Since just about every public policy issue of our age has an important economic component, surely upcoming debates will feature differing opinions about how to organize the economic interests of 330 million people. Office seekers will take sides on key questions, such as when government should be involved in the production and distribution of certain goods and services, versus when private markets be relied upon. This is a good time to review some basic economic concepts and demand that office seekers understand them.
Any such review could begin by examining a core teaching of economics: that competition among profit-seekers leads to the betterment of society as a whole, even though it is profit, not serving the larger society, that motivates the decision-makers in the market. It is this belief in “free markets” that forms the basis for much of public policy, the rebuttable presumption that markets are superior to government in the production and distribution of goods, services and assets. But it is in the rebutting that the conflict lies: when the pre-conditions for competition do not exist, markets will not self-regulate for the public good. Without keener knowledge of how markets work, politicians can’t propose efficient regulations, including when to leave markets alone to self-regulate.
Exceptions to Free Market Efficiency
Initiated by Adam Smith, a large body of knowledge has been developed to describe the circumstances under which market allocations driven by profit-seekers are superior to government programs and when they are not. Examples of the latter include:
Monopoly power: some of our most important services are sold to us by public utility monopolies - distribution of electricity, natural gas, water, cable TV, internet connectivity, sewer services. Although the competitive process cannot work for these incredibly important goods and services, the properties of the market can be used to guide their regulation. For example, the price of these services is usually regulated to provide the same sort of competitive rate of return on investment that one would find in a competitive market.
Patents: the government grants inventors temporary protection from competition so that, during that temporary period, monopoly profits are the reward for inventive and creative activity. When that period is over, the secret behind the invention is supposed to become public knowledge so that competitive markets can bring the benefit of the invention to consumers at prices that better reflect costs. When this doesn't work, as in the case of insulin, the government can step in and regulate the price. For example, President Biden's Inflation Reduction Act includes a $35 per month price cap on insulin.
Information asymmetries: when buyers or sellers can be taken advantage of because they are acting with different information about the safety, durability, or performance characteristics of a product, regulation is required to bring markets to the level of efficiency a free citizenry expects. For example, the Food and Drug Administration tests food for safety and drugs for efficacy, tasks well beyond the expertise of consumers.
Risk Spreading: primarily this is done through insurance, mostly through private insurance companies who charge a premium to pool the premiums of a very large number of people. This pool enables the insurer to write checks for those who suffer insured-against events -- car accidents, home fires, burglary -- out of the money gained by the premiums of those who have better luck. The premiums of the accident-prone are higher than the premiums of those without a record of problems. Hence, lousy drivers pay higher premiums than safer drivers, and sick people pay higher premiums than healthy people. The Affordable Care Act is a regulatory response to this latter example: the perversion of pricing the sick out of access to the medical care they need to get healthier.
Public goods: goods that the unregulated market cannot allocate well because profit-seeking firms cannot expect to earn a profit by providing the efficient amount of them. Examples range from public parks to police and fire protection to national defense, and they are paid for with taxes. Also included are public infrastructure assets that enable the private market to work more efficiently but which the market will not produce for itself. Included in this category are streets, roads, highways, bridges, tunnels, water and sewer systems, harbors and airports, and many others.
External costs: These are costs not paid for by the buyers or sellers in a market exchange, and there is no market-driven incentive to control them; they require regulation. Pollution is an example; the market actively encourages pollution because it reduces costs to the polluter. To address climate change while growing the economy, the power of the market to produce wealth must be harnessed and redirected to produce wealth with fewer emissions of greenhouse gases. The tools for doing this include taxes on those activities that produce emissions, emission quotas or bans, or subsidies for those producers whose activity results in fewer emissions.
Moderation of the Business cycle: A key role of government policy is to manage total spending so as to keep the economy running at full employment without inflation. During recessions, for example, the spending of the nation’s consumers and business investors is too small to employ all those who want to work. Government spending can fight a recession with investments that build and maintain government-owned productive assets -- streets, roads, broadband, police stations, ports, communication satellites, etc. -- and employ people in the process. Society can use these long-lived productive assets for many decades. Of course, government should avoid spending on goods that produce little of lasting value, such as weapons systems that the Pentagon does not want or “bridges to nowhere.”
Using Prices in the Public Sector: the public sector can achieve greater efficiency by implementing some free-market principles. Chief among these is to use prices when enabling people to use public assets such as highways and airport landing rights. For example, gasoline taxes require road users to pay for the roads. Similarly, carbon taxes can be used to require carbon emitters to pay for their harm to the environment. Both of these taxes use the price system in the same way price is used in private-sector markets: to organize incentives and to require people to pay for what they use.
Epilog: The country needs its office-seekers to compete in the marketplace of ideas, especially about economics. Our politicians should be conversant in the basic ideas of economics, starting with those illustrated here. Voters should root out and replace members of state legislatures and Congress who are ignorant of these principles in economics to help ensure that public policy best serves the majority of our citizens.