If every individual (or firm) makes decisions based
on the total net benefit to everyone - not just themselves - then outcomes
would be socially optimal. Obviously the market contains negative externalities
and public goods issues that can be mitigated or solved by top down central
intelligence (a role usually performed by the state), but if you can align
private incentives with social net benefits, you get the most efficient
outcomes, and the market does that best in most areas of society. Or to put it
another way, market failure is the exception in the free market, but is it the
rule in the political market?
You may wonder why I’m using ‘market’ for the
political landscapes too, so let me explain. Think of society like a whole
interconnected market, where that market is a mix of private goods and public
goods. We said that outcomes would be socially optimal when decisions are based
on the total net benefit to everyone. In a free market, it’s easy to see why
failure is the exception not the rule.
Imagine I set up a stall on Norwich Market called
The Halloumi Hut, serving the obviously gorgeous freshly cooked halloumi dishes
that a character like me would serve up. To run this business, I need to bring
together various resources - workers, ingredients, cooking equipment, and my
own time and effort. To hire someone, I must offer at least as much as their
next best alternative - whether another job or their own leisure - so their
cost is passed on to me through wages. When I buy halloumi or other inputs, I
either outbid others who want them or pay suppliers enough to cover their
production costs. The price system ensures these costs to others are reflected
in what I pay. I collect the value of my cooking when customers buy it - their
willingness to pay reflects how much they benefit. Any personal effort or time
I put in is a cost I bear directly. So, all costs and benefits - to me and to
others - are transmitted back to me through prices and wages. If the total
benefit outweighs the cost, I open up the shop. If not, I don’t. That’s how markets
push us toward choices that are efficient for everyone involved.
I frequently point out the ways in which market
failure is rare in the free market and commonplace in political markets - and I
do it with such rigour and charisma that I’m always amazed that everyone
doesn’t just drop what they are doing and agree with me. Given that this is
econ 101, and repeatedly demonstrated empirically throughout history, why do
people habitually place too much confidence in governments and not enough in
markets? (Read this IEA paper of mine if you can’t see the dangers of that).
I’ve laid this out a lot more comprehensively in my
economics book, but my answers in brief would be:
1) Markets work subtly, and governments act more
visibly and bombastically. Market coordination happens decentrally and quietly:
prices shift, resources reallocate, and innovation happens gradually.
Government action, by contrast, is immediate, dramatic and usually at the front
of the news - so it feels more responsive, even if it's less efficient.
2) Market failures - rare as they are - often hit
the headlines in a dramatic way, reinforcing the left’s incentive to distrust
the system.
3) Self-organising systems make people feel
intuitively uncomfortable - they prefer to think of top down agents in control.
4) Many people are not exposed to basic economic
thinking - price theory, seen and unseen, opportunity cost, incentives,
trade-offs, etc - so they are more likely to hold ideological views that
override empirical evidence.
5) People are genetically predisposed to favour
socialism over markets (see my side bar on Socialism)
6) Politicians lie and distort the truth so readily
that they are trusted far more than they deserve to be.
But there is a seventh reason that needs more
fleshing out, because I think it might be the primary mistake that leads to
overconfidence in governments. When people think of a government, I suspect
that (consciously or subconsciously) they think of it as a little like a
benevolent uncle who stands firm in the family and has the wisdom and sagacity
to organise society according to its superior knowledge. But just as one can
see the folly of corporation tax by seeing that corporations are really just a
collection of individuals, similarly one can see the folly of
overconfidence in government by seeing that governments are really just a bunch
of people, acting with their own interests first and with a woefully incomplete
and inadequate understanding of the interconnected market. Try this; when you
think of the concept of government in the future, don’t think of an abstract
wise uncle, think of concrete individuals like Boris Johnson, Ed Miliband,
Dianne Abbott, Liz Truss, Jeremy Corbyn, John McDonnell, Ed Davey, Keir
Starmer, Caroline Lucas, David Lammy, Angela Raynor, Kwasi Kwarteng, Rachel
Reeves, Michael Gove, and so on – they are the typical politician who have put
themselves forward and asked you to trust them to manage our complex society. The
paradox of government is that most people wouldn’t trust the competence or
motives of most individual politicians to act in their interests to engender socially
optimal outcomes, yet when they come together as a cluster called a ‘political
party’ the confidence increases.
I know that people work collectively better in ways
they cannot as individuals, but they don’t work collectively better in the same
way that the free market enables us to work collectively better because, as we
saw above with my Halloumi Hut sketch, the market most consistently aligns
private incentives with social net benefits to produce most efficient outcomes,
where failures are the exception, and the political market shows the opposite.
This is because they operate under fundamentally different systems and with
different incentives at the heart. Free markets increase total aggregate value,
where each individual agent bears the net costs of his action, making his
interest the same as our interest. The free market does that imperfectly, the
political market much more imperfectly. Politicians bear virtually none of the
costs of their bad policies, and the electorate is not privy to the full extent
of politicians’ short-term, selfish incentives.
The most efficient systems are systems that align
local knowledge with personal responsibility, that reward value creation, and
penalise waste. The free market, for all its imperfections, is the only
mechanism we’ve discovered that does this consistently and organically. It
harnesses dispersed information and decentralised decision-making to produce
outcomes that, more often than not, benefit everyone involved. Government, by
contrast, operates in a fog of incomplete information, distorted incentives, and
absent accountability. That people place too much faith in the one system that
persistently divorces power from consequence is regrettable. Because the most
fundamental difference between markets and politics lies in who bears the costs
of failure. In a free market, bad decisions are punished - swiftly and
impersonally. If I overpay for ingredients for my Halloumi Hut, if I hire the
wrong staff, if no one wants my halloumi, I lose money. I feel the cost. But
politicians operate in a system where the feedback loops are weak or broken
entirely. They spend other people’s money on behalf of other people and are
rarely held accountable for the unintended consequences. When policies fail,
the costs are dispersed across millions of people, and the connection between
action and outcome is easily obscured.
Look, none of this is to suggest that government
has no role to play. There are domains - especially the provision of certain
public goods - where collective action through central intelligence is
essential, and where market mechanisms alone fall short. But central authority
can rarely outperform decentralised incentives, personal responsibility and
local knowledge. No, I’m afraid the reality is, through government, incentives
are frequently misaligned with the public interest - because they are aligned
with appearing virtuous, furthering the career and reputation of politicians,
and helping the party stay in power by saying whatever it takes to secure
votes. The market is not perfect - but it is the best we have for most societal
transactions, and as a result of an aggregation of revealed preferences, it is
profoundly more honest and reliable than the fiction of a wise and benevolent
state.
It remains one of the strangest and most
unfortunate things, that I doubt I've ever met anyone who would endorse the
outcomes I know political market failure produces when it occurs, yet the world
is replete with people who habitually endorse its mechanisms and repeatedly
trust its architects in prospect. The typical voter who trusts these
politicians time and time again is a bit like someone who cheers for a magician
when he saws the wrong person in half, and then asks for an encore.