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Tuesday, Aug. 5, 2003

How the reforms have failed

"Market fundamentalism" describes the view that it is desirable to leave all economic activity to a free market. This is because a free, competitive market is "efficient" or, more exactly, "cost-efficient," say advocates of this theory.

Adam Smith's "invisible hand" is equivalent to a market mechanism. He theorized that laissez faire -- the policy of allowing the free pursuit of self-interest -- would lead to the maximum well-being of society. This theory has been considered a basic tenet of economics based on market fundamentalism.

In "The Wealth of Nations" published in 1776, Smith convincingly contravened the then universally held view that the public good was the ultimate goal of society and that controlling the pursuit of self-interest would help achieve the goal.

Smith, a professor of ethics at Glasgow University, was a pioneer in modern economic thought, or market fundamentalism. Although the theory would not take the world by storm until the late years of the 20th century, it was part of the classic liberalism that flourished in England from the 1840s to the 1870s.

In 1926, John Maynard Keynes wrote the book "The End of Laissez Faire," an antithesis to Smith's theory. Keynes' economics was based on the judgment that the market was imperfect.

If the market were perfect, it would be desirable, as the neoclassic economists said, to leave all economic activity to a free market. Unfortunately, the market is not perfect. A few examples:

* Prices lack elasticity. This causes constant imbalances in the market. Theoretically, there should be downward pressure on prices at a time of excess supply and upward pressure at a time of excess demand, but such dynamics often don't apply.

* A situation in which supply matches demand should produce an equilibrium price structure, but the equilibrium changes with conditions. Theoretically, shifting from one equilibrium to another should require little time; this is the nonfrictionality of the market. In actuality, though, there is some friction in the market. Unsold stocks and merchandise shortages, however temporary, demonstrate there is friction in the market.

* Market participants base their actions on expectations. If they expect price rises, they will rush to make purchases; if they expect price declines, they delay purchases. Neoclassic economists assumed that people could accurately forecast future developments, but in reality, consumers, businesses and governments lack such ability.

With this in mind, we can appraise the performance of Prime Minister Junichiro Koizumi's market fundamentalism-based reform agenda. Keynes said government intervention in the economy was essential because the market was imperfect. The basic philosophy shared by the supporters of Thatcherism, which swept Britain in the 1980s, and of Koizumi's reform agenda is that to reduce the size of government, efforts should be made to bring the market closer to perfection.

Thatcherism succeeded in moving the market to near-perfection. However, market fundamentalism-driven reform is accompanied by side effects such as widening income gaps and deterioration in the quality of public medical services and education. And in 1997, these problems brought an end to 18 years of Conservative rule in Britain.

Koizumi has been pushing various reform programs -- such as transferring postal services from government control to a public corporation, changing national universities into independent public corporations, raising hospital fees under health insurance, easing monetary restrictions quantitatively and injecting public funds into the financially troubled Resona Bank. But I seriously doubt that these measures have removed some of the frictions in the market and increased price elasticity.

Koizumi's reform programs have failed to move the market closer to perfection, yet they have had a serious downside, such as rising unemployment and declining stock prices. The success or failure of reform depends on the speed of its implementation and the procedures used. I believe that Koizumi's reforms have failed in these respects.

Takamitsu Sawa, professor of economics at Kyoto University, is also the director of the university's Institute of Economic Research.

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