10/02/2012 11:14 am ET | Updated Dec 02, 2012

Laissez-Faire Is Whack

A specter is haunting America: the specter of laissez-faire capitalism. Despite consistent evidence from the past four decades that key economic sectors unmoored from regulation (investment banking, commercial banking, energy, housing, among others) resulted in short-term gains for the few, grievous harm for the many, and severe damage to the public good, free-market fundamentalists keep stoking the fires of laissez-faire anti-regulation policies.

Even more disturbing to many of us in the academic world is that the push for laissez-faire "legitimacy" by its ideological advocates runs counter to more than 230 years of historical evidence.

Free-market fundamentalists explain away the Savings and Loan scandal, Enron, the tech bubble, the housing bubble, and the 2008 financial crisis as bumps on the road to economic nirvana that would be more readily achievable if government would just get out of the way of business. They ignore the fact that these economic crises occurred because government got out of the way of business. They occurred because regulators were asleep, or captives of their respective industries.

How did we come to this pass, where it is now respectable for ideology to trump evidence, for charlatans to be recognized as intellectuals, and for self-promoting businessmen to be accorded iconic status? The answer lies, I believe, in the domination of the economic discourse by the ascendancy of conservative and libertarian university Departments of Economics and think tanks; and in the domination of the political machinery by conservative and libertarian economists hired by Republican governments from the Heritage Foundation, the American Enterprise Institute, the Hoover Institution, and the Cato Institute. This formidable political-economic complex has recently added a wholly funded "grass roots" movement -- the Tea Party -- to the mix.

To maintain this market-centric-laissez-faire-political complex, the mandarins of this architectural structure must create and maintain an "origin myth" embedded in the founding of the American Republic and its most sacred document, the Constitution, as a laissez-faire experiment fulfilling Adam Smith's politico-economic strictures of the invisible hand and rugged individualism. Accompanying this "origin myth" is a fictive narrative that holds that the historic, continuing productive monochromatic capitalist engine was derailed by class traitors like Teddy Roosevelt, Woodrow Wilson and Franklin D. Roosevelt. For free-market fundamentalists, the breach of the free-market dike of the Constitution occurred from the proto-collectivist activities of the Progressive Era and the collectivist policies of the hated New Deal and was further aided and abetted by successive welfare state initiatives by misguided Republicans like Dwight Eisenhower and Richard Nixon (housing subsidies, national highways, disability insurance, environmental protection).

The purpose and importance of the "origin myth" and the fictive narrative is to defend an ideology by dialing up a lost "golden age" and summoning its rightful heirs to this legacy of a paradisical Eden, minus the Snake of collectivism, of course. The problem with this formulation is that the years of the Early Republic and subsequent American economic history is replete with examples of governmental intervention in the economy. In short, America has never experienced the Adam Smith-invisible hand-laissez-faire economic policies embedded in the overheated minds and feverish souls of the American right.

An intensive analysis of pre-Constitution state activities, the formation and powers of the United States Constitution, and the economic activities of the first national U.S. government tells us a drastically different story -- one of extensive governmental intervention in the economy.

Prior to the Constitution, the national government, i.e., Continental Congress lacked fiscal power. Hence, governmental intervention in the economy occurred at the state level. Virtually every state, constitutionally or statutorily, sought to encourage or protect their "home industries" through subsidies or through tariffs on similar industries in other states seeking market share in their states.

State governments also set wages and prices, regulated hours of work, controlled licensing of occupations, and ran state enterprises. Many states also regularly favored debtors over creditors by altering the length, terms, and payment modes of private contracts. In short, states saw property not as sacred but as a state-regulated entity. Luminaries such as Thomas Jefferson, John Adams, and Noah Webster went so far as to declaim that states should utilize their "regulatory power" to redistribute property to non-land-owning citizens. There was also a chaotic internal interstate commerce system which saw states like New York set tariffs on goods going or coming from New Jersey or Connecticut. Virginia did the same with goods coming or going through to North Carolina and Maryland. While states were prohibited by the Articles of Confederation from making treaties with foreign nations, they were free to individually set import and export duties (a power denied to the Continental Congress).

Thus, states prior to the Constitution, exercised widespread powers in intervening in the economic life of their respective states. No laissez-faire here.

The call for the Constitutional Convention in Philadelphia in 1787 sprang largely from economic factors: inability of the Continental Congress to finance the American Revolution because states refused to provide their required requisitions to fund the war; the Continental Congress' lack of taxing and commercial powers; inability to pay off the public debts resulting from the war; Shay's Rebellion in which debtors sought to prevent the state of Massachusetts from imposing onerous taxes on Western farmers and seizing of their land; the seeming bias of other states towards debtors over creditors; the multiplicity & mutability of state laws which sometimes created a volatile investment climate. As James Madison commented in a letter to Thomas Jefferson in March 1786: "Most of our political evils may be traced to our commercial ones."

In response to these concerns, the Framers in Philadelphia created a supreme national government, granting it substantial economic powers including the power to lay and collect taxes, set tariffs on imports, control interstate and foreign commerce, set excise taxes, and set taxes on slave importation. The Constitution sets no restriction on what can be taxed! Neither does the Constitution place restrictions on what kinds of imports can be taxed. The Constitution places no limit on the commerce clause except two: exports could not be taxed, and there must be uniform duties on foreign goods entering all U.S. ports.

Besides granting the national government wide-ranging economic powers, the Constitution banned states from interfering with private contracts but placed no such ban on the national government. The Constitution prohibited state governments from issuing paper money but placed no such limitation on the national government. In short, the Constitution transferred certain state economic powers to the national government, while prohibiting other state economic powers.

Adam Smith's economic ideas exerted no influence on the pre-Constitution state governments. His influence was also completely absent from the deliberations in the 1787 Constitutional Convention in Philadelphia or in the Constitution itself. An analysis of the influential politico-economic thinkers of the Early Republic years found Smith barely visible, outshone by Montesquieu, Blackstone, and Locke. Indeed, Montesquieu, who was a supporter of governmental intervention in the economy, was much in fashion at the Constitutional Convention.

During the first steps of the new national government, laissez-faire was also absent. This was never more evident than in the first substantive act passed by the new Congress, the Tariff Act of 1789. The Act proposed three goals for government tariffs: 1. collect revenues to run the government 2. pay off the public debt 3. "the encouragement and protection of manufactures." In short, one goal of the first government was protective tariff legislation, carrying on the tradition of the pre-Constitution state governments.

The Congressional debate during the first tariff bill saw virtually every state attempting to use the legislation to protect their home industries from foreign competition: New York wanted a high tariff on malt to protect its liquor industry; Pennsylvania wanted a tax on steel to protect its nascent industry; Virginia and South Carolina sought to protect its hemp industry; New England Congresspersons wanted to protect its iron industry by placing high tariffs on foreign nails, spikes, etc. And so it went. Protectionism run rampant.

Congress concentrated on tariffs as revenue enhancers in subsequent annual bills -- but this did not stop the first lobbyists from organizing around the various industries and to annually lobby their representatives for protective legislation in the areas of rope making, coal, iron, hat making, etc.

The second obvious intervention in the American economy by the new national government in the Early Republic was the creation of the Bank of America by the first Secretary of the Treasury Alexander Hamilton. The Bank, a public-private partnership, was chartered by Congress in 1791. It was a repository of government revenues; it circulated loans to startup businesses; it controlled the money supply; and to ensure the primacy of gold and silver it insisted that commercial exchanges be carried out in specie rather than in fiat or paper money. (Ron Paul's claim that the Constitution prohibits the national government from issuing paper money is false. The Constitution only prohibits states from doing so.) The Bank of America, the national government's first Central Bank, sought a policy of stable money to cement a relationship between capital and government.

The third and fourth major instances of governmental intervention in the American economy during the Early Republic was through the treaty making process. Two treaties stand out in this regard: the 1783 Treaty of Paris between America and Britain, which brought formal independence to the United States of America, and the 1795 Treaty of San Lorenzo with Spain. The Treaty of Paris secured fishing rights for New England fisheries in the waters of Newfoundland, Nova Scotia, Labrador, and the Gulf of St. Lawrence, navigation rights on the Mississippi River and the lowering of trade barriers.

The 1795 Treaty with Spain, coming as a result of political pressure from business interests in Kentucky and Pennsylvania, resulted in opening up Spanish controlled regions in the south and west for population growth and trading opportunities. Most importantly, for the national government's attempt to further economic growth, American commercial ships were granted free navigation rights on the Mississippi River and duty-free access to the port of New Orleans. Government thus used the treaty-making process to further the economic interests of various economic sectors of the nation. No laissez-faire in evidence here.

What is to be done! Well, we must first challenge an academic-think tank complex heavily funded by wealthy right-wing/conservative capitalists intent on forging history. We can do this by creating a countervailing alternative complex committed to historical accuracy. This would necessitate funding by enlightened capitalists like Soros, Gates, Buffet, and providing wide dissemination of objective research in academic, political and popular arenas. We are not suggesting that these enlightened capitalists eschew their advocacy in issue specific solutions to African AIDS, world hunger, malaria, etc. Just that they engage, as well, in the battle for America's mind and soul.