Twenty years ago, we divided the world's economic systems into two camps. On one side were communist, government-run economies. On the other side, capitalist, free-market economies.
Now, Chinese free-market capitalists are going gang-busters. And China's problem right now isn't too much government intrusion into its economy; it's too little -- or at least too little of the right kind. Some Chinese toy makers have used lead paint, some Chinese pet-food producers have used toxic chemicals, and makers of counterfeit toothpaste in China have used other toxins.
A basic free market principle is that when consumers cannot differentiate between risky products and good products, they'll withdraw from the market, which is what's happening to China's consumer exports. China's responsible exporters are suffering because irresponsible ones have cut corners to make fatter profits, and global consumers can't tell the difference. So the challenge for China is to rein in its rip-roaring free-market capitalists with regulations that better ensure safe products.
The American financial market is facing much the same challenge. When it became apparent that many sub-prime mortgage loans were far riskier than assumed, and were packaged with other loans, investors began withdrawing from financial instruments altogether. That's because they couldn't figure out how much risk they had taken on. So the challenge for the United States is to rein in our rip-roaring financial capitalists with regulations that clarify risk -- by, for example, forcing hedge funds to disclose more and requiring higher performance from credit-rating agencies.
The lesson on both sides of the Pacific is that free-market capitalism and government intervention are not on opposite sides of a great ideological divide. Free markets need governments to police them so buyers can be confident about what they're buying, whether it's a toy or a bond. If governments fail in this basic role, buyers will be scared off. And this will bring down even responsible sellers.
The practical question, then -- in both China and America -- is not whether you're in favor of free markets or government regulation. It's what kind of regulation is needed to make markets work.
This column is adapted from Reich's weekly commentary on American Public Radio's Marketplace.
