Question

The State and Economics

Political economy: a more ‘honest’ name?

In the old days, no country had a Ministry of Defence. They all had a Ministry of War because, well, war is what it really does. Patents used to be called patent monopolies, as they were (and still are) artificially created monopolies, even though they may be socially useful. So there you have it. Sometimes, an old, forgotten name conveys the essence of the thing it is describing much better than the modern one does.

The same goes for the old name of economics – political economy, or the study of political management of the economy. In this day and age, when economics has become the ‘science of everything’, one can easily get the impression that government economic policy is really not particularly central to economics. However, much of economics is still about actions by the state, or the government – or recommendations against them.* 1 And indeed even those economists who try to sell economics as a science of everything by showing that ‘economic’ (rational) decision is everywhere are – at least unwittingly – contributing to the debate on the role of the state in the economy. When they show that people behave rationally even in the most unlikely areas of life – family life, sumo wrestling and what not – they are saying that, in plain terms, people know what is good for them and how to achieve it. The implication is that they should be left alone: no paternalistic government telling people what to do, believing that it knows what is good for them.

Of course, no serious economic theory says that the government should be abolished altogether. But there is a huge spectrum of opinion on the appropriate role of the state. At one end of the spectrum, we have the free-market view, which wants no more than the minimal state that provides military defence, protection of property rights and infrastructure (like roads and ports). At the other end, we have the Marxist view, which believes that markets should be marginalized – or even abolished altogether – and the whole economy coordinated through central planning by the state.

Once we depart from these two extreme views, the possible permutations of exactly what the government should or should not do become mindbogglingly numerous. Indeed, even those who want the ‘extreme’ solutions of the minimal state or central planning cannot quite agree amongst themselves on, respectively, what exactly the minimal state should do or to what degree of detail the economy should be planned.

The Morality of State Intervention

The state cannot be above individuals: the contractarian view

A perennial theme in the debate on the role of the state is a moral one – whether the state has the right to tell individuals what to do.

Most economists these days believe in individualism, namely, the view that there can be no higher authority than individuals. In its purest form, this philosophical stance leads to the view that the government is a product of a social contract between sovereign individuals and thus cannot be above individuals. In this view, known as contractarianism, a state action can be justified only when every individual gives his/ her consent.

‘Nasty, brutish, and short’: Thomas Hobbes and the original contractarian argument

There are different theories of social contract, but the currently most influential version is based on the ideas of the seventeenth-century English political philosopher Thomas Hobbes. In his famous 1651 book, Leviathan, named after the biblical sea monster, Hobbes starts by presuming a ‘state of nature’, in which free individuals existed without a government. In that world, Hobbes argued, individuals were engaged in what he called the ‘war of all against all’, and as a result their lives were ‘solitary, poor, nasty, brutish, and short’. In order to overcome this state of affairs, individuals voluntarily agreed to accept certain restrictions on their freedom imposed by a government so that they could have social peace.

Modern contractarian, or libertarian, argument on the role of the state

Hobbes himself actually used this theory to justify absolute monarchy. He advocated a total submission by individuals to the monarch’s authority, which is justified by its ability to elevate humanity out of its state of nature. However, the philosopher Robert Nozick, the economist James Buchanan, the winner of the 1986 Nobel Prize in Economics, and other modern advocates of contractarianism have developed Hobbes’s ideas in a different direction and advanced a political philosophy to justify the minimal state. In this pro-free-market version of contractarianism, more commonly known as libertarianism in the US, Leviathan came to depict the state as a potential monster that needs to be restrained (which is not what Hobbes intended). This view is best summed up in Ronald Reagan’s comment that ‘Government exists to protect us from each other. Where government has gone beyond its limits is in deciding to protect us from ourselves.’

According to the libertarians, any state intervention without the unanimous consent of all individuals in society is illegitimate. Therefore, the only justified actions of the government are things like provision of law and order (especially the protection of property rights), national defense and supply of infrastructure. These are services that are absolutely necessary for a functioning market economy to exist and thus whose provision by the state would be accepted by all individuals (were they to be asked). Anything beyond these minimal functions – whether it is minimum wage legislation, the welfare state or tariff protection – is seen as violating the sovereignty of individuals and thus the first step on ‘the road to serfdom’, as the title of Friedrich von Hayek’s famous 1944 book goes.

The modern contractarian, or libertarian, philosophical position has to be taken seriously. Once you begin to believe that the state is ‘above’ its citizens, it becomes very easy to demand sacrifices by a minority for the ‘greater good’, arbitrarily defined by those who control the state. Indeed, the world has suffered from too many political rulers believing that they know what is good for everyone else – from Pol Pot and Stalin on the left to Pinochet and Hitler on the right – and imposing their views, often through violent means. Asserting that the state is not above its citizens is a very important defence of individuals against the abuse of power by the state, or, rather, by those who control the state machinery.

The contractarian argument exaggerates individuals’ independence from society

Nevertheless, the contractarian position also has some important limitations. To begin with, it is based on a fictional, rather than real, history, as Buchanan and Nozick themselves readily admit. Human beings have never existed as free-contracting individuals in a ‘state of nature’ but have always lived as members of some society (for further discussions, see the section on the ‘embedded individual’ in Chapter 5). The very idea of the free- standing individual is a product of capitalism, which emerged well after the state.

Thus seen, by basing their theory on a fictitious history, the contractarians have vastly exaggerated individuals’ independence from society and underestimated the legitimacy of collective entities, especially (but not exclusively) the state.

Market Failures Markets may fail to produce socially optimal outcomes – this is known as market failure. I have already discussed the basic idea behind the concept in Chapter 4, using the case of externality. But here we investigate it in greater depth, as it gives us very important analytical tools to explore different roles that the state may play.

Some goods have to be collectively provided: public goods

Many goods (and services) are private goods in the sense that, once I pay for it – say, an apple or a holiday – only I can consume it. However, there are some goods whose use by non-payers cannot be prevented, once they are supplied. Such goods (and services) are known as public goods. The existence of public goods is arguably the most frequently cited type of market failure, even more than externality, the original market failure.

Classic examples of public goods include roads, bridges, lighthouses, flood defence systems and other infrastructure. If you can drive on a road without having paid for its construction, why should you, as a car owner, volunteer to pay up when someone is trying to raise money to build one? A lighthouse cannot selectively block its light from your ship because you have not contributed to its construction and upkeep, so you, as a ship owner, can let others pay for it and still enjoy its service.

In other words, if you can free-ride on other people to pay for a public good, you don’t have the incentive to voluntarily pay for it. But if everyone thinks the same way, no one will pay for it, which means that the good is not going to be provided at all. At most, it may be provided in sub-optimal quantities by large consumers who would rather let some people free-ride on them than not have the good at all. A big company dominating an area may build a road and let other people use it for free, as the cost of not having a good road may be too high for its business. Even in this case, however, the road capacity will be determined by the company’s needs, rather than by those of the society, and thus sub- optimal from the social point of view.

It is therefore widely accepted that public goods can be supplied in optimal quantities only if the government taxes all potential users (which often means all citizens and residents) and uses the proceeds either to provide them itself or to pay some supplier to provide them.

Please summarize and analyze (minimum 500 words.)