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.
