Downing Street and Whitehall

Markets good, government quite good too

Ten years on from the global financial crisis – and the government bailouts that saved the financial system from collapse –  the UK Prime Minister gave a speech at the Bank of England, extolling the virtues of free markets.

A free market economy, said Theresa May, “is the greatest agent of collective human progress ever created” and “led societies out of darkness and stagnation and into the light of the modern age.” This was strong, stirring stuff. It channelled Adam Smith’s 18th century description of the “invisible hand” of market forces, creating benefits for all from our individual self-interest.

May didn’t mention government, though she has in the past: “too often the state is a poor provider of services, and its monopoly over the delivery of those services must end.” This had echoes of Margaret Thatcher’s determination to “roll back the state” and Ronald Reagan’s assertion that “government is not the solution to our problem, government is the problem.”

From Thatcher and Reagan on, the majority of UK Conservatives and US Republicans have had an unquestioning faith in the market as the only way to organise economic activity. May spelt this out too: free markets, she said, are “unquestionably the best, and indeed the only sustainable, means of increasing the living standards of everyone.”

These tenets of the Conservative/ Republican creed have, over time, led to a simple refrain: markets good, government bad.

Pick up a modern economics textbook, however, and you will get a more balanced picture of markets than the eulogy painted by May. Make no mistake, modern economists think markets can be pretty good too. In Macroeconomics in Context (Goodwin et al., 2014), the authors state that markets allow “many separate decision makers, acting on decentralized information, to coordinate their behavior, resulting in highly complex patterns of voluntary exchange transactions.” Markets for cars, building materials, washing machines, etc (so called private goods), fit into this description.

Nevertheless, the book also recognises that “the idealized model of a completely free private market (as in the basic neoclassical model) rarely exists in practice.” Market regulation and public provision are important parts of actual market-oriented economies.

Real-world markets are regulated because “problems such as poverty, inequality, environmental degradation, and declining social ethics may be caused or exacerbated by unchecked and unregulated markets.” It’s not hard to think of examples in the UK: fuel-poverty due to energy costs, access to housing, pollution from diesel emissions, and payday loan sharks. Theresa May recognises the need for regulation, though often appears reluctant to use it: a cap on energy prices was proposed, withdrawn, and has now been proposed again.

Government planning and provision happens because “markets on their own are not well-suited to addressing certain kinds of economic problems … some goods cannot, or would not, be provided well by private individuals or organizations acting alone.” Examples include the police, roads, and law courts. A police force protects the whole community; roads can be used by anyone; the legal system is available to all. These are public goods. No one can be excluded from using them if they are supplied (they are non-excludable); and using public goods does not reduce their availability to others (they are non-rivalrous).

“Because it is difficult to exclude anyone from benefiting from public goods, they cannot generally be bought and sold on markets … it often makes sense to provide public goods through government agencies, supported by taxes, so that the cost of the public benefit is also borne by the public at large.”

Macroeconomics in Context, Goodwin et al., 2014

Can you recall any Conservative/ Republican speeches extolling the virtues of government and taxation in providing public goods? I can’t. Perhaps because the idea that public goods are best provided by government agencies (and funded via taxation) threatens their core belief in free markets as “the best” and “only sustainable” way.

Not all economic goods fall neatly into the categories of public or private – some have characteristics of both. Even in these areas, there is evidence that markets are not “the best” and “only sustainable” way of organising services.

Health is an example of a sector where provision can be public, private, or a mix of the two. US healthcare is predominantly private (market-based) whereas UK healthcare is predominantly public (government-run). The UK National Health Service is high quality, efficient, and popular. It came top of the latest international survey of health systems, with the American market system coming bottom. The UK service costs 9.9% of GDP and is accessible to all, while the US system costs 16.6% of GDP and excludes 28 million uninsured Americans who cannot afford to access the market.

The point is, there is an alternative model to the market. For some goods, a government planned service can be efficient and deliver the outcome that you want – in this case, universal access to healthcare based on medical need.

The exclusion of so many US citizens from their healthcare market is a reminder of something the Conservatives and Republicans don’t talk about: free markets have inequality built in. In her speech, Theresa May sketched out a description of her idealised market. Here’s the first line: “It consists of an open market place, in which everyone is free to participate …” It seems uncontroversial enough so far, but already there’s an issue: you aren’t “free to participate” if you don’t have enough money.

Here is the economics textbook on participation in the market as a potential buyer.

“There is one additional reason to look closely at the standard market model. This is its assumption that, when the market functions in a smooth, idealized way, taking decisions out of the hands of individuals, the results are purely “objective,” with no bias toward any person or group. In fact, this model does have an undeniable bias, toward those with money – and a larger bias toward persons or organizations with more money. This is because “demand” in the context of supply-and-demand interactions means “willingness and ability to pay.” So pure market results are based on the distribution of purchasing power – money – in the society.”

Macroeconomics in Context, Goodwin et al., 2014

The Affordable Care Act (aka “Obamacare”) in the US reduced this kind of inequality in healthcare (20 million people gained coverage under the ACA). However, Donald Trump doesn’t like the idea of market regulation and government subsidy, so is attempting to repeal the legislation. If successful, more Americans will be excluded from the healthcare market.

Theresa May is doing something similar to the NHS. The supply of government funding is being cut (per person) in England, despite rising demand: over four million people are now on the waiting list.

It makes no economic sense in America or Britain: unwell workers are unproductive workers. It only makes sense if you believe that free markets are “the best” and “only sustainable” way and that government is a “poor provider.” Beliefs that differ from the evidence-based economic consensus…

“Although market systems have strong advantages in some areas, they cannot solve all economic problems … macroeconomic systems cannot rely on “free markets” alone if they are to contribute effectively to present and future human well-being.”

Macroeconomics in Context, Goodwin et al., 2014

Markets are good, but for those problems that markets can’t solve, government can be quite good too. A nice speech, acknowledging this simple truth, would be a welcome start to a more balanced and realistic economic approach.

Image credits

Downing Street/ Whitehall by Pres Panayotov /

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