The Economic Role of the State

The government has to provide not only services but also goods, because of market failure.

If the government does not build a hospital or a school in a very poor area where people cannot afford to pay the costs, who will build and provide services that are essential and indispensable for people. The private businesses will not build it because there is no prospect for profit or return of their investment. The same is for a post-office, library, road and transportation, and many other services that are necessities for society but not economically or financially profitable. Businesses and companies and private enterprises will not do any businesses if there is no profit for them, no matter who necessary and important these services and goods are for people there.
 
Even according to Adam Smith (1937), who is regarded as a founder of modern economics or classical economics, there are three duties that the government has to attend to: first, to protect the society from the society from the violence and invasion of other independent societies; second, to establish an exact administration of justice; and lastly, to establish and manage certain public works that are necessary for society but no private sector is interested in to engage. Smith’s position on these three roles of government is in fact based on the public good concept and private property theory.

Adam Smith statue on the Royal Mile in Edinburgh 

Image from http://www.livingphilosophy.org.uk/News.htm

Adam Smith's The Wealth of Nation (Book cover)

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The first reason for the government to provide services or goods is because of “market failure”. Markets do fail occasionally, more often than the traditional view that market failures are the exception (Stiglitz, 1989). More than that, Stiglitz (1993) argues that competitive markets become inefficient too. Moreover, markets do not always produce goods and services that are important and necessary for consumers (Kell, 2009).
 

Joseph Stiglitz

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Here is a little bit introduction on how different schools think about the economic role of the state.

For economic liberalism, “states ought to abstain from intervening in the economy, and instead leave as much as possible up to individuals participating in free and self-regulating markets” (Thorsen & Lie, 2006: 2). Similarly, Austrian economists firmly hold that government is inefficient and should leave most of the economic activities to private hands. Ludwig von Mises (1944) is adamant in his view that government bureaucracy is inherently inefficient precisely because it is not faced with any of the forces which make private business management its opposite.
 

Karl Popper (back row), Ludwig von Mises (front row to the right) and 

other participants during a session at the first meeting of the Mont Pelerin Society 

Image from https://www.montpelerin.org/montpelerin/mpsAbout.html

On the other hand, Keynesian economists such as Paul Samuelson, Paul Krugman just to name two, and the development economists such as Michael Todaro, Amartya Sen, Joseph Stiglitz, Jeffrey Sachs and Ha-Joon Chang to name just a few, believe that market does fails and state or government has roles to play in economy. The task of government is, Borooah (2003: 4) argues, “to take the necessary steps to ensure that all impediments to the proper functioning of markets were removed”. By using better combinations of policy tools, the government can provide effective interventions in market mechanism (Kell, 2009).

Paul Samuelson

Image from http://blog.pucp.edu.pe/item/123770/an-interview-with-paul-samuelson-part-one

 Amartya Sen

Image from http://www.agricultureinformation.com/mag/2013/03/prof-amartya-sen-speaks-with-no-adequate-data/

Michael Todaro

Image from http://www.newsargus.com/obituaries/archives/2010/05/14/michael_j_todaro/

Paul Krugman with John Nash, winner of the 1994 Nobel Prize in Economics.

Image from http://sandberghans.blogspot.com/2008/10/sharp-critic-of-president-bush-wins.html

Jeffrey Sachs

Image from http://www.themorningsidepost.com/2013/09/24/camelot-revisited-qa-with-jeffrey-sachs/

Ha-Joon Chang

Image from http://blogs.lse.ac.uk/internationaldevelopment/files/2014/04/HaJoon.jpg

I believe that the government has to provide services and goods primarily—there are many other reasons but I will focus on only three of them—because
 
(1) Social welfare versus economic efficiency: Economically efficient behaviours or actions can sometime be socially welfare-decreasing ones. There are occasions when economic efficiency can only be achieved at the expense of social welfare (Summers & Summers 1989; Stiglitz, 1993). In other words, actions or choices of individual could be personally beneficial to him or her but not necessarily be socially beneficial. Competition that is the fundamental principle where market economics is constructed is not always perfect. Change (2007: 90) argues that “unfettered competition can lead to social waste”. Accordingly, Stiglitz (1993: 22) argue that “[T]here are feasible government interventions that can make all individuals better off. Similarly, Kell (2009) argues that without proper and appropriate regulation, market mechanism affects society as a whole negatively and unjustly.
 
(2) Profits verses social responsibility: Private enterprises that are naturally interested in and focus on profit, are not interested or willing to provide services and goods to people living in remote areas where demand for service and good are low and therefore are not economically profitable. Moreover, profit-seeking firms are not again willing or interested or even refuse to provide basic goods and service for instance, provision of water, electricity, postal services, public transport, to customers who cannot afford for such basic goods and service. Again, private sector investors, which are arguably interested in short-term gains and not favour risky large-scale projects with long gestation periods, are unable or unwilling to finance projects that may have high returns in the long run but carry high risks in the short term (Forfas, 2010).
 
(3) Equity and Justices: Relating to the matter of equity and justice among citizens, when private enterprises do not provide basic and essential services and goods to people because of lack of economic profits and gains for them, the state has to provide these services and goods through public enterprises even if it means losing money in the process, but in order to support equality, regional development and other economic and social goals (Chang, 2007; Forfas, 2010).
 
As I said, there are still many other reasons that require the state or the government to provide services and goods.

The question is not whether government intervention is necessary or not but how government can effectively involve and manage in the economy. What necessity and important is to establish an enlightened government or state that can discern between pros and cons in having SOEs in the economy and have capability and political will that are essential for establishing and running government departments and public enterprise effectively, competitively and successfully.
 

References

Borooah, V. K. (2003). Market Failure: An economic analysis of its causes and consequences. Retrieved on February 26, 2014 from http://www.borooah.com/ Teaching/Microeconomics/Market_%20Failure.pdf

Chang, H-J (2007b). Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism. London: Bloomsbury Press.

Forfas (Ireland’s policy advisory board for enterprise, trade, science, technology and innovation) (2010). The Role of State Owned Enterprises: Providing Infrastructure and Supporting Economic Recovery. Retrieved on February 6, 2014 from http://per.gov.ie/wp-content/uploads/Document-6a-30-7-10.pdf

Kell, P. (2009). Market Failure: When should policy makers act? Retrieved on February 6, 2014 from http://www.percapita.org.au/_dbase_upl/Peter%20Kell.pdf

Mises, L. von (1944) Bureaucracy. New Haven: Yale University Press

Smith, A. (1937). An Inquiry into the Nature and Causes of the Wealth of Nations. New York: Modern Library.

Stiglitz, J. E. (1993). “The role of the state in financial markets.”  World Bank Research Observer, Annual Conference on Development Economics Supplement (1993):19-61.

Summers, L. H. & V. P. (1989). "When Financial Markets Work Too Well: A Cautious Case for a Securities Transaction Tax." In Regulatory Reform of Stock and Futures Markets: A Special Issue of the Journal of Financial Services Research. Boston, Mass.: Kluwer Academic Publishers.

Thorsen, D. E. & Lie, A. (2006). What is Neoliberalism? Retrieved on March 1, 2014 from http://folk.uio.no/daget/neoliberalism.pdf