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Neither the state nor the market is perfect. They both need each other to function properly.
The market and the state are frequently depicted as belonging to entirely separate spheres. But contrary to what is often said about them, they don’t compete with each other; in fact, each needs the other to work properly.
They do different things. For example, markets. Without them, there’d be little competition or innovation.
Yet without the state and the rule of law, markets would descend into anarchy. Why?
1. Businesses need protecting
2. Contracts have to be enforced
So, businesses need the government to provide regulatory oversight that protects the common good whenever there is market failure.
But governments can fail too. This is called government failure.
How does this happen?
1. Politicians, above all else, want to be elected and then reelected.
2. This means incentives are not always aligned between politicians and society.
3. Politicians are therefore corruptible. They have the temptation to go against what is right for society. Society isn’t always best informed, so politicians have to enforce policies that are publicly acceptable e.g. gun laws in the USA.
4. Politicians can also target specific groups of people in their campaigns e.g. pensioners. But as we have learned throughout history, promises are easy to make and hard to deliver on. Take, for example, Brexit in the UK. It took the best part of 4 years for the UK to finally get started leaving the EU.
Another example is government debt. Projects may start with promises of great things, such as investment in to the rail networks. But the government often has to borrow money to do this. When things go wrong, they have to borrow more money to try and fix the problem. The result is government debt which the taxpayer has to eventually pay for. If debt becomes too high, so do taxes, and this can impede long-run economic growth.
Businesses face a similar quandary when it comes to decision making. Who gets to make the decisions and why?
Every business has multiple stakeholders – groups affected by how a business operates. Balancing the interests of different stakeholders can be a tricky matter.
For example: investors and employees.
1. Investors dictate policy – they’re tempted to ignore the company’s workers. They will cut jobs so more profits can be made.
2. Employees – they can let short-term gains get in the way of long-term strategies that can help the business. They can raise their own wages which leaves little for reinvestment into the business.
This is best known as the Principal-Agent problem, and it is a particular issue when there is a divorce of ownership from control.
This means that both business and governments are capable of failure. Informed choices have to be made to maximise the welfare of all stakeholders.
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