This note is about a subject with perhaps more deliberately-sown confusion than any other: the role of government in a market economy.
We start with the saint of free markets Adam Smith. Adam Smith had no delusions that the free market system would somehow manage itself. He saw three roles for government in a market economy: defense, justice, and education. Further he understood that the private sector and the free market were not the same thing—one of the roles of justice was to prevent the private sector from creating monopolies and thus perverting the free market. In other words even as an ideal, the free market was neither self -policing (it needed to be protected against its own tendency to create abuses) nor self-sustaining (it needed government to create the population of educated workers).
With that as introduction, we want to talk more about the relations of business and government. There are three sections. The first two expand on policing and sustaining of the free market, as just discussed. The third talks about scope—what objectives for society are in or out of scope for the free market. The Trump administration has positioned itself as the defender of free markets against government. Instead they are defenders of something rather different, with real dangers as a result.
Policing the free market
Monopolies are bad. they raise prices and stifle progress. They are also by many measures growing in power. But they are not the only area where the free market needs to be protected from itself. For example, lack of business transparency perverts the capital markets, so the SEC plays a crucial role.
A more complicated but equally crucial role is regulation of the boom and bust cycles (with bank failures and human misery) that used to be endemic to capitalism. Government has two responsibilities for controlling those cycles:
- It needs to act “countercyclically”. Despite the jargon term, this is so basic as to be biblical—save in good times to prepare for bad. In a recession the government is the only party able to stop the spiral of low sales -> layoffs -> even lower sales-> even more layoffs. It does that by injecting money into the economy to stabilize sales. But in a recession, tax revenues are down, and the money has to come from somewhere–preferably savings but if necessary debt. In 2008 George W. Bush had just fought an off-budget 2 trillion-dollar war, so the cupboard was bare. Republicans screamed about increasing the deficit, even proposing constitutional amendments for balanced budgets. Their line “real people tighten their belts when they have to” was a deliberate misrepresentation. Real people save for bad times; otherwise they have to borrow to put food on the table.
- Government needs to recognize and control the excesses that can creep in to cause havoc in the business cycle. While many factors contributed to the 2008 crash, the most spectacularly deadly was the perversion of the banking system caused by mortgage-backed securities. In the giddiness of deregulation no one was looking. The aftermath produced the Dodd-Frank legislation as an antidote.
Finally, as a last example, there are categories of risk where you can’t count on the business decision-making process to do the job. Low-probability/high costs events (plane crashes, oil rig blow-outs) should in theory be prevented by rational decision-making, but in practice it’s hard to refrain from increasing profits by ignoring something that “really isn’t going to happen”. So there is a role for government there too—protecting both the public and the businesses.
– The administration’s anti-trust position remains to be seen. Trump campaigned against mergers, but appointed an industry-representing trust lawyer to head the anti-trust division.
– There seems to be no recognition of business cycle issues. Trump’s tax plan runs a big deficit to stimulate an economy close to full employment. This runs the risk of repeating 2008 with an even worse debt position to fight it. He also wants to repeal Dodd-Frank and says he won’t enforce it now.
– The general rule is that any regulation opposed by any business is bad.
=> There is no serious recognition that the financial system needs policing. Trump runs the show based on what he has wanted to see for his own businesses. This is a blind dash into another 2008 or worse.
Sustaining the free market
Adam Smith pointed out the need for government to supply a suitably-trained workforce. In the eighteenth century that meant simply literacy. The definition of suitably-trained has changed over time. By 1940 a then astounding 50% of American students finished high school. In that era no other country approached that level of broad education support. Then the GI bill made college possible for veterans, and public colleges expanded widely throughout the 1960’s and 70’s. This coincided with unquestioned American economic dominance. An educated workforce (at all levels) remains a critical national requirement.
You can take that one step farther. Equality of opportunity is usually discussed in terms of social effects, but there is a corresponding benefit to the free market. Business and the market benefit when all persons are able to achieve up to their capabilities. The United States used to lead the world in upward mobility, but with rising inequality it now ranks behind most developed countries.
There is one more government role that fits here as well, namely research. Government support of research produces people to be hired by cutting-edge businesses, and also supports the creation of new businesses to exploit the progress of science and technology.
– For college, the student debt crisis speaks for itself. A whole generation of students can’t imagine when they will be able to get out of debt. This is compounded by De Vos’ support of shady lenders and weakening of controls on fraudulent educational institutions.
– For K- 12 education, states have retreated in funding, and De Vos is proposing a voucher system that will abandon the broader population. Vouchers will be fixed in dollar value, to be augmented by surcharges at the now-privatized schools. If you want a good education you pay for it; if you can’t, there is no guarantee of what you get. This is institutionalized separate and unequal.
– Trump’s budget essentially abandons the government’s role in research, and his appointees have attempted to minimize the role of science.
=> There is surprisingly little recognition that government has an important role here at all–except to privatize it!
Scope of the free market
Adam Smith felt that the private sector could not be trusted even to defend free markets. So it is not surprising that there are other aspects of society that need defending as well.
We give a few examples:
– Well-being of workers. Smith describes effects of supply and demand on workers, and he even points out that adequately-paid workers may be more productive, but he makes no claim of utopia from the free market. In fact in Smith’s description, workers’ welfare depends on a market for labor in which individuals have little bargaining power.
– Resources and the environment
Enterprises will use the environment for their own benefit, unless there are rules to the contrary.
Public resources such as roads, bridge, airports, internet, etc. should be built and maintained as needed by everyone.
– Trump has pushed to limit OSHA workrules, opposes unions, and has no plans to raise the minimum wage.
– The EPA is being severely cut and redirected to helping businesses.
– The stated approach to infrastructure is via private investment, which will go where the money is.
=> There is no recognition that areas such as these can be out of scope for the private sector. Instead there is a blind belief that growth solves everything.
From this summary it should be clear how far we are from free market economics.
The current national policy is that the private sector just needs to be encouraged to go do its thing. We don’t have to care about policing its risk, we can let it take care of education and research, and nothing other than its success is needed to solve every other problem in society. Just make sure it’s flush with cash and let it go.
That was the history of the nineteenth century, and for vast part of the population it was no picnic. And it is worth remembering that 1929 really did happen.
Even thinking of the more recent past there’s an eerie familiarity about our situation. We have a supremely confident lunatic fringe with the power to run amok. The last lunatic fringe to take control of our government (remember the neocons?) gave us the Iraq war—which destabilized the Middle East and bankrupted the country—and the crash of 2008.
This time it could well be worse.