MARKETS AND GOVERNMENT: REALIZING THE PROMISE OF GAINS FROM EXCHANGE AND COOPERATION

Abstract

Recent policy debates have focused on the boundary between markets and government, as if one could partition them. The placement of this boundary has been debated using the established theory of market failure and the developing theory of government failure. But the questions raised by this approach are not well-posed, and miss several important points. First, markets and governments together can achieve and have achieved enormous success in the last two hundred years in broadening geographical settings. Second, markets need government, and government needs markets to enable societies to capture the gains of cooperation and exchange. Third, we challenge the relevance of idealized “competitive equilibrium” as the reference point against which real outcomes are to be compared. As an alternative, we propose that the appropriate benchmark for comparison is Pareto improvement through solving problems of collective action. In that regard, both firms operating in markets and government agencies operating in a statutory setting should be considered together as organizations. Viewed from this perspective, both firms and government agencies have some shared features and some sharply different features in their capacity for fostering cooperation. In this paper we outline the advantages and risks of complex organizations, and provide some general guidelines for public policymaking.

Keywords

• market failure, government failure, diminishing returns, increasing returns

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