The remaining of Adam Smith’s legacy and worshipping false idols- US financial crisis , and Egypt

Adam Smith doctrines were revolutionary against the exploitive feudal system, where "Laissez faire et laissez passer” (Let do and let pass) was a connotation to individual freedom to work, trade, and more importantly, choose. A free market, in Smith’s mind, was a clear manifestation to equity and efficiency. This is crystallized by the utopia called “perfect competition”. The equality between marginal benefit, marginal cost and prices from one side, and prices giving signals to consumers and producers from the other side present a beautiful dynamic system for efficiency (or pareto optimal). As any undergraduate student of economics can tell, this mechanism maximizes consumer and producer surplus, firms make normal profits (or no economic (abnormal) profits) and consumers utility is maximized. In addition, equity comes clearer with the equality of marginal productivity and wages i.e. each worker is paid a wage that is equal to his addition to production. So, shortly and with no further complications of economics, under perfect competition, entrepreneurs get profits or return that is equal to the cost and risk incurred, and workers get wages that is equal to their contribution.

Underlying these principals lies the idea of invisible hands or keeping markets operate without any government intervention as this could lead to malfunctioning of the basic principles mentioned above, where prices would halt to give signals which will lead to inefficiencies, and social objectives become ahead of economic ones leading to inequity and inefficiencies as experienced by the public sector.

While there is no intention to challenge these principals here, I just wonder, how the current financial crisis in USA, the homeland of capitalists, reveals the discrepancy between what Adam Smith had in his mind and reality, between efficiency and equity as being professed and the exploitation not only of labor this time but also of citizens as well.

The way I see it, is that what remained from Adam Smith’s teachings are some worshippers to an idol called “free market”, thinking that through submitting to this idol they will get closer to the soul of the real god.

For those who worship this idol and perceive “government intervention” as the all-evil satan, I say the real gods are efficiency and equity.

This is exactly what happened in the current financial crisis in USA, for several months economists have been screaming out loud warning from a soon mortgage crisis and yet the government did not take any action. Does it have to be the collapse of Fannie Mae and Freddie Mac that initiate the intervention? Does it have to take down Lehman brothers and Morgan Stanly to get the government moving? According to Paul Krugman, the government should have intervened earlier after the burst of the housing bubble and the consequences of diminishing the capital of many financial institutions.

Not only had the government intervened after the collapse of the giants by bailing out their debts and write-offs, but also the bailout that initially amounts for $700 billion, and expected to reach $ 1 trillion, is financed from tax payers pockets. So, the giants were left all these years to make abnormal profits and when they fail, the average citizen bails them out!!! Why did not the government move earlier, where were the institutions that review and forecast the ability of them to sustain? Was this perceived as a critical violation to the bible of capitalism? So What??

Similar incidence occur in our part of the world, yesterday (22/9/2008) the minster of trade and industry issued a decree to import steel, and I wonder, having a market characterized by monopoly over iron billet causing steel prices to soar , was the decision of importation so hard to take? Wasn’t it an obvious short term solution to the surging prices? I also do not know what happened to the initiative taken earlier to establish steel and billet factories in Egypt, isn’t this a long term solution to the soaring prices or it’s a deal with the devil “government intervention” that scared them. The same story applies to cement industry in Egypt, a clear oligopoly case. Why did not the government allow for cement importation?

Needless to mention that monopoly and oligopoly are great violations to the essence of equity and efficiency, as in these cases, monopolists/ oligopolists maximize their profits i.e. achieving abnormal profits and decreasing consumer surplus.

Why it is always the consumer and tax payer benefit that is sacrificed?

Why factories and corporations use subsidized fuel and electricity? While the rational is that removing these subsidies will cause prices to soar? Isn’t there any mechanism to control prices and redirecting subsidy to those who need it? Again this is the essence of perfect competition, where firms are price takers not price makers, where no firm can make abnormal profits because of free entry.

Few months ago, the government declared a 30% raise in government employees’ wages, and to finance this raise, the government partially removed subsidies on fuel, which resulted in increasing prices, and combined with the international increase in food prices, inflation reached 25%.

From the first glance, one can say that government employees are left better off with additional 5% increase in income. But using simple mathematics refute this argument, as inflation increase in annually compounded pattern, while the increase in wages and the way it is structured in Egypt make wages to follow simple interest compounding or at most compounds every 5 years, not to mention the mediocrity of the wages in Egypt and level of incomes to meet with the ever increasing necessities of life.

It is understood that in theory perfect competition is an optimal solution, however, in practice; markets fail to achieve equity and efficiency. And here the government should step in and correct these inefficiencies. Needless to say, government should not create this failure by taking delayed decisions that come on the expense of the citizens.

I do not belong to the classical or neo-classical school of economic thought, but considering the current habit of making citizens the scapegoat, let me crave and dream of applying the neo-classical doctrines as being postulated, at least in their temple efficiency and equity are sought as the salvation and we are not slaves of “free market”.