If this election is to be a national vote on the role of government versus markets to advance our nation’s wellbeing – as pundits suggest it is – it’s best that we step back to discuss what markets can and cannot do. In the process we will hopefully remember that we all benefit from a vibrant private sector and that government plays a vital role in its creation.
Economists rightly applaud the role of markets and price in particular as the invisible hand that aligns demand and supply. Compare the economies of West Berlin and East Berlin before the fall of the USSR and you can see the power of price and free markets versus a planned economy in creating an economy that responds to people’s needs.
Yes there is beauty in the invisible hand, and it generates significant national wealth. But the political far right makes a mistake in leaping to the conclusion that markets therefore maximize societal well-being. They ignore the important “caveat” section of Economics 101 textbooks: The outcome of the pricing mechanism best serves society’s needs only when three conditions are met:
- Buyers and sellers have all the information they need about prices
- Markets are characterized by free competition
- Price captures societal benefits and cost
We have more than enough information on prices in today’s internet-based world. But the amount of money in our political system leads many markets to be anything but the “truly competitive” ideal in Economics 101 textbooks. And the gap between societal costs and benefits and price is, if anything, only growing.
If a product imposes costs on others – e.g., environmental damage, not captured in price, then price will not reflect societal costs and society will overproduce that item. Weak regulation of compounding pharmacies kept their prices lower, but also contributed to the meningitis killing or worrying people who used injections to reduce pain. Similarly if a product creates benefits for others we purchase too little relative to what is in society’s best interests. If prices of locally-made products were reduced to reflect the benefit to the local economy from local purchasing, might you purchase more locally made products?
Public goods are a special case of pricing mechanisms not working. Some goods and services come with a free-rider problem – those not buying a product or service benefit from the purchases of others, leading to underinvestment if production relies solely on private markets. So we look to government to provide vital public goods – with education, national defense, a legal system, natural disaster support, basic research some classic examples. Government research is especially important today given the lack of enough good paying jobs – most of our fast growing industries have been fueled by basic research funded by the US Government.
Like democracy – it’s a terrible system but it’s the best system we have in Winston Churchill’s assessment – the free market can be a terrible system in terms of externalities and inequalities, but it’s the best system we have. But government makes the free market system much better – by investing in public goods wisely and by addressing externalities not reflected in price. Its tools to do so include regulations, tax incentives and investments. And a smart government would get money out of the political system to make our economy competitive and avoid the crony capitalism quicksand we have fallen into.
While we each may benefit more from one candidate’s policies, ultimately our interconnectedness makes society’s well being a key driver of our individual well-being and that of our offspring for generations to come. So the million-dollar question going into this election is not whether government or markets are best for advancing our nation’s well-being. The right question is, “Which candidate will use government most wisely to advance our nation’s economic, environmental and social well-being?”