Last year during the height of the banking crisis I remember Larry Kudlow stating that the US market has a choice. It could pursue the EU model of high regulated markets producing low consistent returns or the American model of less regulation and volatile cycles of high risk and potentially higher returns. If the sole focus of government was the peace of mind and well being of investors Mr. Kudlow’s observation would be valid. Government however must consider a larger community of stakeholders in its scope of concern. Regulatory oversight, the harmony of capital and labor and the incubation of an economic culture that is favorable to and supportive of SMEs are the critical questions confronting all governments particularly those in developed economies.

The EU’s social democratic economic models embody the best and worst aspects of these issues. The social democratic state attempt to combine entrepreneurial impulses of capitalism with the management and administration of social welfare for all its citizens. Democratically “elected administrators” use the apparatus of the state to facilitate and manage the competing interests of capital and labor, free markets and regulation while seeking to balance an entrepreneurship friendly culture with long term sustainability.

Yesterday a toxic tsunami of aluminum sludge coated 16 square miles of pristine Hungarian countryside. It is a telling example of a severe risk event that confronts modern life. A lassiaz-faire approach to the event is not viable and offers no solace to those harmed by this assault. Communities cannot be asked to suffer a market response that promises to correct the problem of the next instance of this event. The construction of better berms and the implementation redundant protection devises to safeguard against this risk for the future is little compensation to those who were killed, injured and lost property or livelihoods as a result of MAL Zrt poor risk management practices.

Better to suffer a regulatory initiative that is based on an understanding of an economic ecosystem as complex and inhabited by competing interests of diverse stakeholders. The ecosystem including the shareholders of MAL Zrt, residents of the surrounding communities, plant workers (also community residents), small businesses (SME) and down stream farmers making a living on arable land and access to clean water all have a stake, albeit competing, in the safe operation of the plant. The possibility that the toxic sludge may find its way into the Danube poses a threat to the water supply of other eastern European nations. This elevates this catastrophic event to other EU jurisdictions. The inter-dependencies and interconnectedness of the pan-regional and larger global economy requires vigorous regulatory safeguards, mitigation initiatives and enforcement response.

The true cost of this event is potentially staggering. It supersedes the narrow interest and economic value of shareholders rights and capital invested in MAL Zrt. Bad economic behavior exemplified by BP’s Horizon Deepwater failure to install redundant protective devises to keep production costs to a minimum, ended up costing BP shareholders and Gulf Coast stakeholders dearly.

State intervention in markets and the reemergence of managed economies is a reality of the global economy. The “managed economy” of the Peoples Republic of China places western style “free market” economies at a disadvantage. The managers of the PRC efficiently deploy and manage capital, effect trade and market protections and scrupulously manage currency valuation. It has created enormous social wealth for China and has contributed to its rapid rise as a preeminent world power. China’s rise requires better coordination of private capital and government to marshal a competitive market response to the challenges posed by managed economies to free and open markets of western democracies. The massive pools of capital deployed by sovereign wealth funds of oil producing regencies and the growing insurgency and power of underground economic activity also pose significant challenges to the viability of unregulated markets.

America’s free market model that eschewed regulation since the 1980’s evolved into a mercantile economy with a weakened economic base. The outsourcing of manufacturing infrastructure loosened free market impulses that left in its place a debtor nation whose warped economy depended on housing/commercial real estate construction (collateral creation/securitization), credit marketing, retailing and a service sector that was designed to support the new economic paradigm. It is a model that has proven itself to be wasteful, costly and unsustainable.

Deregulation has led to the dislocation of the capital markets from the real economy. It has contributed to the massive disparities in social wealth and a crumbling infrastructure. Milton Friedman’s mistaken belief that free market impulses would preserve infrastructure investment has been proven incorrect. Ironically this has added to the government’s burden to provide social assistance to segments of the population disenfranchised from economic participation. Some believe that the basis for the prosecution of the wars in Iraq and Afghanistan are economic stimulus programs designed to keep the economy going due to the vacuum created by the loss of manufacturing.

China’s example nor the resurrection of the soviet socialist model is not a desirable alternative for western democratic capitalist societies. Centralized control and state economic planning is rife with inefficiencies. State run economies threatens liberty, stifles innovation and encumbers economic dynamism. The virtues of capitalism (innovation, dynamism, liberty) needs to be encouraged and blended into the new economic reality of a highly dependent and interconnected world that requires cooperation, coexistence, sustainability, fair asset valuation, and the equitable sharing of resource and responsibility. SME’s are at the forefront of innovation, value creation and dynamism and will play a leading role in the creation of new social-political values as sources of sustainable growth and wealth in the emerging economic paradigm.

Risk: regulatory, capitalism, sustainability