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Does the financial crisis signal the end of free markets and a return to state intervention?

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At a recent videoconference with journalists, I was asked the question in the title of this post several times.   Does the fact that private banks in the United States are going bankrupt mean that the free market system is a failure?  Does the fact that the United States government is bailing out these banks and in some cases “nationalizing” them mean that state intervention is back?

In a word, “No.”  First, any financial system needs some form of government intervention, a point lucidly made by Bob Shiller.  The problem with some aspects of the financial system in the U.S. is not that there was no government intervention, but that it was flawed.  The solution is to improve government regulation of the system.  This however takes time.  Meanwhile, there is a danger of the system collapsing, which is why the government is bailing out various institutions. 

What are the lessons for developing countries in general, and Africa in particular?  In many countries, the extent of government intervention in the financial systems was so great to begin with that the system had become “stuck.”  Think of the various directed credit programs, where government banks lent only to politically-connected families, rather than the most productive people in the country.  In these circumstances, less government intervention, not more, would improve access to finance.  The key word here is “less”, and not “zero.” 

More generally, the discussion of state intervention and markets refers to other areas than finance, such as goods and labor markets, where also there are market failures but, as my friend and former colleague Bill Easterly points out, there are also potential “government failures”


Shanta Devarajan

Teaching Professor of the Practice Chair, International Development Concentration, Georgetown University

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