Do Markets Need State Intervention?

DISCLAIMER: This article was taken from an essay I wrote for a university module hence the academic style.

On the one hand, arguably state intervention in markets stifles efficiency, progress and innovation, and infringes on individual liberty and incentives. Contrastingly, market intervention arguably allows regulation to prevent market failures and externalities, provide positive freedom and reduce inequality. Ultimately markets require state intervention but this should be limited to market failures, moderate financial regulations and the provision of certain public goods in providing opportunity. This is because it is also important to retain the benefits of the private market in yielding innovation and efficiency through competition which are vital in improving living standards whilst inequalities in outcome rather than opportunity are morally justifiable.

It could be argued that governments stifle markets with state intervention as free markets efficiently allow the allocation of resources. As Adam Smith argued, the ‘invisible hand’ of the market arguably leads to a mutually beneficial allocation of resources in which pursuing self-interest allows a more efficient allocation of resources through self-regulation alongside the benefits of innovation through competition[1]. Moreover, as Friedrich Hayek argued the market conveys valuable information about scarcity, demand and opportunity costs that state intervention such as taxes would fail to indicate[2]. This inefficiency is demonstrated by the centrally planned nature of the Soviet Union in which there was an overproduction of goods, although according to data found by Barretto Humberto and Robert Whitesell,[3] this was only marginally worse than the US, this is likely due to the methodological unreliability of the soviet data. More notably, formerly centrally planned nations such as Russia and China’s embrace of market economies has correlated to economic growth. Arguably, state intervention would benefit efficiency through the elimination of wasteful competition and better coordination of resources. Despite this, due to a lack of knowledge by the government as Hayek argues this ultimately leads to inefficiency in production[4].

However, although it is beneficial in many private goods sectors for limited state intervention, the market can also yield inefficiencies through externalities, market failures such as monopolies and certain provisions such as public goods require state intervention as they are non-excludable and non-rivalrous. Unlike Hayek, even Smith acknowledged the limits of profit-seeking behaviour in every scenario with his concept of the third order of society in which public interest is undermined by owners of stock[5]. This reflects how free markets can produce failures in competition and therefore inefficiency. Therefore, morally and economically, the state has an important role in providing opportunity through public goods and competition.

The market requires intervention in some areas due to the inevitable market failures of a free market. Notably, public goods such as healthcare, welfare benefits and public transport require state management and externalities require regulation as otherwise they could pose greater social costs. Although many public goods exhibit the characteristics of private goods as they vary in the extent of excludability and rivalry, there have been several examples of goods provided for the public with nationalised health services and state schooling used particularly in the UK and Nordic Countries and nationalised transport in Germany and France. Whilst arguably these are less eligible as public goods than public infrastructure and national defence, all provide many areas of public benefit such as the reduction of externalities such as disease transmission with healthcare, improved transmission of knowledge with education and reduced pollution with transport. Moreover, alongside efficiency from a moral perspective, the state should provide these to ensure positive freedom through the enhancement of opportunities in a mixed economy as Anthony Crosland argued[6]. This retains the efficiency with a competitive private sector alongside state management of public goods the market fails to adequately provide. Although concerns about the efficiency of these public goods are also raised in modern debates over whether the NHS is fit for purpose in the UK with the health spending as a proportion of GDP higher than any other country, however in reality following the austerity measures of 2010 real terms funding has decreased significantly leaving the NHS underequipped to deal with challenges[7]. Therefore, key sector public ownership is not necessarily less efficient it just requires funding. Moreover, as Elinor Ostrom argues there is a fundamental inability of the market to provide public goods, common-pool resources and account for externalities due to the free-rider problem[8]. In the context of climate change regarding externalities, this could be catastrophic with the economic damage of projected sea-level rise. Solutions such as Robert Coase’s theorem of private bargaining[9] are dependent on low transaction costs and would be affected by distributional effects and incomplete information therefore suggesting that ultimately these market failures are best handled by the state.

Moreover, another crucial market failure that the state must intervene to protect is a threat to competition. Monopolies and oligopolies can occur naturally or through predatory pricing and mergers and acquisitions for example. Although Smith argued for the competitive benefits of the market particularly through innovation, this is also stifled in the free market when predatory capitalism is practiced. Despite the Schumpeterian principle of creative destruction[10] and arguable benefits to monopolies as economies of scale, there can be barriers to innovation and progress when a corporation or a small number of corporations dominate the market often using methods of collusion, predatory pricing, price fixing, bid rigging and barriers to entry. As a result, a consumer’s gains from an exchange are undercut for profit with inflated prices whilst the potential for future innovations is suppressed due to reduced competition. Examples of these predatory practices can be seen in 2013, with electronics manufacturers such as LG and Samsung were fined by China over price fixing and in 2018 Google were fined for illegal practices in collusion with Android. Although for the prosperity of the wider economy, these practices are ultimately damning, Rand would argue for example that ultimately the individual’s only duty is to themselves through “objectivism”[11]. However, this idea of negative freedom is ultimately unjustifiable as it is not meritocratic due to the suppression of some individuals’ opportunity to compete. Therefore, both morally and economically state regulation to ensure competition is vital. By contrast, in a competitive market environment which requires state intervention to regulate this, the conditions for innovation are created (as seen in the accelerated developments in science and technology following the Industrial Revolution).

Furthermore, financial regulation is needed to prevent financial crashes. These are often caused by irresponsible lending, asset bubbles, financial institution failures and other market failures such as asymmetric information. Notably, in the 2008 financial crash, in which the housing market bubble created by financial instruments of subprime mortgages were sold to investors, both irresponsible lending and asset bubbles were heavily involved. On the one hand, Friedman argued that government failures could also occur with policy mistakes leading to crises with monetary policy alone sufficient[12]. Arguably, this is expressed with the moral hazard problem of the bank bailouts which reduce the personal jeopardy of a crisis for the bankers. This is a compelling argument against subsidising banks that are considered ‘too big to fail’ from default with huge economic costs as evidenced by the National Audit Office that total guarantees amounted to over £1 trillion[13]. However, with strict enough regulation and clear contractual conditions over bailout assistance, this incentive to risk default for individual profit can be removed. This demonstrates how the supposed unintended consequences of intervention that Hayek and Friedman warn of can be mitigated through clear regulation that ensures competitive markets can occur.

 Contrastingly, despite sharing views of limited state intervention Hayek believed even monetary policy delayed a longer-term adjustment in the market with his theory of the business cycle[14]. However, as J.M Keynes effectively showed even monetary policy alone is not capable of producing the positive feedback of a multiplier effect needed to restore an economy’s economic performance[15]. Despite the likely aftermath of higher interest rates from borrowing which may crowd out private investment, in many financial crises the interest rates have reached low enough and sometimes near-zero levels that a slight increase will not have a major effect. Moreover, the effect of tax cuts and government spending would assist in balancing out the potential for increased interest rates to deter investment. Although competition and self-interest can be utilised for innovation and growth as mentioned, Hayek’s view of self-regulation is undermined by the potential for exploitation in the market through deregulated financial services and market failures. Resultingly, the state must regulate markets to prevent crises which are not simply self-correcting.

Moreover, from the perspective of political philosophy, arguably the market should intervene to provide equality. From a Marxist perspective, capitalism inherently creates inequality through a class struggle in which surplus value is exploited from the labour force[16]. Therefore, arguably the state must intervene to provide a classless society where individuals are free from the alienation of labour. Whilst the excessive inequalities of free markets can produce exploitation, fundamentally inequality is also desirable as long as adequate opportunity is provided. From a libertarian perspective, this ensures individuals are rewarded for their pursuits whilst inequality also allows incentives which in competitive markets as discussed leads to innovation and therefore greater living standards. However, whilst Friedman is correct in analysing the desirability of unequal outcomes for the individual, ultimately individuals should receive positive freedom through equality of opportunity by an enabling state as John Rawls convincingly argued[17]. Arguably this suppresses individual liberty and, as Hayek argued, state intervention can lead to central planning and therefore tyranny[18]. However, ultimately if the state is held accountable democratically, such state intervention into the market to develop opportunity seldom develops into tyrannical central planning. This is demonstrated by the variety of nations in the world that employ free at the point of use public goods alongside a market economy, although to varying degrees. Fundamentally, the partial sacrifice of individual liberty to allow the state to intervene in a mixed economy allows greater overall freedom by enhancing every individual’s capability so that they are truly free to compete with very few obstacles in a meritocracy. This in turn will drive living standards and human development in a way that both the stifling of opportunity under economic libertarianism and the central planning of Marxism fails to ensure. Although for Marx the state would eventually wither away[19] and thus the market would be automated long term, the process of historical materialism requires a growth in state power that as Hayek convincingly pointed out, can descend into tyranny. However, fundamentally this occurs in revolutionary takeovers as witnessed under Stalin and Mao whereas democratic nations are capable of allowing state intervention without such tyranny occurring through authoritarian abuses of power.

While there is a distinction between equality of opportunity and outcome in determining the extent of state intervention, there is admittedly a crossover. Notably, with taxation for example, although spending can be used to finance welfare and public goods to improve opportunity, this will lead to a reduction of inequality in outcomes through progressive redistribution. In defence of enforcing equality through outcomes, Thomas Piketty argued that neo-liberalism was incorrect to suggest taxation affected incentives greatly by using evidence of the US’ prosperity from 1930-80 despite a high marginal top rate of taxation being at an average of 82%[20]. However, ultimately if uncoordinated drastic changes were made to taxation this would lead to driving business from a nation as the global consensus of higher taxation no longer applies post neo-liberalism. However, there is a revenue-maximizing rate of taxation which would simultaneously retain investment alongside ensuring taxation could be redistributed to afford the opportunity. Although naturally equality of opportunity often leads to outcomes being affected, ultimately as long as this is for the betterment of living standards and opportunity this is beneficial. Therefore, state intervention via taxes is also required to achieve a level of positive freedom on a moral and economic level which allows a competitive meritocracy for economic growth.

As discussed to some extent, arguably state intervention fundamentally impinges on individual liberty. As Hayek argues central planning can lead to a concentration of power[21], and despite the Marxist theory of the state withering away, a dictatorship of the proletariat is still advocated in the short term with the extension of state power capable of leading to tyranny. However, the path from moderate state intervention to tyranny is typical of authoritarian regimes where there is an incentive for unaccountable leaders to dominate and there is an abundance of examples of liberal democracies which employ welfare provisions, have moderate rates of taxation and regulate markets to provide competition. This is epitomised by the earlier examples of public sector expansion in European nations and despite the neo-liberal regression in top marginal rates of tax since the 1980s, the average for European Union (EU) country top marginal rate still stands at 37.8% as of 2021[22] which still represents some state intervention into the market and regulations over competition are still enforced by the EU as in the previously cited 2018 Google and android collusion. The fact that such measures are used widely in democracies suggests that claims of state intervention leading to tyranny are vastly overstated. Moreover, despite Friedman’s argument of government failures, at least democratic governments are accountable to an electorate whereas the market failures of corporations (particularly through monopolies) are only prevented through state regulation. Free markets can impinge on the positive freedom of an individual in the absence of a state to provide public sector goods funded by revenue-maximizing tax and competition to provide opportunities for small businesses. Therefore, ultimately the amount of individual freedom forfeited by allowing moderate state intervention over the market is outweighed by the benefits of enabling every individual the opportunity to prosper through positive freedom. Also, the idea of individual liberty being compromised is vastly overstated with many rights and freedoms still adequately guaranteed. Denmark for example with the highest marginal tax rate in the EU at 55.9%[23] and public ownership of healthcare, transportation, education and energy upholds many progressive freedoms such as anti-discrimination, right to education, freedom of speech, privacy and worker rights. Therefore, ultimately from a moral perspective alongside the economic benefits of greater competition through regulation, the state should intervene in the market to some extent.

In conclusion, although states should be limited in their intervention of markets in some sectors due to the benefits of innovation and growth, they should ensure these sectors are regulated sufficiently whilst mitigating market failures through public ownership of essential sectors with a mixed economy model. Therefore, the case for some state intervention in the market has both economic benefits of ensuring competition and incentives through inequal outcomes alongside the moral application of positive freedom with equal opportunity.

[1] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London, 1776), Book IV, Chap II.

[2] Friedrich A. Hayek, The Road to Serfdom (Chicago, 1944), Chapter 4.

[3] Barreto Humberto and Robert S. Whitesell, Estimation of Output Loss from Allocative Inefficiency: A Comparison of the Soviet Union and the U.S (Amsterdam, 1992), 219–236.

[4] Friedrich A. Hayek, The use of knowledge in society, (American Economic Review 1945) 519-530.

[5] Smith, Wealth of Nations, Book V, Chapter 1.

[6]Anthony Crosland, The Future of Socialism: The Book That Changed British Politics (Constable & Robinson, 2006), 173.

[7] Is NHS Fit For Purpose? (https://www.theguardian.com/commentisfree/2021/dec/19/a-dangerous-lie-is-stalking-the-nhs-that-it-is-no-longer-fit-for-purpose), accessed 29/11/2023.

[8] Elinor Ostrom, Governing the Commons: The Evolution of Institutions for Collective Action (Cambridge, 1990), Chapter 1.

[9] R. H. Coase, The Problem of Social Cost: Journal of Law and Economics, Vol. 3 (Chicago, 1960) 1-44.

[10] Joseph Schumpeter, Capitalism, Socialism and Democracy, (New York, 1942) Chapter 7.

[11] Leonard Peikoff, Objectivism: the philosophy of Ayn Rand (New York, 1991), Chapter 4.

[12] Milton Friedman, Capitalism and Freedom, (Chicago 1962), Chapter 3.

[13] Bank rescues of 2007-9 (https://commonslibrary.parliament.uk/research-briefings/sn05748/) accessed 29/11/2023.

[14] Friedrich Hayek, Prices and Production (G. Routledge & Sons, 1931), 69-73.

[15] J M Keynes, The General Theory of Employment, Interest, and Money, (Macmillan 1936) Chapter 10.

[16] Karl Marx, Das Kapital: Volume 1, (Moscow, 1887) Chapter 9.

[17] John Rawls, A Theory of Justice, (Harvard, 1971), 513.

[18] Hayek, Road to Serfdom, Chapter 4.

[19] Karl Marx and Joseph Engels, Selected Works, Volume Three, (Progress Publishers, 1973) 13-30.

[20] Thomas Piketty, Capital in the Twenty-First Century, (Harvard 2014) 515-540.

[21] Hayek, The Road to Serfdom, Chapter 4.

[22] European Union Personal Income Tax Rate (https://tradingeconomics.com/european-union/personal-income-tax-rate#:~:text=The%20Personal%20Income%20Tax%20Rate%20in%20European%20Union,of%2036.60%20percent%20in%202011.%20source%3A%20European%20Commssion), accessed 03/12/2023.

[23] Top Personal Income Tax Rates (https://taxfoundation.org/data/all/eu/top-personal-income-tax-rates-europe-2022/) accessed 03/12/2023