The Price of Civilization_ Reawakening American Virtue and Prosperity - Jeffrey D. Sachs [12]
Smith brilliantly recognized that the self-organized market equilibrium is likely to result in a high level of productivity and therefore a high level of income and wealth of the population. In modern jargon, we say that the competitive market equilibrium is efficient, meaning that there is no waste of resources.3 Well-functioning markets squeeze out waste in the use of resources. A wasteful firm is outcompeted by a more efficient, lower-cost firm. An artificial scarcity created by one business is undone by the entry of a competitor. And so on throughout the economy, until waste is squeezed from the system.
Why Markets Need Government
Unfortunately, free markets by themselves are not able to ensure the efficiency of the economy. Governments are needed to provide certain public goods, such as highways, that markets by themselves will either not provide or not provide to the right scale. Private markets work well when there are many suppliers and consumers, as is the case for goods and services such as clothing, furniture, automobiles, hotel services, restaurants, and the like. They begin to misfire when economic logic calls for a single supplier, for example to operate the police force, fire department, army, court system, highway network, or electricity distribution system.
In such cases, society basically needs just one supplier or at most a very small number, rather than many. We don’t want competing armies or competing police and fire departments in our cities. Similarly, we need just one highway and power line from city A to city B, not several competing highways each offering the same route.
Free markets also fail when producers cause adverse spillovers to the rest of society, such as by polluting the rivers with toxic chemicals or emitting climate-changing carbon dioxide into the air from a coal-fired power plant. In such cases, the private economy tends to oversupply the goods in question, unless there are specific regulations or levies imposed on the offending actions. We say that the market needs “corrective pricing,” such as a tax levied on the pollutant, in order to reduce negative spillovers.
Private markets fall short in the case of scientific research as well, where spillovers of knowledge occur. Scientists don’t—and shouldn’t—own the rights to their basic scientific discoveries. Imagine if Isaac Newton’s estate held a patent or copyright on the gravity equation. The implication is that one of humanity’s most important activities—scientific discovery—needs to be promoted in ways other than the pure profit motive. This is done through status (such as receipt of the Nobel Prize), financial support from philanthropists, government grants (for example, through the National Science Foundation and the National Institutes of Health), government prizes, and other nonbusiness approaches (such as volunteer work and open-source creations such as Linux and Wikipedia).
Free markets also need governments to help regulate the marketplace when information between buyers and sellers is “asymmetric.” When sellers have inside information unavailable to buyers, fraud and waste are rife. In the lead-up to the 2008 financial crash, for example, Wall Street sold toxic assets to unsuspecting German banks, thereby extending the bubble and increasing its ultimate cost. In a different sphere, some doctors increase their fees by prescribing medical tests and procedures that are not needed, while patients and insurers are unable to second-guess the medical advice. In both cases, the implication is the need for government regulation: of securities markets to prevent financial fraud and of health care insurers to prevent medical fraud.
It’s worth recalling that all great promoters of the market economy,