Wednesday, April 25, 2012

When Markets Aren't Enough...

American society, and capitalist economies in general, has achieved unprecedented levels of prosperity by utilizing competition and private markets. Both of which have proven beyond doubt to be among the most essential tools for human advancement. Few dispute this. In fact, in the last few decades economists across the spectrum of ideas have all come to regard the preceding claims as truth.

Still, many remain unsatisfied. Some in the economic community, Cornell's Robert Frank being a prominent example, argue that a capitalist economy, while generally beneficent, creates sub-optimal outcomes. The existence of poverty in all capitalist economies is proof of this. They have a point. More disputably, however, they carry that point further and argue that sub-optimal outcomes imply a need for positive government intervention to correct the situation. This is where agreement ends. The counter-contention to this is a negative one. Mainly, that intervention by public actors to improve private outcomes inevitably worsens the situation. This, they argue, is because the government lacks the information needed to accurately assess and correct the situations that lead to poor outcomes. The former contention, that market failures and undesirable outcomes demonstrate a need for regulation, planning, and income redistribution, has been vastly more successful in the past century than the latter. Together with the widespread acceptance of a need for intervention, we have seen the widespread adoption of the modern welfare state. Critics of intervention still maintain their negative position. But while they never quite lost the argument, they have lost a large share of influence.

Let's assume that they were wrong. Assume that, as it turns out, government intervention can improve the situation on behalf of those in poverty sufficiently enough to outweigh any costs or unintended consequences of public action. How, then, should the defenders of the market order and critics of government action respond? In short, what should redistribution look like in the context of a market economy?

One of the oldest cases against government redistribution is that private redistribution is more efficient. Critics of welfare programs also argue that, if they are removed, private charity will swell to take the place that government programs formerly occupied. Both may well be correct, but, even if we ran the experiment, we can never fully know if the resulting outcome would be the best one possible. Moreover, there are reasons to think that it wouldn't. In spite of their enhanced efficiency, private, nonprofit organisations have their own share of problems that inhibit their ability to reduce poverty. Funding is one problem. This is because charities rely on private donations to make their activity possible. It's easy to assume that there exists enough good will in people to solve any problem, but the real world is not so simple. Private donors face a strong disincentive to give, knowing that by doing so they cannot ensure that others will be as generous. Sometimes, the knowledge that others are giving can be a direct disincentive to donate. Why sacrifice for a cause that the Bill Gates's of the world could solve relatively painlessly?

If the result that I've outlined is correct, and private charity would be inadequate if it was provided by purely private means, then the obvious place for government intervention would be to increase facilitate charitable activities. This could be achieved in numerous of ways by public policy, but one of the least distortionary ways to do so would be by incentivizing private giving. We already do this, by allowing taxpayers to deduct charitable donations from their taxable earnings. Such a modest scheme would be few objections even in the most capitalistic societies. If the level of charity is still perceived as insufficient, the level of private donations could be enhanced further by a system of matching donations. For every dollar donated, a donor could receive a reduction in their taxes owed by some portion of that amount. Thus, donors will give larger sums to charity knowing that it only cost them a fraction of the amount that they spent. This will preserve most of the same incentives by private donors to chose the worthiest causes to direct their money toward, while having a positive effect on the volume that they do so at.

I am not fully convinced that there is a case for government redistribution. It may turn out that, at a certain extent, additional private charity stops being beneficial to the citizens that it tries to help. But it is important that defenders of a market order propose realistic alternatives to the status quo, even if they are less than ideal. With the case for public welfare so far from being discredited, society should at least attempt to provide such services in the least-harmful manner. We can safely assume, regrettably, that we won't.

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