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)

Image from http://www.amazon.com/Wealth-Nations-Modern-Library-Classics/dp/0679783369%3FSubscriptionId%3D0G81C5DAZ03ZR9WH9X82%26tag%3Dzemanta-20%26linkCode%3Dxm2%26camp%3D2025%26creative%3D165953%26creativeASIN%3D0679783369

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

Image from http://www.ny1.com/content/shows/one_on_1_archives_qz/118024/one-on-1--joseph-stiglitz-stocks-up-on-economic-insight

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

What if Hayek died early and Keynes lived very long?

Hayek and Keynes were personal friends but intellectual rivals. Keynes was a brilliant, unconventional Englishman. Hayek was an outspoken émigré from ravaged Austria. Their economic views have changed, shaped and dictated the way we understand economics and economy, state's role in the economy and state's economic policies, once and for all. (Keynes' name is frequently mispronounced; so is mine too. Do you know how to pronounce my name? :-))

Adam Smith is a father of modern economics, but it is Keynes who invented macroeconomics. John Maynard Keynes published his The General Theory (we can also read the whole book at the Google-books), a brilliant analysis of how to fight the Depression, In 1936. That book made him the most influential economist of the age. Keynes advices governments that it was possible to manage their economies. (Nobel Laurate and also the most famous Keynesian, Paul Krugman wrote an introduction to Keynes' General Theory. I will write a short note about it later. It is an important paper). 

Image from http://www.betterworldbooks.com/the-general-theory-of-employment-interest-and-money-id-9650060251.aspx

Curiously, Hayek did not write any reviews or any counter argument on The General Theory. Bruce Caldwell, Professor at Economics Department of Bryan School, North Carolina University, wrote a (free down-loadable) paper entitled “Why didn’t Hayek review Keynes’s General Theory?” in History of Political Economy, 30:4, 1998. I will also write a short note of it later. But we have to remember that working slowing and taking time is Hayek's nature; had he died young I believe he would definitely not get a Nobel prize (it takes very long time to get his view and theory understood, accepted and appreciated). If Keynes lived long, I believe he will definitely get a Nobel prize, probably not only one, but two; one for his economic theory and another one for his literary works (like Winston Churchill).

He invented concepts we take for granted today, like gross domestic product (GDP), the level of unemployment, the rate of inflation, all to do with general features of the economy. Moreover, he also initiated, organised and established the IMF and the World Bank. Keynes did not have long to live. Ill and overworked, his health gave way. When he died in 1946 at 62 (in fact he was not so young, according to the standard of our developing economies), Keynes was raised to sainthood.

Oh, Great Keynes, your contribution to the humanity is invaluable, much more greater than the values of all Kings, Queens, Princes, Princesses, all royal families combined together. What did these so-called majesty do for the humanity; they just colonized, bullied, attacked, annexed invaded, stole, looted almost all nations around the world, and exploited, tortured, imprisoned and assassinated countless national heroes, great leaders and freedom fighters of many nations. (I know my discussion was digressed now.)

Look at how they were behaving like children, they were so cheerful and carefree. I like their hats.
Image from http://tek.bke.hu/keynes120/foto/keynes/keynes_russell.jpg

On the other hand, Hayek thought government interference in the economy was a threat to freedom. Hayek always rejected macroeconomics. He rejected any government intervention during the Great Depression itself. He feared that Keynes's brave new world was a big step in the wrong direction. In 1944 he published The Road to Serfdom that is about Hayek's ideas of freedom and competitive enterprise and opposition to any state's planning and controls in the economy. (There is also a (free downloable) condensed version of it appeared in the Reader’s Digest April 1945 edition, an illustrated version of it is also included at that book.) His ideas were at that time shunned by the academic world. Most of the university departments disliked him, and economists treated him as an outsider. No universities wanted to hire him, except the Chicago School.

Image from http://www.bibliovault.org/thumbs/978-0-226-32061-8-frontcover.jpg

He won the Nobel Prize for economics in 1974. Unlike Keynes, Hayek lived a very long life, and died in 1992 at the age of 92. (Look at the interesting numbers; 1992, at the age of 92.)

Look at how serious Hayek was, he did not smile, and was so thoughful. I don't like that class, it's too conservative; the class had only two women (perhaps just one woman).
Image from http://thinkmarkets.files.wordpress.com/2011/05/hayek1.jpg

(I will talk about them later; these two are so brilliants, two of the most important persons in the economics, and also the most important persons who influence my intellectual life. There are too much to talk about these two monsters; we can write series of books about them.)

Myo

(17 June 2011, Friday. 6:31 p.m.)

Note: I haven't written any posts these days, because I have been too busy with my study. This one is an old one that I have written long time ago. I am going to give references, to make it more academic and also include some photos of Keynes and Hayek, with a couple of their books. Both of them are so important for us.

Institutionalism: Old and New



Image from Amglifestyle
http://amglifestyle.com/2011/12/08/good-read-the-wealth-of-nations-by-adam-smith/

According to Adam Smith (1976), the productivity of the economic system depends on specialisation (the division of labour). The more the specialisation is, the greater the productivity of the economic system will be.



Ronald Coase ( Nobel Laureate, is now 101 years old, born 29 December 1910).
Image from The Ronald Coase Institute http://coase.org/aboutronaldcoase.htm



Coase (1997: 73) argues that specialisation is only possible only when there is exchange and the costs of exchange (transaction costs) is low. Moreover, the costs of exchange depend on the institutions such as legal system, political system, social system, education system, culture, and so on) of a country. Therefore, the performance of an economy is, in effect, governed by the institutions (Coase,1998: 73).

According to Ronald Coase the basic difference is that “the old institutionalists were concerned in the main with describing institutions rather than with analysing them” (Ferrarini, Nye, Bullard & Eyzaguirre, 1998).


References

Coase, R. (1998) The New Institutional Economics. In the American Economic Review, Vol. 88, No. 2, pp. 72-74. Retrieved on April 18, 2012 on http://www.coase.org/coaseonline.htm

Ferrarini, T., Nye, J., Bullard, A. & Eyzaguirre, H. (1998) Interview with Ronald Coase. At Inaugural Conference, International Society for New Institutional Economics, St. Louis, Missouri, USA, on September 17, 1997. Retrieved on April 18, 2012 on www.coase.org/coaseinterview.htm

Smith, A. (1976) An Inquiry into the Nature and Causes of the Wealth of Nations. (edited by E. Cannan). Retrieved on February 03, 2005 on http://www.adelaide.edu.au/library/etext/s/s64w/s64w.zip