Tuesday, October 18, 2011

Markets vs. Government VS. Markets & Government

There have been a few good posts here and as a guest on the SWEET blog/club, I am happy to see that there is some diversity among the opinions and arguments. I might have unintentionally steered the discussion toward an apparent dichotomy between Markets vs. Government VS Markets & Government in an earlier post with regard to opportunity costs and a link to Gary Becker's WSJ comment (Becker is in no way an anarchist, by the way but I am). But that discussion is not the purpose of this blog at least not yet.
I think there are two questions that must be considered and those questions are very related.
The first question is: What is the role of the government? This is a question that has been debated since people have thought about economic and political organization of the society. For some the role of the government was to protect and enforce property rights and enforce contracts. Those were the basic King's duties and most political philosophers such as Hobbes (who considered a necessary evil). Adam Smith, considered as one of the founder of modern political economy, thought actually that the government's duties extended beyond this. He thought the government should provide public goods and prevent monopolies.
But to come back to something closer to home, people like to refer to the U.S. Constitution where it says twice it is referred to the "general Welfare." The U.S. Constitution starts:

"We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America."

and in Section 8, the Constitution states: "The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;"

These two mentions to "general Welfare" have created controversy among people who interpret the Constitution and obviously interpreters often forget that the meaning of words has changed and we have to understand that the democratic process has changed a lot as well as the meaning of federalism.

Overall, I suspect the way one reads the US Constitution (or any Constitution for that matter) is highly related to one's ideology but also one's views on markets operate and what the necessary conditions to have a harmonious society.

Now enter in the picture economists who came up with the model of perfect competition, an abstract construction depicting a perfect ideal world with no market power, completely transparent, equal access to resources, and perfectly identical goods. In addition, the underlying assumptions is that property rights are well defined and enforced. In such world, markets work perfectly and adjust instantly to any changes in market conditions resulting from an external force (such as change in preferences, new information, discovery of new resources, decrease or increase in population, natural disasters, etc.).

In such a world, the role of the government is really minimum: enforce property rights and contracts. However, we live in an imperfect world with imperfect individuals. Which raised the question as to whether the government might have a bigger role than we think. Should the government intervene when markets fail? What happens when property rights are not well-defined (common property problems, externalities)? What happens when information is imperfect or some people are better informed than others (moral hazard, adverse selection, externalities)? What happens when somebody controls a resource or benefits from significant economies of scale (natural monopoly)? What happens when a group of firms or individuals decide to collude (cartels, unions)? The real world is full of these issues. Most textbooks will argue that's where we should have government intervention to tax polluters, issue emission permits, fishing or hunting licenses, mandate information disclosure, prevent firms to collude, ensure that prices are fair, etc. But also textbooks will argue that there are many instances of private solutions to these market "failures." These market failures (that we shouldn't call failures because they only are failures with respect to the perfect competition model, they are more market imperfections or market conditions) leave profit opportunities for entrepreneurs or samaritans to minimize or improve these market conditions. Warranties, privatization, consumer reports, Underwritten Laboratories, Facebook, Match.com, Amazon.com, Apple, Wikipedia, etc. are all examples of market mechanisms that have been created or have emerged to improve these market conditions. The beauty of markets is not that they are perfects or that they solve problems, the beauty markets lies in the constant evolvement of these processes where individuals alert to market conditions and profit opportunities will contribute to improve market conditions even though their goal is very self-interested. We shouldn't discount the effects of reputation mechanisms in keeping short-term oriented self-interested individuals.

There is little doubt that sometimes government intervention has improved market conditions but in effect the real question is not whether government intervention has improved market conditions but rather what type of government intervention has improved market conditions. Taking the example of the environment (which is a big concern in Alaska), when one looks at government intervention, the successful government interventions tend to have been those that simulated markets such as emission permits, cap and trade, or better privatization!. The command and control interventions of government tend to have been very counterproductive and create significant unintended consequences.

Which leads to the second question that is implicitly asked in the title of my post: when trying to improve market conditions, which is better: markets or government? The answer is not easily answered but as Becker replied in his WSJ piece, markets seem to do a better (or less bad) job than the government. This explanation in my opinion lies in two things: (1) Hayek's local knowledge argument and (2) profit-seeking (not rent-seeking, which is seeking to achieve profits by using the government intervention to obtain monopolistic privileges) is healthier than vote-seeking.

This post is already really long. So I am going to let you discuss and ask questions rather than going on an on.


  1. Markets and Government is definitively better than Markets or Government. Reason being is that in the former each decision can be parsed by a selection of constructs, whereas in the latter each decision is - rigidly so - restricted to one construct. Axiom: choices are always beneficial.

    "What is the role of government?"
    Which government?
    For what era?
    Answer those two questions and a little research can give you explicit answers.

    "What are the common roles of government?"
    Assess all eras of all governments and you can achieve a statistical way to represent which roles are the most common.

    "What are the common roles of government that people expect?"
    What people?
    From what era?

    "What are the common roles of government that the common will expects?"
    i dunno lol

  2. I don't think that answering the question to what's the role of government is conditional to what era, to what government. Government has a very specific definition that most people agree on. It's an organization that has the monopoly of the force (see Thomas Hobbs).
    You certainly cannot do a statistical analysis of what are the most common duties of the government. That's like saying because everybody does it, it must be right to do it. It's not because everybody was practicing slavery (and that in the US Constitution slavery was legal), it's ok.
    Similarly, it's not because people in different eras expect different roles from the government that some are right and some are wrong or everybody is right.
    To the last question, as an economist, I would argue that if government duties and decisions were to be decided by the common will or majority, I would think it would be the worse possible ever.
    Given the lack of economic education of the population, you can imagine how disastrous such process would be.

    My original statement was twofold. What's the role of the government? Does the government have a role in improving the functioning of markets? Which leads to the second question. When comparing government and markets, which are better in improving the functioning of markets, markets or government? The traditional answer is: it depends! My answer is: show me an instance where government is superior to markets in improving market performance. In my opinion there isn't a real good illustration where government has been better than markets at improving market functioning.

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  4. Don't you hate when you write a three page response and the website logs you out, rendering you unable to retrieve any of the information you posted? I really, really do, but main points:

    (1) I find it is vital to determine which era and which government we are talking about to avoid metaphysical development of ideas. I do agree that the development of theory is also very important, but with the plentitude of shoulders we find ourselves standing on I believe that our primary goal should be tackling problems and questions with two things: inherency and relevance. We need to ask the questions of today!

    (2) You can _definitely_ create a statistical representation on which roles of government are the most common. All it takes is counting. Information is limited, like always, but that's not incapacitating. I believe we have a misunderstanding and I apologize if I was unclear, but I would like to give you the chance: Can you explain what you meant when you said it is impossible to do a statistical analysis of the common duties of government?

    (3) You had a straw-man argument: I didn't claim that that the common roles of government are the most beneficial ones. Nay, under the right circumstances I would argue the contrary! My purpose when stating the series of questions was to illustrate the need to ask better questions. Sorry for the confusion.


    I do believe that there are instance of government intervention that created a benefit for the economy. I would argue that while there are private sector solutions to problems like Monopolies and Externalities that the public sector produces solutions more efficiently. I would also argue that the private sector hardly has an answer to the way people neglect investing in Public Goods and the way the market encourages Inequalities.

    If you're up for discussion, just say the word.