The eminent economist William Easterly used a recent Project Syndicate column I wrote as the subject of a Twitter poll:
As a number of comments on his Tweet pointed out, Bill was setting up a false dichotomy: that either you are for markets or against them, with the subtext that no reasonable economist could be anti-market.
The need to get away from the idea that state and market are mutually exclusive approaches to the economy was the inspiration for my new book, Markets, State and People: Economics for Public Policy. Both markets and governments – and indeed organisations that do not fall into either category such as unions, co-operatives, charity trusts or school governing bodies – are essential to the fabric of the economy. The organisation of society in ways that will continue to deliver the extraordinary progress seen since the end of the 18th century is a complicated business. There is unlikely to be a single correct way of combining individual needs, wants and choices. The mix of institutions and policies has varied considerably over time and across countries.
The inherent difficulty of collective choice is underlined by the fact that there are two parallel analyses. One focuses on ‘market failures’, the other on ‘government failures’. The benchmark economic model presumes that competitive, decentralised markets deliver the ‘best’ outcome for society, given a set of assumptions. When one or other of these assumptions does not hold true, there is a market failure. For example, one assumption is that there are no externalities – spillovers from one person’s decision to other people. When there is an externality, such as pollution from a factory as a by-product of its manufacturing, market prices will lead to too much production of the goods and its pollutants. Economics suggests various policies to correct this, such as a tax on the pollutant, or regulation to limit it. The free market school argues that such intervention will not be necessary as long as it is possible to negotiate an improved outcome; for example can nearby residents combine to successfully negotiate for compensation? Either way, the standard economic approach sees such situations as divergences from the market benchmark.
Alongside this goes the public choice school of thought, emphasising the fact that ‘government’ consists of people, who have their own incentives and aims. For instance, regulators like to regulate, gaining status from a big budget and power over the firms they regulate. The rule books and tax codes have grown steadily over time. And heaven knows there is no shortage of examples of bad, often counter-productive, government decision-making. Yet there is obviously a need for some regulation, for standards, or consumer safety. Governments need to provide public goods such as defence, basic research, and street lights. Governments can also stimulate innovation in areas where returns are otherwise too uncertain for private investors, various green energy technologies being a current example.
The boundary between state, market and other organisations has shifted substantially over time, depending on events such as the Great Depression and war or the 2008 financial crisis, on the way the economy has changed, and on the tides in economic theory. One example of how these three driving forces came together to change the boundaries significantly came in the late 1970s and early 1980s. The oil crises of the 1970s led to a period of tumult for the UK economy, with high inflation, rising unemployment and major public sector strikes culminating in the 1979 ‘Winter of Discontent’. At the same time the economy had begun to move away from manufacturing toward services, with many more women having entered the paid workforce, a trend reinforced by high energy prices raising the cost of traditional manufacturing. The third leg of the stool was the discrediting of traditional Keynesian economics due to the combination of high inflation and high unemployment, caused – its newly confident free market critics argued – precisely by the attempts at demand management.
The election of Margaret Thatcher in 1979 crystallised these trends into a set of political choices designed to shrink the state through privatisation and deregulation. How much it actually shrank is debatable but it is clear the public philosophy of markets first, state intervention if absolutely necessary, became embedded in the 1980s, not only in Britain.
We may be at another turning point, as the aftermath of the financial crisis, the digitalisation and globalisation of the economy, and a new wave of economic thinking combine to shift public policies in a more interventionist direction. But whether that occurs or not, the key message is that in many contexts, collective decision-making is challenging. Fundamental characteristics such as asymmetric information between parties to a contract or economic arrangement, or the increasing returns to scale that make an industry a ‘natural’ monopoly, are hard to manage for the collective good whether they are owned by the state or private investors. Good public policy requires not being pro or anti any single approach, but rather understanding the specific context and the needs and demands of the public.
About the author
Professor Diane Coyle, Inaugural Bennett Professor of Public Policy
Professor Coyle co-directs the Institute with Professor Kenny. She is heading research under the progress and productivity themes. Learn more