I’ve never understood why people who have little faith in the workings of the market assume that government can magically do things better.

It’s bizarre when you think about it. It’s as if businessmen are irrationally driven by greed and the desire for power and prestige, but those in government are extremely wise and only concerned with the common good. Since when did we get such an exalted view of politicians?

First let’s get something straight: believing in the superiority of markets to government direction of the economy doesn’t mean that you have to have a blind faith that markets work perfectly or even well all of the time. Instead, those of us who place our faith in markets are guided by the belief that over the long haul a market-driven economy will perform much better than one where the heavy hand of government guides the outcomes.

Contrary to what many seem to believe, the current financial mess is a great example of why so much faith in the government is misplaced. That’s not to say that all the players in the market have covered themselves in glory, but only that so far the interventions by government have caused a great deal of damage during this time of turmoil.

Whatever the cause of the credit crunch—and I believe that any fair analysis would show that both government and irresponsible players in the marketplace share the blame for the troubles we are in—we can easily see that much of what government has done over the past few months has made things worse, not better.

Take the bailouts. We have heard much about how government intervention was critical to prevent a credit market meltdown—and we will never know what might have happened had things been left to their natural course—but what we haven’t seen yet is much in the way of positive results from the Trillion or so dollars that are getting pumped into the economy.

So what has all the government activity intervening in the markets done for us? So far the record has been appalling. Stocks have slumped farther and faster since government interventions began in earnest, credit market conditions worsened, and investor and consumer confidence dropped like a rock. You can pretty much date the time the credit crunch became a crisis to the week that Lehman Brothers was allowed to fail but AIG was bailed out: it became abundantly clear that government had no idea what it was doing or why.

So far the government interventions we have seen have been ill-thought-out, ill-timed, and have sent contradictory signals to the market. Far from smoothing things over and reassuring consumers and the market, Washingtonpolicymakers have created even more confusion and uncertainty than existed before they got involved. Markets responded as they always do when things are uncertain: private investors pulled back and consumers stopped spending, ensuring a serious recession. So while it’s possible that the right set of government interventions might have prevented or ameliorated this crisis, the wrong ones so far have done real damage.

The biggest mistake that people make when they assume that government can engineer better economic outcomes than markets can is to link the power of government—which is enormous—with the assumption that sufficient wisdom accompanies such power.

In reality power and wisdom are rarely tightly linked, and the greater the power the less likely it is that anybody or any institution could have the wisdom and the knowledge to use it properly. One of the great advantages of free markets is that power and knowledge are generally dispersed widely, usually limiting the damage that any individual or set of mistakes can make on the system as a whole. In fact, it’s when market players get too big and too powerful that things go seriously awry.

Ironically, the reason government officials felt obliged to intervene in the current market mess was the likely bankruptcy of financial institutions that were “too big to fail”—in other words, their failure imperiled the financial system as a whole. The same principle of course applies to government itself. Mistakes made by government ripple through the economy and can imperil the entire economic system (think of the mistakes that led to the Great Depression, which was worsened greatly by bad decisions in government).

In an ideal world the right policies at the right times might help stabilize markets when they are gripped by panics or manias. But government officials are as imperfect and as likely to make mistakes as any market actors, and as likely to have personal axes to grind—with the additional problem that their power is potentially absolute.

The problem with investing too much power in the hands of government can be boiled down to this: no person or institution is wise enough, or can be trusted with the kind of power available to government unleashed by constraints.

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