Finance, Technology and Macroeconomics

No business being in business?

by Cielito Habito
Inquirer

WHEN must government intervene in the economy, and when must it keep its hands off?

Academic economists are often faulted for being too partial to liberalized markets. But not even the most zealous free-market economists would argue that the government should entirely keep its hands off the economy.

Interventions

Should government be in the business of producing and selling goods and services--like rice, medicines, electricity, education, health services, or third-party liability car insurance--to the public, or should it just leave these to the private sector? Should it be telling private firms what and how much they must produce? Should it pick "winners" among the economic sectors and bias government tax and subsidy policies toward them?

Is it right for government to tax its citizens' every move, from earning an income, owning property, travelling abroad, selling/buying cigarettes, text messages, and practically everything else--and then decide who can be exempted from paying these taxes? Should it tax the rich more heavily than it does the poor--or even the other way around (which we indicated in last week's column to be our actual situation!)?

Invisible hand

It is largely true that leaving the markets alone usually leads to outcomes that are efficient--that is, one where the economy's limited resources are put to their best use. When the government tries to "play god" and decides what, how much, how, and for whom goods and services are to be produced--in short, the basic resource allocation decisions in the economy--it invariably fouls things up. China and the former Soviet Union tried it for many years, and eventually decided to give it up and rely more on the free market, even now embracing the WTO. North Korea and Cuba persist in that path, with disastrous effects for the former, and unclear effects in the latter.

Adam Smith, considered the father of modern economics, had argued in the eighteenth century that left to themselves (laizzez faire), markets would be guided by an "invisible hand" that ensures the most efficient outcomes.

When markets fail

But perhaps what Adam Smith did not explain enough was that markets are far from perfect. They often fail to yield efficient outcomes, and more often, fail to yield outcomes that are equitable or fair. Economic textbooks give at least three reasons why markets fail: public goods, externalities and economies of scale.

Some goods and services are public goods that, in the words of economists, are non-rival and non-excludable. When you buy a nice dress for yourself, you keep everyone else from using it; it is a rival good. But when you benefit from the security of having a national defense system in place, others can benefit from it as much as you do (non-rival), and neither can anyone prevent everyone else from enjoying that benefit as well (non-excludable). In such cases, people will want to "free-ride" and avoid paying for these services, or at least pay less than what it really means to them. Thus, it won't work for a private firm to produce and sell such public goods. Government must step in and provide them directly.

Externalities

When firms produce and people consume certain products and services, they could inflict some indirect damage (external costs) or cause indirect benefits (external benefits) on others. For example, when a cement factory pollutes a river, government must make the producer absorb that additional cost imposed on society to lead him to correct it. Government can regulate the production outright (e.g. impose strict pollution controls), or tax the factory in proportion to the pollution it causes. When the owners of dilapidated antique houses in Vigan or Pila spend money to repair and restore their homes, everyone else benefits from the improved ambience and preservation of cultural heritage. Thus, government can be justified in subsidizing their restoration costs (e.g. by real property tax exemptions, as was done in Vigan, or outright funding assistance). Whether costs or benefits, so-called "externalities" may warrant government intervention in the form of additional taxes or subsidies.

Anti-trust laws

Bigger firms often enjoy a cost advantage over smaller ones due to economies of scale, leading to a tendency for bigger businesses to crowd out or "eat up" their smaller competitors. Last week, we identified this phenomenon as a key reason why the rich tend to get even richer. When economies of scale make bigness an advantage in an industry, government can impose rules that neutralize this advantage, prevent big industry players from bullying their smaller competitors with unfair trade practices, or enhance and expand competition in the industry. The U.S. has anti-trust laws that accomplish this; we have yet to provide the same in our legal system.

Government has no business being in business, it is often argued. But as in every rule, there can be valid exceptions. The challenge is in telling when they are indeed valid.

posted by JD @ 3:09 PM