Where rhetoric meets reality

Markets and governments should not be viewed as opposing forces, explains Natalie Gold

November 20, 2008

President Bill Clinton declared that "the era of big government is over". There is bipartisan agreement in the US that, as far as possible, public services should be provided by markets rather than governments. Yet government activity and spending is on the increase. This is true of Republican as well as Democrat administrations: under President George W. Bush, federal spending has increased twice as fast as under Clinton. This puzzle - the gap between rhetoric and reality - provides the starting point for Lawrence Brown and Lawrence Jacobs' book.

They survey the rise of "market utopianism", with its historic origins in Adam Smith's invisible hand. The depiction of markets and government as opposing forces is a modern one. Despite his appropriation by free marketeers, Smith thought that markets needed to be tempered by government regulation. The 20th-century backlash against government can be traced back to influential public choice theorists, including George Stigler, James Buchanan and Gordon Tulloch, who argued that governments were not automatically a benevolent corrective to market failures, but were themselves inefficient and subject to capture by private interests.

To solve their puzzle, Brown and Jacobs present case studies of healthcare, education and transportation. In each area, markets were introduced with the aim of encouraging consumer choice and competition among providers. But government re-regulation was necessary to ensure a market dynamic and to control negative side-effects, and to ensure that consumers have enough information to make informed choices.

Brown and Jacobs assert that market reforms have worked only when the basic good or service offered to consumers was easy to evaluate in terms of price. They diagnose success in areas such as airline tickets, laundry and food services, and failure in healthcare, education, road and rail transportation and energy. When markets failed, there was a net increase in regulation as the Government stepped back in.

It is surprising that there is no mention here of the theory of "asymmetric information", or the work of George Akerlof. It is well known in economics that markets will not work efficiently where one party to the transaction has relevant information that the other lacks. Healthcare and education are prime examples. This creates an a priori case for regulation, and may also explain some of the failures that Brown and Jacobs record.

Although relevant theory is sometimes cited, this is not really a theory-driven book. Their argument is made using case studies, and its main strength is as an exposition of how markets have failed and had to be adjusted. It is a very accessible book, which could easily have a non-academic readership.

Another possible readership is policymakers. Brown and Jacobs advocate a pragmatic policy, where markets are complemented with regulation. This conclusion seems rather too generous to markets, given their argument that the increase in regulation was needed to correct market failures. This, in turn, raises doubts that markets are more efficient than governments, and suggests the need to reanalyse their comparative benefits.

A small niggle is whether Brown and Jacobs can really claim to have solved the puzzle with which they motivate the book. Government spending as a whole may go up, regardless of the performance of markets, because of increases in other areas, for instance defence and social security.

Nevertheless, this does not detract from their main conclusion that the performance of markets depends crucially on the institutional framework that surrounds them, and that markets do not displace the need for regulation.

The Private Abuse of the Public Interest

By Lawrence D. Brown and Lawrence R. Jacobs

University of Chicago Press

168pp, £21.00 and £8.00

ISBN 9780226076423 and 6430

Published 16 September 2008

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