Leviathan or Moloch? Why state interference in the economy is necessary (Part II) | Sam Volkers

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This article is the second in a three-part series by Sam Volkers, discussing the relationship between government and economic management. The third part will be released next Saturday.

You can read part one here.


When discussing what a possible new economic system should look like, and, more importantly, what the state’s role should be in this new economy, it is important to first discuss why the state should intervene in the economy in the first place.

Reason #1: The free market does not always create the best outcomes

The first reason why the state needs to intervene in the economy, is that the free market does not always create the best outcomes. The most prominent example of the free market not creating optimal outcomes is the situation called “market failure”. Market failure can be defined as (Investopedia 2020):

“Market failure is the economic situation defined by an inefficient distribution of goods and services in the free market. In market failure, the individual incentives for rational behaviour do not lead to rational outcomes for the group.”

Some of the most important examples of market failures are externalities, public goods and monopolies (Investopedia 2020).

Externalities are effects caused by the production of a good or service on other people or things that are not reflected in the market price of said good or service. Pollution is a good example of this. To mitigate the effect — or prevent the creation — of negative externalities, the state is needed. In the case of pollution, the state could, for example, use tax incentives to stimulate cleaner production methods or use punitive taxes to discourage using polluting production methods.

Another important form of market failure has to do with the supply of public goods. Public goods are goods and services whose use by non-payers can not be prevented once the goods are supplied (Chang 2014: 382). Think of infrastructure, such as bridges and roads, or services, such as national defense. These are goods and services that are vital for a well-run country, but because people can use them without paying, it becomes hard to acquire the funds that are needed to provide them. To solve this “free-rider problem”, it is necessary for the government to tax all potential users (usually all citizens and other tax-paying residents of the country) and use the tax-incomes to provide these public goods (Chang 2014: 383).

Then there is the problem of monopolies and oligopolies. Sometimes a business — or in the case of an oligopoly, a few businesses — becomes so large that it can dominate an entire market (for example the railway market) without having to worry about competitors. This is what is called a monopoly. If a business becomes a monopoly, it can set its own prices without having to worry about being outcompeted, because there is no competition. This often leads to high prices and low-quality goods and services. It is important to make a distinction between public and private monopolies, however. Where public monopolies (monopolies formed by a state-owned enterprise) are usually still beholden to the will of the people (high prices and poor goods and services can make a government very unpopular and lose them votes), private monopolies are big corporate bureaucracies that are beholden only to the interests of their shareholders — which rarely align with those of the people — and often use their power and money to influence politics in their own favor. The state can deal with monopolies by breaking them up into smaller companies, like Theodore Roosevelt did, or nationalizing them, which is often done in the case of so-called natural monopolies (1).

Reason #2: Some things are too important to be left to the market

As mentioned before, there are certain goods and services that are provided by the state from which nobody can be excluded access to (public goods), and which would be hard the profit from if provided by a private enterprise. The state does however also provide certain goods and services which could, in theory, be provided by private enterprise (for example the railroads or healthcare) in a way that generates profit for these private enterprises. The idea behind privatization is that, if a state-owned enterprise (SOE) is privatized, it will become just like other private businesses. It will have to compete with other businesses on a competitive market, which means it will have to innovate and create better and cheaper products/services in order to attract customers. On paper, this will lead to cheaper, better, and more efficient goods and services for consumers and profits for investors. Although this sounds good on paper, in reality, it does not always work out this way.

While some sectors of the economy have improved due to privatization, most notably the telecommunications sector, a lot of other sectors have not gotten better or have even become worse. In many cases, privatization has led to worse working conditions for employees and higher prices instead of lower ones. This has led to many of these goods and services becoming less available for those with lower incomes (Joop 2017). The reason why this happens is that, most of the time, state-owned enterprises are either natural monopolies, or in a sector of the economy where competition is near impossible. In the Netherlands, a good example of this problem can be found in the privatization of the railways (which was reversed in 2016) and the trains. The problem here is that the Netherlands simply is not big enough for multiple competing railway networks and train companies (NOS 2015), and this had led to a near monopoly by the now semi-private NS (Nationale Spoorwegen). This situation has not led to the NS becoming more efficient or lowering train fares — as private monopolies rarely do their best for these things — all the while they still rely on the state to provide them with financial support. Why does the state still give them financial support? Simple: the railroads and trains are simply too important for our country to go bankrupt. Another example of this is the production of pharmaceuticals. Right now the production of life-saving medication and vaccines, such as the vaccine against Covid-19, is in the hands of a small group of private enterprises. And although most of the R&D (2) in this sector has been paid for by the state, the state still has to bargain with these companies in order to get the vaccines. In essence, the state (and thus citizens) is giving money to these companies without having some form of control over how the money is spend or how the business operates. This might not be a problem in non-vital sectors, such as those that produce consumer goods, but in vital-sectors this can be a big problem, especially during times of national emergency. This is illustrated well when we compare the Dutch vaccination program with that of China and Russia, where the vaccines were produced by state-owned enterprises. Both China and Russia rapidly created their own vaccine and distributed it within their country as well as abroad, whilst the Dutch government still does not have enough vaccines months after the program began. This is why privatization does not always work: some sectors are just too important to be left to the market.

Reason #3: A weak state with little control over the market will lead to immoral behavior of economic actors

The 17th century British thinker Thomas Hobbes once said:

“Life in the state of nature is solitary, poor, nasty, brutish, and short.”

In the quote, Hobbes was talking about social relations in the state of nature, but it also accurately describes the harsh social and economic reality that is created if markets are left unregulated by the state. Although the free market is not by its very nature a bad or immoral thing, it can become so if the end goal — providing reciprocal services for the betterment of the people’s and nation’s welfare — is forgotten and money becomes a goal instead of a tool (Buijs 2019). This will allow for the immoral behavior of certain economic actors on the market to flourish, which will result in bad outcomes for workers, consumers, the environment, and the country as a whole.

If left unregulated big businesses will become monopolies or form cartels to consolidate their power. They will then use their dominant position to crush smaller competitors and squeeze their workers or outsource jobs to one-up their competitors and accumulate more wealth for themselves (think of the way Uber treats its workers and how that company has ruined taxi-markets worldwide). This will then lead to gross economic inequality, with a few owning everything while the many live in squalor. In some cases — such as during the Gilded Age — these big corporations and rich individuals will use their money and power to influence politics in their favor. They will try and buy the state. This is why the state has to use its power to prevent this from happening by banning the formation of cartels and breaking up the monopolies. The state should also use its position as arbiter of the common good to manage the disputes between capital and labour and make sure both sides get their fair share.

Another example of immoral behavior is the sale of harmful or fake products (e.g. tobacco, fake medication, drugs, cheap Chinese goods made of toxic materials) to consumers. These products can cause great harm to people, and society in general, and thus the state must fulfill its role as the protector of the consumer’s interests and regulate or ban — depending on the type of product — these products, while also spreading awareness about the negative effects they have on people and society. The state also needs to be aware of misleading advertising and other unfair marketing strategies that are used to trick consumers into buying products and deal with that accordingly.

Then there is the problem of environmental damage that some businesses will cause if they are not properly regulated. Although in some cases environmental damage is not on purpose, there are also cases where it is caused because of corporate disinterest in the local environment (e.g., a factory dumping its industrial waste in a river or using toxic materials because it is cheaper). Besides damaging the (local) environment, these practices can also have serious effects on the health and safety of locals, but it is often hard for citizens alone to put a stop to these practices, because businesses — big businesses and multinationals in particular — will always have more money and better lawyers than citizens. Therefore the state — being the defender of public interests — is needed. It can discourage these practices by using taxes or regulating these businesses (Chang 2019) or, if it is a serious problem, it can outright ban them.

Reason #4: Spend money to make money: Sometimes the government needs to step in and get things done

Some projects are just too expensive to be funded by individuals and private businesses alone. Often these are projects that are vital to economic prosperity — and sometimes even national security — but are not immediately profitable in the short-run. This makes it unattractive for investors and private enterprise to invest in these projects. An example of this can be a steel mill or some other form of manufacturing industry. Often, private firms and investors are not attracted to manufacturing industries, because of the high costs and little immediate short-term gains, even though these industries are vital for a prosperous and secure national economy.

The state, however, is not driven solely by short-term gains but also long-term gains. It also has more economic power and money than any individual or private enterprise ever will. In general the state is the biggest economic actor in any national economy, often accounting for between 30 and 50 percent of GDP. In the Netherlands, over 20% of GDP comes from government procurement (Chang 2019). This puts the state in the perfect position to solve these issues. It can offer financial support in the form of investments and subsidies to help private businesses in setting-up these projects, or it can carry out these projects themselves.


Definitions:

  1. Natural monopoly: A natural monopoly occurs when the most efficient number of firms in the industry is one. A natural monopoly will typically have very high fixed costs meaning that it is impractical to have more than one firm producing the good.

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