Role of State in imperfect market

The important point about market is that it will tend to solve its own failures in the very long run. Not only market forces will improve themselves on long run, but also complementary local institutions will spontaneously emerge to solve the problem of market failures (Hayek, 1988; North, 1971 and Arrow, 1969).

Say a farmer may have credit and input problem which limit its production in face of increasing demand for agricultural products and rising prices. However as the price keep rising, the level of profitable opportunity for solving those credit and input problems will increase. In this reality it does not take to be rocket scientist to know in few decades someone will figure out how to make money by financial innovation or input market innovation. The profitable opportunity will stimulate the rise of institutions that can solve credit and input problem in the long run. This is the blind watch maker system of market which makes it a self reappearing machine.

What non economist and often economist mix up is the market modeled in text books with the market observed in the real world. The market in text book is fantasy of economists in trying to explain the virtue of competition, which is hidden from the visible world as invisible hand. The market observed in the world is result of century experimentation with exchange by generations of humanity starting from gift exchange. It is pride for me to repeat the admiration of Hayek (1988) in stating market and market prices are one of the greatest inventions of humanity and one of the greatest institutional steps which create the great leap for humanity. Have you ever wonder how our society is organized in to such civilization? When you ask this, you will see the huge virtue of market as institution. Or try to explain to visiting alien from distant planet how our world works and market will come again and again as virtue of our world. Market is very good tool that can destroy humanity or help humanity, no matter its imperfection. We are not advocating don’t touch my market and virtue of selfishness of Rand (1957 and 1964) or only small change is allowed of Hayek (1988), but we are advocating for careful intervention in approaching a complex system like market. Why?

Market is not developed by stroke of a pen, as the result it cannot be changed by stroke of a pen. Change does demand evolutionary understanding and evolutionary policy which is pragmatic and outcome oriented in nature to use it for improved functionality than dogmatic big push of late state free moment (North, 1992, 1994). Market is evolutionary and often ugly in its process. Imagine how many years the farmers have to be in poverty and customers without adequate supply of agriculture products before the market respond to change. Far worst, if the opportunities for profit are not adequate or if there are institutional supply rigidities; market may not solve its problems at all. Market may decide to marginalize or to destroy some communities in long run.

This is like saying given adequate time our body will develop capacity to stand AIDS, which is of course after death of millions of peoples. There is also chance nature my choice our extinction as the right solution. Any evolutionary based system is self sustaining and self perfecting in nature and market is classic example of that because it is one of the most adaptable system to change compared to most human institutions. Does this mean we have to bow to rule of market as advocated by Rand (1957 and 1964), Hayek (1988) and WB (1997), without any question? No, because the unfortunate implication of the above logic is that we have to wait 200 - 300 years or more in order to achieve the level of development attained by developed economies. Far worst even delayed success is not granted in long run, if we are not fit at all. The million dollar question is then what is the proper state intervention? Before we go there, let’s listen to few cat fight and food fight of Academy of Plato.

There are those who advocate historical development is caused by market (WB, 1997; Smith, 1776; and Hayek, 1988) and there are those who present counter agreement for high role of state in historical development (Chang, 2007; Reinert, 1996; List, 1909; Rodrik, 2007; Cimoli, et al., 2006; Wong, 2004). Yes historically government intervention was fundamental in any development. It is true fact that as government of China promotes its industries and business, the government in USA does also promote its own productive and business interest. Historically the imperial government of UK did make high intervention to promote its industry and international trade position. No question about it. Even some may find data that shows the highest state intervention in the world is done by USA to conclude free market is just policy prescribed for the poor so the poor can stay poor and the rich can get richer.

The problem is that the world we see is not like this. Is USA, let alone now even historically, less of an advocate of free trade than China? Is freedom highly restricted and managed in USA as it is in China now? Is the freedom of the market in USA as restrictive as the freedom of market in South Korea in time of its development? This black and white view of reality which does not see the rainbow of reality in social life is the reason why the let state free moment and the let market free moment never stop bickering forever in never ending cycles of historical phobia.

Can any reasonable mind think market and society has less freedom to work under the blind watch maker system of market in USA compared to China and South Korea in time of their modern renaissance? In USA market has bigger role of organization while government tries to take leading role in Asian renaissance. When market led economy is identified the lead role of market in resource allocation is well respected in most life of the people. This is true in historic USA and UK, as it is true in current time. We can see non black and white view of this colorful world from Freeman’s (1998) historical analysis of development where importance of freedom, innovate culture and institutionalized technological innovation is clearly taken into account. While Chang (2007) did give more emphasis on state lead institutionalized technological innovation only ignoring other sides of the dynamics.

It is true any wise government will not simply promote static comparative advantage. For example Cimoli, et al. (2006) observation of Asian renaissance did lead to conclusion that static inefficiency is intentionally created in order to create high return industries in terms of dynamic comparative advantage by firms which can compete at international market in long run. The same reflection is given by Wong (2004) and Chang (2007). This is also supported by historical evidence of List (1909) and Chang (2007). All governments work hard to promote domestic industry including the contemporary governments of USA, UK, European Union, China, Japan and soon. Any wise government will do it, because when we operate in the blind watch maker system of market we have foresight that can be used in the due process. We don’t simply let our life to fall in mercy of market forces all the time, we do what we know is possible in order to milk the market cow as much as possible.

However this is not all economic history of the world, where the great government comes in to picture with sward of developmental state to share the ladder of development and fire of knowledge from the rich Olympus lead by Zeus to poor people of his own country. There is more to economic history of the world. For example even if USA government promote technological development of different industries to crate comparative advantage it also allow high level of market freedom which includes challenging the ultimate decision of government as unconstitutional, if necessary. Can we say the same for China? Even if UK in its industrial revolution and expansion of trade used its military might and global dominance to promote its industry and worked hard to restrict trade in some commodities in its industrial revolution time, there was more intellectual freedom, innovation and market development which lead to development vibrant private sector in the due process who end up limiting the power of the king himself. Adam Smith did challenge the status quo and even Marx did find refugee in England, while List is treated like criminal in Germany for advocating industrial development by state intervention. The world is not about black and white. The world is not about letting state or market free. It is about what works and what does not work. To promote industry is one thing to tell them what specific management and technology they should follow is another thing. There is degree difference in level of divisibility and freedom given to people between UK and USA verse S. Korea for example in letting the blind watch maker system to work. Some catch up stories of Asia often involve micro management of performance and direction of firms than just simple promotion and investment on industries. See Wong (2004), Chang (2007) and Cimoli, et al. (2006).

Can we say state intervention is always useful? No the world is endowed with endless list of state failures which are as large as market failures (WB, 1997). What heterodox economists do is pick winners in the game of development with heavy state involvement and they give them new name as developmental state. If Brazil, Venezuela or South Africa where to end up being success story in our time, they will be great example of developmental state. When they fail market forces, international powers and lack of developmental state will be blamed for that. Government everywhere do try to achieve development so everything is not about letting state free as everything is not about letting the market free. All what heterodox economics supply is why orthodox economics is wrong and why state is often right, when the reality is much complex than that. In this respect observation of Colander et al. (2003, page 6) is important

Often the fundamental intellectual content of a heterodox school is rejection of orthodoxy, or at least major elements of orthodoxy. In economics, at least, beyond this rejection of the orthodoxy there is no single unifying element that we can discern that characterizes heterodox economics. In fact, it is well known that many varieties of heterodoxy have more disagreement with each other than they do with orthodoxy.

The point we are trying to make is that first there is no clearly understood consistent theory which explain development through state intervention as result the solution is not letting state free as the solution was not letting market free. Now ignoring the constant bickering of economists the important question is what is the important role of state in evolutionary market dynamics. To understand role of state we should understand the importance of human foresight. Why wait until market favors institutional solution after misery of millions? Why not state involvement to facilitate the evolution of necessary institutions and if necessary to promote direct state intervention to create better life for the population in sustainable manner? Why wait until nature cure AIDS or allow our extinction through natural selection, when we can increase our odd of survival by foresight based adaption. This is where state can play important rule in compressing the gestation period of development by helping the market function better.    

However we also know comparative advantage could be created through careful planning and strategic intervention. This is another area where state intervention could be useful in creating distortions and promotion in the market, like control on foreign exchange, allocation of resources, allocation of public investment, infrastructure development and state policy to promote the development of high value comparative advantage which can generate sustainable better life for the population. The question is not if such interventions are needed. The million dollar question is: can state despite its failures and structural rigidities attain this.

The standard notation of orthodox school is to state the Hyades of communism cannot win against the tender of Zeus in form of market competition. The standard notation of heterodox school is worship of Prometheus. Prometheus is the Greek god who shared fire of gods with humanity by steeling it from Zeus.  He also did trick Zeus to take the bad meat. As result humanity is able to enjoy the good meat for lunch, while having superiority over all animals by gift of fire. What they cry is let Prometheus free and he will make us prosper while facing the fury of the all powerful Zeus. Zeus does not care but Prometheus do they say.  

But such certain conclusion is absurdly impossible because the reality of the detail is much more complex (Rodrik, 2007). Let’s make it simple to understand. First there is issue of capability either to know the solution or to develop it by trial and error. To deal with complex structures like market you need pragmatic mind which uses his intelligence carefully. If there is knowledge that would be simple, but as Rodrik (2007) point it out the micro details are very diverse and it is hardly possible to have one general theory which works everywhere. This will make development a learning experience and the question becomes do you have good feet which can over run the market to bit market dynamics. The orthodox school will say no (see WB, 1997) and the developmental state promoters will say yes (see Chang, 2007; Reinert, 1996; List, 1909; Rodrik, 2007; Cimoli, et al., 2006; Wong, 2004). Personally we have seen where government had great achievement and we have seen where government has great failures. The answer simply depends on specific reality. We cannot say no because China and South Korea did it well. We cannot say yes because the failures are countless.

Another problem of state intervention is it demands honest dedication, by all parts of government up to micro level, to such policy especially as state intervention increase in magnitude and micro detail. Neoclassical assume human beings are always selfish. Their conclusion as the result is more state intervention and especially micro management will lead to corruption (WB, 1997). Those who promote state intervention either accept some corruption as legit (Chang, 2007) or assume the existence of dedicated state which is Prometheus of our modern area (List, 1909).  

In space dominated by highly selfish beings the state apparatus is dysfunctional and open for corruption. This will be explained in great detail next. However human beings are not ego centric atomistic selfish being, as they are enlightened and strategic in their selfishness (Mezgebo, 2017). As result the self is very elastic. If national identity, professional identity, civic duty, trust and soon are well developed, they can be important driving force in solving the moral hazard problem of state intervention. If we take South Korea for example, inhuman oppression that they face under Japan and new ignited nationalism did create strong sense of national identity which was useful tool in promoting their state intervention in effect manner. However such identity, unless it is carefully engineered or it exist by historical accident, is hard to come by and easy to corrupt. Imagine living in slum house and under poverty in service of your country when everyone is getting richer around you.

Under such reality it is not always necessary true state intervention would be gift of fire from Prometheus but another time and resource wasting state intervention, which can be added to large list of failures promoted by state. Here is where books written to promote developmental state seem to fit. They seem trying to create the view point that if right kind of state uses its hands right it can compress the gestation period of development. After all those economies who used strong state hand in recent years did able to compress the gestation period of development to less than 50 years in Japan, less than 30 years in South Korea, Singapore and Taiwan, and less than 20 years in China. The interest of books written by advocates of developmental state seems to come from desire to create awareness that if we used it right state intervention could work in reducing the gestation period of development.

The real choice however is not between free market and Free State. The choice is what works and if you can make it work, you can even use astrologists and traditional healers as governors of development let alone state. However though we like to act as governors of market, often the weak person do tend to show off a lot because his/her weak base of power, in reality it is not logical to stand against market dynamics in the long run. Even China, South Korea, Taiwan, Hong Kong and Singapore did try to make the market work for them by playing it right, but they did not try to get outside of market dynamics in long run. That is because it will be suicidal to defy market in very long run.

First problem is we don’t know how to organize our dynamics in long run by completely defying market dynamics all in all in very long run. Even if some genius figure it out how to defy market in long run, still S/he needs to operate in international market organized by market forces. This is why those who think they are governing market are often governed by international market dynamics. If in long run you are governed by market forces, you cannot be almighty God of domestic market, but just local administrator of local market under long run leadership of international market. Now let’s explain state failure to kill the Greek myth of Prometheus, so we can see the real state as it is. Often it is shame to see well respected economists trying to solve moral decay by increasing the power of state in social life. This is because they are under the spell of Prometheus’s witchcraft and they are not thinking right.