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When and How Should the Government Intervene in a Market Economy?

Inspired by (and in response to) Russ Robert’s EconTalk podcast

The role of government in state welfare, public competition with industry, and in regulation and subsidies of private businesses, varies greatly among developed countries. Even within the United States, the application of government intervention is not homogeneously applied across all market segments or social needs. In some industries (education, postal service, health care, prisons, etc.) public options dominate the industry, while other industries have little-to-no public option/competition (banking, farming, etc.). Further, the public services are sometimes reserved for only the poorest (food stamps, medicaid, housing), while other public services are available to all members of society (primary/secondary education). Some industries have government subsidies (farming), and some are highly regulated (banking). This raises the question, “When and how should we apply government intervention?” When confronted on the matter, we usually side with our preconceived notions and dismiss others’ views. As Russ Roberts states, “Liberals see the world as a battle between victims and oppressors. Conservatives see the world as a battle between civilization and barbarism. Libertarians see the world as a battle between freedom and coercion.” No matter which group you subscribe to, there are virtues and disadvantages to each. Can we push past our biases and maybe even come to some consensus?

The idealistic Left or Right might believe the best option is at one of the extremes: a highly free market society or highly socialized/communist society. What would happen at those extremes? Here is a bullet point for both sides’ arguments.

Problems with a highly free market/capitalist society — minimum government intervention and little state welfare.

  1. There is little to no monetary gain in helping very poor or disabled people, so these people get left behind in a free market society.
  2. It is true that people from any economic class can rise up to the highest levels in a free market society, but the probability is much lower for the poor. They are the exception to the rule [Brookings.edu]. Richer families still provide many advantages such as better education, better networking including business connections, role modeling, trade knowledge, etc.
  3. The wealthy can use their wealth to increase their competitive advantage while decreasing others’ competitive advantage through various ways: hiring people better than them to compete for them, by historical supremacy, etc. For example: a new company providing the same service as an established service; customers tend to stay with their established provider. Also, from private agreements-such as contracts to be the sole provider of a good/service to certain companies, etc. If your potential vendors have agreements not to work with you, then it is more difficult to break into a market.
  4. Not every field of study in math and science are easily or quickly commercializable. For example: in math, the field of prime number research has gone on for thousands of years. It wasn’t until modern computers were invented that prime numbers found a use in cryptology. Fields like pure mathematics would not be pursued in the free market since companies cannot normally pursue an idea for decades prior to any knowledge that there is a commercializable application. For many cases, government grants are the only funding for these endeavors. Argument against: maybe there are better uses for funds than these non-commercial endeavors.
  5. Monopolies: Markets with high barriers of entry have few competitors and therefore less pressures to innovate. Businesses like Amazon, can become so big that they take over industries. They can leverage their large capital to undercut smaller companies and force small companies out of business. A company like Tesla would have been very difficult for Elon Musk to start without him first becoming wealthy from Paypal. Tesla required much more money to develop since it had to break into an established market. Without Tesla, it would likely have taken much longer to get electric cars of quality and quantity since the current car makers had little pressure to innovate since they were making good money without innovation. A poor individual with a good idea would likely not have their idea become reality if the barrier to market entry is too high or they would have to go through the rich to make their good idea into a reality. If a small company does make something innovative, large companies often buy the small company, and may choose not to continue producing that innovative product since they are already making money without it. Aside from stifling innovation, large companies may price gouge with little repercussion as customers have few alternatives.
  6. Local monopolies: It is not always possible to have a truly fair market for every market. For instance, many communities will have very limited options for health care near them. There is a geographic monopoly for products that are necessary (if you break your leg or suffer a heart attack, you are not likely to shop around). Also, when it comes to healthcare, people’s conditions are hard to categorize, treatments are hard to standardize, outcomes are not fully known (few yelp reviews for your doctor), and a customer’s knowledge of the product/service is normally lacking in such a way that, as a whole, it becomes too difficult to establish a fair price. See Times article “Bitter Pill” for some examples of disparities in pricing for standard treatments broken down by location.
  7. As long as there is a larger supply of workers than the demand for workers, companies will only ever pay employees the minimum they need to in order to get the job done. Profits go to executives and shareholders that get rich by having the money to buy the shares and foresight (or luck) to buy the right shares. There is no assurance that the employee will be paid enough to maintain a healthy standard of living. If there was a surplus of available jobs, employers would need to compete for the employees. In a global economy, non-skilled labor is being shipped out of the United States, so there is not a surplus of jobs. Instead, it is a race to the bottom for pay. Automation, like outsourcing, is reducing the number of jobs. Some day, it may be less efficient to have humans work compared to robots. How will people afford to survive without work? How do we ensure a healthy standard of living? What if automation technology is concentrated into the hands of the very few? How will wealth be distributed if nobody is really earning it and it is simply passed down from predecessors? Eventually, enough people will be adversely affected that there will be something done to help these people. AI is already causing some job loss, and the losses will be gradual. It is already happening. What do we do for the people affected during this gradual loss of jobs? Retraining is expensive, takes time, and is no guarantee of success. These low skilled workers are not considered useful in the free market to continue earning a living wage.
  8. We would like the “American dream” to contain reasonable hope that with hard work, there are no limits to upward mobility, but the truth is having money is a huge advantage when it comes to making more money. If you start out with little money, it would take you a long time to invest in something like real estate (it is harder to build credit and harder to get loans). This is good in the sense that people should prove themselves before someone will take a risk on giving them money, but the rich do not need to prove themselves at the same level as the poor since investors have confidence in the investment because the rich are also risking their own money (they have skin in the game). The poor do not have as much expendable money as the rich, so the personal risk is higher for them at lower amounts of money. Further, the poor are not as able to absorb downturns in markets. In contrast, if a wealthy person is not over invested at the time of a market downturn, they will have the money and opportunity to buy at a discount. In this way, it is a game the wealthy cannot lose (if they are not too greedy). They will then claim with a smug attitude that they are self-made, but they started the game of monopoly with multiples of more cash than the rest of the players. Sure you could roll sixes all day, but don’t count on it. A similar analogy can be made with gambling. It is the same reason why “the house always wins” even when odds of winning are equal — because in gambling and in society “the house” or the one with comparatively unlimited funds, can absorb the losses and keep playing, while the poor can quickly lose it all and are out of the game.
  9. The rich hang out in exclusive social circles, and help each other. On rare occasion, and usually when it is beneficial to them, will they allow the poor into that circle. Counter argument: in socialist/communist societies, cronyism also occurs often.
  10. A free market system creates competition. There will be losers in the competition. What effect does that have on a person’s psyche? Their self worth? What is it worth to have a society of people that feel value in themselves and others more than their monetary value? A focus on and over-valuing of wealth leads to materialsim, greed, jealousy of others who have more than you, and anxiety of losing your wealth or your job. We care about each other less and think obtaining that next shiny thing will fulfill us when instead it leads to isolation and loneliness.
  11. Free market volunteerism claims that people lose rights when government controls something that the free market could control. For instance, back to health care. The libertarian thought is that things like the affordable care act removes our liberty, our freedom to choose to pay for health care or not. They do not consider the ways something like forced health care is actually increasing one’s freedom. Are you more or less free if an insurance company cannot decline you health care due to a preexisting condition? Are you more free if your bill is not increased by the hospital in order to pay for those without health insurance? Are you more free if insurance rates keep increasing and there are no affordable options? Are you more free having a health issue and having no option for medical help because you cannot afford it? Insurance companies in this system are less free indeed, but they are still in business, and may even have more pressures to innovate in such a system.
  12. Individual wealthy people have limitations too. Even the wealthiest may not have enough to build large infrastructure such as roads, sewers, and electrical grids for entire cities. Economies of scale can keep the optimum city designs from being created. Also, once a city becomes so large that roads/sewers/electric grid work becomes a major hazard, a privately run city would likely need some mechanism of governance to ensure all parties are paying their fair share. Something like the road could be owned privately, but the owner could control people’s travel or shipments of goods. In essence, they could become a dictator of movement. There are examples like these that occur to various degrees. The socialist society is at risk of totalitarianism, but the fair market society is susceptible to plutocracy. Another example is the ITER fusion reactor. Such an expensive device could not be realized by private companies because of the cost.
  13. Businesses in the free market are willing and in some cases forced to take risks that hurt themselves (or the public) in the long term, to stay competitive in the short term. They do this in many forms: selling products/services at a discount (possibly at a loss), over leveraging themselves in investments, making risky investments, paying too much for products/services, paying too much for acquisitions, or selling off portions of their company. They can hurt the public by using chemicals like chromium. By the time it is found to be unhealthy, the CEO has retired with a fortune, and the company may claim bankruptcy without victims receiving compensation.
  14. Businesses are averse to risk that could help them in the long term, but hurt them in the short term. For instance, instead of making an investment in an unproven field, businesses will spend little time or energy to innovate. This is seen in the semiconductor industry. Most of the innovation has been made at public universities and adopted by the industry once proven. Further, large companies that hold majority market share may wait until smaller companies have used the new technology before adopting it themselves. Since they have enough money to ramp up quickly, they don’t need to spend the time and money going through the learning pains to get it to work. More conversation on the topic here.
  15. Monopsony: Large businesses can own such a large portion of a specific market that they can set the price for smaller suppliers. This can be harmful if they do not pay fair prices. For example: a large business can hire a paving company to pave their parking lots. The paving company can save money on their cement if they do such a large order, so they take the job thinking this will make them more money and help them gain market share. The large business then decides to not pay the full amount once the work is complete. The large business has the legal team and money to win in a lawsuit. The paving company takes a huge loss and possibly goes out of business. By the time they need their parking lots paved again, the lawsuit is forgotten and another paving company comes along ready to be swindled.
  16. A customer’s/society’s interest is not always aligned with the company’s interests. For instance, there is little incentive for a business to cure a disease when they can instead treat the disease in perpetuity. Why cure ADHD when you can sell Aderall? A business’s best interests may not be in society’s best interest. An example is that of an owner of a private prison. They are incentivized to support more regulation with harsher punishments, and support oppressive enforcement. This undermines the system’s moral credibility with the community, and that in itself has crime control effectiveness costs. People are less willing to be cooperative and helpful. They are much more willing to subvert the system. Much less willing to internalize its norms. [Paul Robinson]
  17. Related to the previous point, a company can also choose it’s customers and leave some people in society with little to no option. For instance, if a student has disabilities or acts out at a private school, the student is easily expelled or not allowed into the school in the first place. They are then left no option other than homeschooling or public school. For the poor, homeschooling is less likely to be an option for many of the same reasons that causes them to be poor (health conditions, substance abuse, intelligence, laziness, time constraints, etc.). That leaves public schools with a higher percentage of resource intensive students. If even one child is disruptive, it can have a profound effect on the learning experience of the entire class, so all the poor students stuck in the public school have a harder time learning. This perpetuates the poor creating more poor children. Another example: there is little incentive for a health insurance company to cover very sick (or those at high risk of becoming sick) or the very poor. Another example, is price gouging such as that by the maker of the EpiPen. A small group of society relies on this drug to save their life during allergic reactions. The low number of customers meant their was little incentive for competition, so when Mylan purchased the license to produce the life saving drug and raised the price 400%, customers had no choice but to pay the price or risk their lives.
  18. Trickle down economics doesn’t work if the highest earners hoard their money. The CBPP has shown the income gap between the top 1% earners and middle 60% keeps increasing while the tax rate for the top 1% earners has been dropping (sharply during the 80’s), and the top 1% now own more than 40% of the nation’s wealth. You could say the opposite of trickle down economics is true. Give the poor money, and it will eventually trickle up to the business owners. Counterpoint: The income gap may actually be decreasing if you look at total compensation (see discussion here). Employee sponsored health care costs has risen, so this is a cost to employers that we don’t see in take home pay. Also, other benefits and tax advantages need to be considered when determining compensation. When tracking at the individual level and not the quintile averages, income mobility of the individual and their offspring paints a different picture. At the very least, the subject is still up for debate.

Problems with a highly regulated democratic welfare state/communist society — markets are either highly regulated or completely controlled by the government, and state welfare abounds.

  1. Capitalism is simply an exchange of goods or services at an agreed upon price for the mutual benefit of both parties. In contrast, governments can use coercive methods of taxes and incarceration to force the exchanges not agreed upon. Counter argument, there are cases of: fraud, exploitation of the uninformed or vulnerable, misinformation, a lack of alternatives, etc. in capitalism. Of course, breaking the law can be litigated but difficult.
  2. The law of unintended consequences is more frequent and harder to undo in a highly regulated market. As Tim Orielly described, “There is a wonderful rigor in free-market economics; When you have to prove the value of your ideas by persuading other people to pay for them, it clears up an awful lot of wooly thinking.” In highly regulated markets, laws and regulation can be made with good intentions, but the people are not always incentivized to educate themselves on issues before voting (if they vote at all). Laws and regulations are passed without understanding the repercussions, like the misconceived notion that being “hard on crime” causes less crime (as we discussed above, it can have a worse effect on crime). These are hard to undo because the law has to be bad enough and effect enough people to motivate them to get a mass of them educated, get it on a ballot, and get them to go to the polls to change the law. If a bad idea occurs in a free market, it will find less and less support until it is made obsolete.
  3. In the free market, people are incentivized to compete to create better/cheaper goods/services. Government control of industries does not tend towards competition, so the economies are typically inefficient and have little innovation. Innovation also improves the company’s competitive advantage versus companies in other countries. Ex. Amazon may be a monopoly in the USA, but if it does not hold such a large market share, who will be able to compete with Alibaba or Tencent? Further, government control tends to aim for achieving a goal, while a free market looks for opportunities to overachieve. If we had to rely on subject experts to innovate, would we expect innovation like the Google search engine to be created by librarians? It often takes outside knowledge to create innovation.
  4. Minimum wage doesn’t fix the issue of workers lacking the skills needed to get higher pay. It puts companies at a disadvantage that are paying for work that is not worth what they are forced to pay. Companies are incentivized to do without the worker entirely (through automation or outsourcing), or go out of business because they cannot afford the wages. Workers may also be happy to take lower wages if they are also gaining a skill such as in an apprenticeship, or simply don’t need the higher pay. More low wage jobs could mean more competition for low skilled workers, which would drive the pay up in a natural way. Some people are likely to make more with a minimum wage. The topic is still up for debate.
  5. The most efficient producer of a good should produce that good. If a country has a surplus of unskilled labor, the goods requiring unskilled labor should be produced there. The human capital in high skilled countries can then be allocated to more skilled labor jobs. Those jobs offer higher pay because the supply of workers with those skills has not been met. The higher pay for skilled labor incentivizes workers to gain the skills. As more skilled laborers are created, the prices on resultant goods/services will decrease, and the public reaps the benefits of lower priced goods/services of high value. Labor incentives are necessary. If this feedback wasn’t present, you would have farmers tilling fields with oxen next door to farmers using tractors.
  6. There is little incentive for workers to be productive or use resources efficiently in a socialist society because you get the same or similar reward either way. Even if you believe you are working hard towards a benevolent cause (helping a customer for example), but the final goal is not achieved (customer is unsatisfied), you can go home and feel good about yourself for the effort you exerted believing you made the world a better place (and you keep your job). In a capitalist society, the results matter, and customers ceasing to purchase your good/service is strong feedback because you can eventually go out of business.
  7. A centrally planned economy and society required by socialist ideology necessitates concentration of power. This concentration of power attracts dictators and can corrupt politicians.
  8. As Hayek famously described, a market economy conveys vital information to producers and consumers alike through the price system. Market prices enable producers to know the relative value of different goods and services, and determine how much consumers value their products. Under socialist central planning, by contrast, there is no substitute for this vital knowledge. As a result, socialist planners often had no way to know what to produce, by what methods, or in what quantities. If everyone was paid the same for every job, people would be less likely to develop a skill if it was difficult to learn, and there wouldn’t be the feedback of increased pay to tell you there is a need for that skill. There is no group intelligent enough to determine efficiently the allocation of resources at all times for all goods. Instead, market prices emerge analogous to how complex creatures gradually evolve through natural selection. Separation of goods/services from the price system can lead to higher prices. For example: socialized (and even employer based) health insurance hides the true cost of treatments/procedures. Drug companies and health care providers know they will get paid, so they drive up prices and are more likely to provide unnecessary or ineffective treatments and tests without the patient seeing the full price and determining if it is worth the cost. Examples: Mylan knew they could jack up the price of the EpiPen and still get paid. Prostate tests for PSA suffer from high false positive rates, screening can be painful, treatment can be unnecessary or ineffective (Risky Medicine), yet doctors feel compelled to prescribe the tests because the true costs are not adequately known by their patients, and it’s free, so why not? Another example: if a tornado has swept through a community causing damage to many houses, prices for construction should increase. You might have been planning to build a deck, but now that the prices are high, you decide to wait. This leaves more construction workers and materials to be used for people who are in more need of the repairs. Some might call this price gouging, but it is effective when it comes to allocating resources to those in greater need. Counter argument: The price system doesn’t just tell us that value of goods. It also tells us who has the money. Someone may value something more than another person, but if they are poor and cannot afford the good, that good could still go to the person that values it less, but is wealthy. In theory, we could all be made to have the same amount of money, and a price system could still exist. For example (I don’t advocate for this), hypothetically everyone’s bank account could be set to one value every few years. The price of goods and wages could still eventually cause a disparity in wealth, but it would reset. I thought of this reset from the the Bible, Deuteronomy 15: 1–3. Every seven years, a debt is wiped clean.
  9. Regulation often disrupts the marketplace or picks winners and losers among companies or technologies.
  10. Subsidies often end up benefiting the wrong people and may even hurt the people intended to help. For example: the US subsidized goods like rice going to Haiti. This put many Haitian rice farmers out of business because they couldn’t compete.
  11. Regulation can be highly costly and burdensome to those who must comply with them, and those costs get transferred to the consumers. Businesses already have some incentives to regulate themselves since they want their customers and investors to feel secure.
  12. When the government competes with the private sector, it tends to do a bad job. For instance, the Post Office competes directly with DHL and Federal Express. It is operationally unprofitable, runs at a deficit, and has a grossly underfunded pension.
  13. Government intervention in the form of state licensing creates a barrier to entry and doesn’t necessarily ensure any higher quality or safety (See interview with Dick Carpenter). Those that benefit from the licensing requirement (people licensed or the paid teachers) use their concentrated power to push legislators to require unnecessary licenses to keep out competition which keeps their pay and job security high. Licensing may be too difficult, cost too much money, or take too much time for many of the poor to acquire the license, and it reduces inter-state mobility. State licensing has been increasing in many low-skilled positions: auctioneers, locksmiths, sign-language interpreters, furniture upholsterers, florists, interior designers. Dick explains, for somebody who wants to work as a cosmetologist and may come from a disadvantaged or low-income background, spending a year on education and experience is a long time, and a lot of resources spent earning a license rather than earning a living. Imagine the savings for customers if a dental hygienist were allowed to open a teeth cleaning service without it being a dentist office, and the extra pay the hygienist could earn. Mandatory bonding, insurance, registration, inspections, certification are all examples of government intervention that do not restrict entry into the occupation. Market feedback can ensure quality.
  14. Tragedy of the commons: When resources such as land are held by the government, often times nobody takes strong ownership of maintaining the land and enforcing rules. There is a strong incentive to exploit the system and overuse the resource. When possible, privatizing the resource can better preserve the resource since the owner has a strong incentive to do so. Counter argument: there must be instances where there is an incentive for a privately owned resource to be misused its owner. People damage or neglect their property all the time.
  15. People should have the right to chose what they want and not have the government tell them.

Some other notable observations:

First note: The wealthy can use their wealth to increase their competitive advantage while decreasing others’ competitive advantage by creating stringent laws and red tape (which may be difficult to fully comprehend). It would seem that the problem of difficult to navigate red tape should be categorized in the problems with highly regulated society’s, but regulation in a highly free market is also unavoidable to some extent (there is no game without rules), so the private sector also adds red tape, not just big government, because it helps already established companies maintain an advantage.

Secondly, I brought up rights twice in the list of examples above, but it is difficult to consider arguments for a person’s rights, and difficult to measure how much rights are gained or lost. As Joshua Greene nicely put it, “…we have no way of figuring out what rights people really have in some ultimate metaphysical sense. And instead we can ask, which kinds of policies actually work.” For devising a rule, let’s put aside for now the question of rights.

General Findings

Since there are a variety of problems at the extremes of government vs. private control, the current optimum is probably a mixture of the two. In general:

#1: The free market does a good job, and government ran industries tend to do poorly: 1) because government, to various degrees, does not get the important feedback given by the price system, 2) because unintended consequences are hard to avoid and are hard to get rid of in government intervention.

#2: Knowing the winners and losers is important because every option for government or free market intervention has an upside and a downside, and creates winners and losers. If the free market does not have enough incentive to serve a part of the community or to maintain the safety of the economy’s citizens, then there must be government intervention of some kind to maintain the quality of life for society.

#3: It is apparent that competition plays a large role in an economy’s success. Competition opens business opportunities to an economy’s citizens, reduces the costs and improves the quality of goods and services. Competition goes down: when barriers to entry are high, when monopolies and monopsonies are created, when the public’s resources for: education, funding, networking, trade knowledge, and political power are unfairly distributed. There may be opportunities for government intervention to increase competition. There may also be opportunities for the current government regulations to be eased to help increase competition.

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