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NEXT time that you visit a reasonably competent
food court, in a reasonably competent mall or
airport, think about the national economy....
    That food court couldn't work well without a
reasonably cooperative set-up, including but not
limited to rules set by mall management.
    That food court couldn't work well without
free-market-like competition among its members.
    All pretty much win, including foot-tired
shoppers drawn from all the way across the mall
because they know they will find something there
close to their mood and preference.
    Now let's think about the national economy - - -


Mixed Economy
National and World Solution Suggestion

by Win Wenger, Ph.D.
 

Some will disagree strongly with our conclusions in this piece. If you check out the basics we cite here, however, you may very well agree instead, and even find that this proposition is yet another example of discovering the obvious.

Nonetheless, our topic this time is one into which many fine minds have ventured and gotten lost. "360 degrees — the number of mutually exclusive different directions in which 180 economists point!" But sometimes fine minds among us strain at obscurities and miss the obvious. Hopefully, we've marked an obvious path here which will make good sense to laymen and professionals both — and on matters of extraordinary importance to all of us.

Let me begin with the most basic lesson in economics, which was taught us by that great discoverer of the obvious, Adam Smith. Publication of his book, An Inquiry into the Wealth of Nations, was one of the two most important events of that crucial year 1776. Every economist since has stood on his shoulders (though some lost their footing!). Smith described the basic mechanism and principles of a self-governing system — in this instance, a market economy — and his work has been the bible ever since for the field of economics. He also described that market economy's limitations.

O

A Basic Principle:  The Economy as a Directory

In a properly functioning market economy, prices and wages act as a guiding Directory. When people want more of a particular good or service, or want it more, they bid up the price for it.

For example, if some well-known researcher proclaims twirling a hula hoop to be one of the healthiest possible exercises, more people will want hula hoops, more will seek to buy them, and some will be willing to pay more for them. Thus more retailers will seek to carry them in stock as they can get a higher price for them, and more suppliers will want to produce and supply these to take advantage of the higher prices they can get for them. This dynamic goes in the other direction as well, once people tire of hula hoops...

Or, as another example, an outbreak of disease decimates cattle herds, making beef scarce. People who had been able to get it cheaply no longer can. Some of them shift to other foods, while others still must have it and are willing to pay higher prices in order to obtain it. The higher prices lead entrepreneurs and importers to make extra effort to get in beef from other suppliers; also they lead farmers to go to some lengths to build up their herds — until the new extra supplies bring prices back down once more...

Prices, reflecting what buyers are willing to pay for and also reflecting what's available from present resources, tell producers to produce more of one thing and less of another. Similarly, wages paid to those who are working in a favored industry will be under upward pressure. (Theoretically, wages should be free to decline in a declining industry, but in our history we've chosen to make that an inadmissible outcome; so we see unemployment instead, one of the many kinks in the market economy and one whose consequences are a much greater dislocation in the economy than would otherwise occur with market variations.)

In a well-functioning market, rising and falling prices (and profits, and wages) serve as a Directory, guiding people and resources into more and more productive uses and away from unproductive uses or uses which are valued less. It's as though an "invisible guiding hand," as Adam Smith put it, were steering people and resources into their most productive uses relative to "the public good."

In command economies, which are less responsive to or even unresponsive to changing wants and needs, unwanted goods pile up; providers of unwanted services go through the motions with their efforts wasted; all the while actual and even vital wants and needs go into shortage or are unmet altogether. This is unmistakably why Communism fell, far more than just its betrayal by bad individual leaders. It is a good part of why so many countries have turned from authoritarian methods toward at least something of the democratic forms of a market society. But because most of them — and most of us — haven't the foggiest notion of the actual nature of a free market system, much less of its limitations, including the very ones Adam Smith warned us about, a lot of the gains have been missed which could have resulted from that turn. One dramatic example is post-Soviet Russia, which could have prospered and become a huge trading partner, furthering our own economic well-being as well as their own and everyone else's. We blew it.

O

Our Goof in Russia

The Soviet empire was crumbling. The last-ditch coup attempt to restore the faltering Soviet Union had failed, as democratic groups within Russia kept each other apprised of what was happening. Boris Yeltsin had triumphantly stood atop a surrendered tank, reply to the same act by Vladimir Lenin sixty-odd years earlier. The Russian people were turning their backs on the old command system and bravely casting their lot with democracy, freedom, and a market economy. They turned for help to what seemed the best possible source, the professional economists of that paragon of capitalistic market society, the United States.

And, inadvertently, we dealt the Russian people a sucker punch.

Our economists tend to be ideologues, and those we sent certainly were wearing ideological blinders which kept them from seeing and relating to the obvious. The command economy under Communism had ruined Russia's economy, so they saw the solution to be that of getting completely away from the command economy as instantly as possible, let come what may. What came was a far greater catastrophic ruin.

So anxious were they to get everything away from command and government controls, that our economists led Russia to overlook one of the most obvious of all issues in economics:  monopoly. Everything in Russia was a state monopoly. Removing the command structure didn't remove the monopoly but left it in the often rapacious hands of narrowly based private interests. No industry should have been released from control until adequate competition had been set up in it and the monopoly condition removed. We fostered this mistake in not only one industry.

We pressured Russia to cut the command strings in all its industries before getting competition set up in ANY one of them! Buyers had no alternative to turn to, whose availability would have held down a price surge. The result was one of history's worst episodes of hyperinflation and the wrecking of what remained of Russia's economy.

A viable and prosperous Russian democracy and trading partner would have been of huge benefit to America, I don't believe this disaster was anything anyone in this country intended, despite the long years of Cold War just ended. There is sufficient explanation of that terrible outcome in that our economists had their narrowly based theories and couldn't see around them to the obvious, just as is the case with most of them today in other contexts. The main part of the blinders that they wore was this:

Command economy, bad. Market economy, good. Market economy efficient at making necessary adjustments. Therefore, to fix what's wrong, whatever's wrong, get command (government) out of the way and let the market fix it.

There are a few problems with this perspective, not least of which is neglecting what it is that MAKES a market economy "good," relatively speaking. It also ignores the very definite limiting conditions beyond which a free market economy cannot operate well and will even operate destructively.

O

The Directory Derailed

What makes a market economy "good," far more efficient than government command could ever be at immediately making the detailed adjustments of a million-and-one changing conditions which keep most people and resources usefully engaged at their best or near-best uses, is the Directory service provided by freely changing prices and wages. When conditions are generally fairly consistent, and when not too much at a time is out of whack, people know pretty much what to expect and how to react, and the market is usually a far better answer than is authoritarian command.

When those conditions no longer prevail, in emergency or with multiple major difficulties under way, the pricing mechanism no longer is an effective guide. The Directory goes off its tracks. People and resources go unemployed, disruption spreads. Without intervention, the economy can actually collapse, so abjectly that Humpty-Dumpty can't be put back together again and no recovery is possible in the foreseeable future.

What our ideologues also conveniently forgot was the fact that under such pressures even that most exemplary (relatively speaking!) of market economies, the United States economy, has ALWAYS had the good sense to lend its Directory a helping hand. Wars, depressions, other emergencies — fairly quickly we've responded to them by setting up structures, either outside the market place or regulations within the market place, to contain the worst effects and bring conditions back toward the point where normal pricing could once again bear a rational relationship to the greater good.

And, of course, at the time of the fall of the Soviet Union, Russia's economy was already far more disrupted even than was our capitalist economy at the time of The Great Depression. Russia's economy was far further than ours ever was, terribly further, from the conditions where pricing mechanisms could possibly bear any reasonable relationship to the greater good. Even without that disastrous monopoly situation leading to hyperinflation, wholesale cutting of command controls, without assuring a rational pricing system to be in effect, was bound to have resulted in chaos and economic collapse. It is difficult to appreciate just how egregiously our advisor-economists ignored the most important key principles of their own field and discipline, stampeding past all good sense in the name of an ideology of free markets!

Some of the same economists are directing some of America's economic affairs today. Fortunately, none of the emergencies currently under way have taken our own pricing mechanism and Directory totally out of rational range yet, and maybe they won't. But in large swathes of the world economy, their ideology makes it difficult for either them or local leaders to see the way out of the emergency conditions prevailing in many national and regional economies. With economies as intertwined as they've been for some time now, this particular snake could turn around to bite us in a most inconvenient place.

O

 
Other Problems With a Free Market Economy

Adam Smith, father of all our basic understandings of free market economies, was very clear also in pointing out the limiting conditions beyond which the market, left to its own devices, will do harm instead of good. He pointed out many of these limiting conditions, all of them instances where the Directory just doesn't work any more or works very poorly, so that people and resources are no longer guided toward their best uses and are actually taken away from those best uses, often away from any positive use at all. Of these many conditions, several are of considerable special interest to us right now:

Indivisibilities:  How do you defend St. Louis from terrorism or foreign invasion, without also defending Chicago? How do you defend against typhus in Cleveland without also helping to prevent it in Buffalo? How do you charge people for, and provide to some and not others, the prevention and near-extinction of smallpox? Hamburgers and hula hoops can be marketed to individuals; their benefits are "divisible" among them, and each individual's benefits can be accounted. For many commodities and services, their value cannot be divided up and assigned by pricing mechanism to individuals. The free market cannot provide products and services whose benefits are indivisible, not without considerable direction from some other, larger, system operating from outside the marketplace.

Cost Externalities:  downstream from the effluent source or downwind from the smokestack, some of you reading this can find this factor easy to appreciate. The cost/benefit analysis of individual polluting firms reflects only their own costs and not that of the neighbors. Some firms and some managements transcend this narrow basis and look to serve the wider community; more do not, and indeed feel obligated to look instead to the interests of their immediate stockholders, to whom they hold a clear and specific fiduciary responsibility, before thinking about the wider community. More generally, cost externalities are what we see in areas of economic activity where the doer feels the benefits but others have to bear the costs. With other people having to bear the costs while the doer gets the benefits, we see a lot of economic activity which on balance does more harm than good to overall public well-being — often a lot more harm than good.

Benefit Externalities:  where the benefits are felt by others, but the doer bears the costs. Shovel the snow in front of your own house so others can pass by unimpeded? No way, most people say, unless compelled by strongly enforced ordinance. A major example — why nearly all the science done is applied science instead of basic science, which tends to dry up the well unless more basic science gets done. With applied science the doer is in a position to harvest most of the benefits, offsetting his costs so it is worth his while to do it. With basic science, a million-dollar investment might turn up scientific findings worth a hundred billion dollars to the economy as a whole — but if the prospective provider of that investment isn't in a position to exploit it directly and realize at least a little more from it than the cost of his investment, that investment isn't likely to happen.

In cost externality situations, things tend to get done whose cost to society as a whole is greater than the benefits to society as a whole — often far greater.

In benefit externality situations, things tend not to get done whose benefits to society would be greater — often far greater — than their cost would be, so that considerable well-being and positive opportunity are lost.

In all three of these conditions (as well as the other conditions cited by Adam Smith), the Directory is off the track. Normal pricing mechanisms for prices and wages no longer direct people and resources toward their best uses, but away from them. What makes the free market system "good" no longer does so.

O

Thesis

  1. Public needs accumulate around the problems caused by these shortfalls in the free-market economy. Government accumulates around these needs, trying to meet the needs and offset the ills resulting from the deranged Directory.

  2. Government, except in a few exceptionally heroic instances, tends to do as poorly or make matters even worse.

  3. Shortcomings of government action, and increasing cost of government, give rise to pressures and efforts to reduce government and restore a wider range of conditions back to a relatively unfettered free-market system.

  4. Resulting dislocations, abuses and exacerbated public needs then call government back into play, expand government and its cost, and usually quickly result in performing as poorly as in phase 2 of this cycle, and so on around again with another drive to economize and trim government.

This cycle has given us two kinds of professionals:

o The ones wanting government intervention at this point or that point of public need or policy, regardless of other considerations because that public need itself is so clearly evident that surely something must be done; the sheer human urgency surely overrides all other considerations.

o Those blindered economists who are so committed to free markets that they demand such matters be left to the free market to "fix" even when it's clear that the market will not and cannot, when left to its own devices, address that particular need. Neither talks much to the other, only at each other. Neither thinks that any position other than their own can possibly make much sense.

O

Breaking Free of the Cycle

In truth, most economists — despite their horrid performance in Russia — have had to accept that some sort of mixed economy is necessary. They accept that some part of economic activity should be best done by the free market and some should be by some sort of intervening factor from outside of the marketplace, such as government, though they don't agree as to how much should be which. To the interventionists, public needs are so compelling that the marketplace is a distraction or a necessary evil, so they don't bother to look more closely at its positive possibilities.

To the more ideological, at least, among market economists, government is the necessary evil and the less of it the better, so they don't bother to look more closely at its positive possibilities. We all are the poorer for this, condemned to oscillate forever, it seems, between the two sides of the cycle — between interventionist government, with its inefficiencies and abuses, and ungoverned free marketplaces with their abuses and neglect of many real public needs.

There has to be a better way, and there is.

Please bear with me and, once again, think of the free-market economy as a Directory. So long as price changes and wage changes truly direct people and resources toward their best and most productive uses, the free market is "good" because the general outcome for most of us is "good." As a self-governing system the free market historically is very good at coping with lots of small changes very quickly and efficiently. People do things efficiently and quickly and take initiatives in the market economy because it is profitable for them to do so.

Government historically is awkward at decisions and cannot cope rapidly and accurately with many different situations ongoing, and people within government do things less efficiently, less quickly, and less frequently take initiatives because otherwise they get penalized instead of rewarded for their actions.

Ironically even so, within overall government structure, emergency services and the military are set up in a tight command structure, even in democracies, to enable one or a very few individuals to direct quick response to dangerous situations, precisely because government is otherwise incapable of coping.

Long-term situations and policy, however, are carefully kept under civilian control because, otherwise, outside the focus of a given emergency, for every situation such a command structure makes right it goes wrong in ten other situations, as we saw was the case with communism and as we see today in most surviving authoritarian countries.

Long-term policy should be democratic, with everyone having an opportunity to make an input into it, having a legitimate chance to affect the outcome by virtue of the case they make. Jeremy Bentham's "Utilitarians" and their successors, such as Locke and Thomas Jefferson, were correct in their thesis that people themselves are more likely to know what's best for them than some far-away authority or ruler, so that if they have such an input, public policies will better tend to be in the general or public good. But the mechanisms through which truly democratic policy-making could operate (even if ours were today, which is questionable) are not very well suited to quickly responding to multiple changing conditions, the way a free market place does, or instantly making countless decisions.

Neither government nor the free market economy is "good" or "evil." Each has a scope of situations and activities for which it is better suited, and a scope of activities for which it is worse suited. Extreme efforts to substitute one for the other cause harm. There may be — and are — some ways to work the two together much more positively and constructively.

Let us look at one of these ways, applied to areas of public need and applied to areas of public policy.

O

Better Meeting Public Needs

A vast range of public needs, especially material needs, is best served by the incredibly fluid responses of a free market system, a pricing Directory which in its innumerable rapid and largely automatic decisions steers most people and resources into those very productive activities which in fact address those needs. We don't want to impede that mechanism. Efforts to "fix" it which interrupt this vast and sophisticated mechanism would create far greater public need than it corrected.

Yet as we have seen, left to its own devices, a free market does go awry in some situations. The vast engine needs a bit of maintenance. A lot of public areas of need it just is not taking very good care of. The solution, though, is not more government, but a different type of governing.

The solution is to substitute use of incentives for more direct means of governing, in a wide assortment of public situations — usually positive incentives, the carrot instead of the stick, so that more people are drawn toward the policy than will devote their lives to finding ways of beating it.

What leads the market mechanism astray in some types of situation, such as cost or benefit externalities, is that, in those instances, what's beneficial to the doer is less than beneficial to the larger community. Adam Smith's "invisible guiding hand" or our Directory no longer guides people and resources to more productive uses, that condition which makes a free market economy "good." And those enterprises which "hold to the good regardless," by so doing in many instances so disadvantage themselves that they sacrifice themselves, leaving the field to those powers who put their own immediate interests first.

The use of incentives — to offset the distortion in private accounts created by externalities, thereby realigning private with public interests and well-being of the community — would allow the free market to operate over a much wider range of conditions than before, while correcting the public needs associated with that externality effect. Over this wider range of conditions, people will be generally led to "do the right thing" because it is profitable for them to do so. Over this wider range of conditions, people will need LESS supervision, LESS regulation, LESS direct government intervention, and government itself will be costing a lot less than before.

Examples of this approach are cited in my book, Incentives As A Preferred Instrument of Corporate and Public Policy. I'll limit myself here to one example:  that cost externality we know as pollution....

  1. General tax on all classes of economic activities which result in pollution, in proportion to the seriousness of the pollution. In order for there to be more carrot than stick,

  2. Those firms are exempted from that tax where they prove — with the burden of proof on the firm — that in this particular instance they in fact have prevented or stopped the pollution. With the burden of proof on the firm, the firm will be bringing the evidence to the government, rather than government having to go police the polluters. Some policing in any case, but a very different situation and much less cost to implement.

  3. Special incentives in form of tax break to firms to invest in the means to limit or end their pollution. "Sunset clause:" provide these tax breaks on a sliding scale — more if they do it now, somewhat less if they do it soon, considerably less if they do it eventually. This arrangement provides thereby the additional incentive to make that investment sooner rather than later.

O

Public Policy

Within the enthusiasm and focus of a specific endeavor, such as putting a man on the moon within the decade of the 1960s, government, and agreed-upon public policy, can accomplish extraordinary things. Once that focus has dissipated, less happy results are all too frequent. After some of those unhappy outcomes, NASA has retreated toward the status of being more of an information clearinghouse than an active agency, though it is still carrying out missions. In light of the above discussions —

What if all income earned by private enterprise in space, if earned in the next ten years, were to be totally exempted from taxes? And if earned in the following ten years, to be partially exempted from taxes? Can anyone seriously doubt that we'd see a far greater surge in development of space, over that next twenty years and subsequently, than we'd see by current arrangements? Indeed, can anyone seriously doubt even that overall government revenues, even with that exemption taking a bite from tax revenues, would be very considerably higher because overall economic activity would be very, very considerably higher?

Another example of using incentive to accomplish public policy more effectively, at less cost, than by conventional governmental means:

We, and any other country which cares to join us in the effort, give something like an extra 3% break on tariffs on goods imported from firms which are jointly owned by Israelis and Palestinians. Or by Irish Protestants and Irish Catholics. Or any other such seemingly insoluble ethnic division.

That wouldn't end conflicts today, maybe even tomorrow, but gradually over time, each such conflict zone would be increasingly under the influence of major powers in the region whose well-being depended substantially upon the well-being of the opposed ethnic group. How would the costs of that arrangement compare to the costs of the present explosive situations? See Winsights No. 36 and No. 34 for more details on this approach to peace-building.)

O

In the Private Sector

Incentives may be substituted for more costly and conventional methods of management and supervision, in the private sector of the marketplace as well as in some agencies. Some care, however, has to be taken in this widely variegated scene to make sure that the incentives used are, indeed, incentives — that is, that they are not only acceptable to but desired by the personnel to whom they are set. Also that the numbers of people among whom they are set are large enough to make incentive-setting an efficient way to proceed — for example, it's a lot chancier and usually more expensive to get one particular individual to respond to your incentive than it would be to set an incentive among a hundred people with aim of having one of them make the desired response. A number of these factors are presented in Incentives As A Preferred Instrument of Private and Public Policy.

O

Conclusions

o We see this incentives-setting approach as greatly expanding the range and domain of individual human freedom and initiative:

  • where a relatively unfettered free-market economy can operate effectively without more overt government intervention;

  • and at most levels both private and public where more can be accomplished through incentivized private efforts and initiative than by overt controls.

o We thus propose that such a "mixed economy" would, in fact, be far freer than the purer free market our ideologues are demanding, aside from whatever further gains in human freedom can be obtained by really effectively addressing some of those public needs which currently are not being well taken care of. A pure free market cannot serve us well, but an incentivized free market operating over a wider range of conditions gives us more of a free market, and a freer market, than can otherwise obtain.

o Our society is unable to do without government, and the attempts to reduce government simply by cutting government always result in more government. Carrying out a higher proportion of the concerns of government by incentive, rather than by the more usual means of intervention, is the most effective way we can reduce the size and cost of government. It is also by far the most effective way to address most of the public needs and concerns which government is meant to serve. I respectively submit that to turn to use of incentives as suggested here not only makes sense but is an exercise in discovering the obvious.

The author would be very pleased to hear from those who:

  • care to discuss the points of this paper, pro or con;

  • would be interested in exploring, in greater detail and in various situations, how incentives might usefully be applied in settings both private and public.

This potentially controversial topic invites your responses and views. It is the only exhibit in this website that does not have the web editor's unconditional concurrence. Email to Win Wenger.
What Readers Say — selected comments
Kate Jones | Jan Narveson | Frederick Mann

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Related Reading:

  • Five-Fold Path Toward a Robust Economy
  • Incentives as a preferred instrument of corporate and public policy

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