The Indispensable Role of Government
Modern market economies create an incredible abundance, due in large part to the dynamic interchange of information. People have the freedom to bid for goods and services based on their wants and needs, and people have the freedom to organize resources to meet the needs of others. Vast numbers of free people integrated by markets is an extraordinary achievement. This generally what we mean by free markets
Yet the “free” in free markets does not mean anarchy or unbridled freedom. This is a misconception, one intentionally fostered by some detractors. Markets do not exist in vacuum, but rather in relationship to host of societal institutions and traditions.
At the most elemental level, a transaction is not free unless the both parties are non-coerced, both parties have sufficient knowledge of a transaction to be able to make an informed decision, and both parties know that there are authorities who will protect their right of ownership and impartially compel compliance with contracts. In short, there must be trust and in particular the ability to trust that even anonymous people will honor their commitments. There clearly is a role for government in this regard. But there are other roles as well.
Markets don’t always allocate costs effectively. Sometimes a person who isn’t party to a transaction ends up benefiting or being harmed by the transaction. If I hire a landscaper to do some work on my front lawn, it will likely improve the value of not only my property, but my neighbor’s property. Similarly if I hire a contractor to build a pig sty in my front yard, the stench and noise will not only affect me but my neighbor who had no part in transaction.
Pollution is one of the most frequently given examples of an externality. A factory pumps pollutants into the air at no charge but diminishes the air quality for everyone else around. Either through taxation or regulation, government plays a role in trying to reallocate the cost back to those who are unfairly benefiting. Government plays a critical role in this regard.
Capitalist economies, by definition, create large complex entities, an abundance of sophisticated financial instruments, and very complex market relationships between firms. There is no way most citizens can comprehend these features. Some regulation and oversight is needed, particularly to ensure transparency so that regulators and watchdog groups can scrutinize behavior. This is another critical role that government plays.
Furthermore, government plays a critical role in international trade. It helps establish the ground rules for trading with citizens and business in other nations. When other nations engage in unfair trade practices (like placing exorbitant tariffs on American goods while deeply subsidizing the production of competitor goods for export to America) the government can use a number of actions to address this problem. Government can also use trade rules as a carrot and stick to work for more just working conditions and economic freedom in emerging nations.
In many ways, the government is a critically needed referee in the economic “game.” When players can have a reasonable level of trust that the rules will be consistently and fairly enforced it facilitates the flow of economic freedom. However, when the referee begins crossing over the line into head coach, (calling plays, making decisions about personnel, and taking positions on who should be given preferential treatment) chaos ensues. Markets become distorted and buyers and sellers can no longer correctly evaluate how to engage one another. Abundance dwindles.
Finally, government must intervene to prohibit transactions that are ultimately destructive to human life or societal health. While some libertarian friends disagree, I would continue to legislate against things like prostitution. While some people who have other legitimate economic choices may freely choose to engage in prostitution, many will succumb to the pressure to debase themselves, rather than do what is needed to avail themselves of legitimate economic options. Prostitution debases human beings (buyer and seller) into a commodity and that debasement tends to engender other destructive trends.
In broad terms, many people have little problem recognizing the need for this distinction. The challenge comes at the margins of these issues. For example, when is an externality truly an externality, or merely an inconsequential annoyance to a third party? What is “enough justice” when we are talking about trading justly with emerging nations that don’t entirely share our cultural institutions and values? There is room for reasonable people to disagree. Where I part ways is with those who believe in something approaching anarchy or those that think that economy should essentially be an extension of government agendas.