political. Activist groups might have to organize boycotts or seminars. They might have to hit the airwaves, the internet, and the press. Shareholders lose when business executives are irresponsible—do you think the shareholders of AIG are cheering right now?

So there is every reason to believe that in a culture without a nanny state, we would be more able than ever to improve business practice, encourage responsible behavior, and maintain social and economic progress.

Regulations criminalize innocent acts along with harmful ones. One company’s irresponsible debt burden may be a normal business structure in another industry. One person’s dangerous medicine may be another person’s life safer. And regulations need not address harms at all: after all, they aren’t tied to a deeper legal standard. Instead they are tied to the judgment—often, the whims—of the regulating officials and the political groups those officials represent.

The whole point of having a system based in rights is to ensure that the law penalizes real crimes, the kind that have victims. If there are pro-active measures that ought to be included in a business plan —like capital reserves for insurance companies, for example—then strong social forces could cause that to happen. Consider: in a world without a nanny state, organizations like Consumer’s Union, Underwriters Laboratories, and Moody’s will be investigating companies and products to establish their soundness, healthfulness, safety, etc. As long as people are rational, there will be strong demand for clear, incisive assessments of firms and products. What happens to an insurance firm, then, if CU rates it “unreliable” for not meeting the CU capital reserves standard? What if a bond rating firm existed to serve the debt holders, not the bond issuers (as is now the practice)? Then ratings will be more objective and they will really matter.

AIG obeyed all the regulations that applied to it. What it didn’t do was follow basic principles of financial prudence. Now the American taxpayer is being forced to keep that damaged firm afloat. In a better system, financial prudence would be part of the culture. A sense of individual responsibility would be a bedrock cultural value. Rationality would be rewarded, and the productive would flourish. Today, instead, irrationality is excused, and the productive are expected to be endlessly responsible for the failings of the irrational, the irresponsible, and the lazy.

Total financial security is an illusion. But a culture of rationality, objectivity, self-responsibility, and prudence: that remains very possible.