Finding the Correct Balance Between State and Markets

I have been engaged in a discussion with a correspondent and what follows summarises my contribution on the problems of development in developing economies.  I publish on Lost Legacy because it discusses a very modern problem of the appropriate relationship between the State and the Market economy which is common in different forms and degrees in all countries:

Adam Smith was quite clear that market-state roles were mutually dependent.  Markets did not have to be perfectly free and nor did the state have to be totally dominant for both to contribute to economic growth.  One without the other would not be likely to contribute to economic success (crudely measured by a daily income of $1 a day or less for the overwhelming majority of the world’s population).   This was true in and well beyond Europe, the first region to raise incomes from $1 towards $100 a day for the majority of its populations in about two centuries.   That rise in per capita incomes is now happening in more quickly in South America, Asia and even in Africa, though at a slower rate in some places and it is taking various forms in the countries experiencing the changes.

Smith would not be surprised.   There are large differences that remain between individual countries, some with authoritarian states that remained ideologically hostile to markets and their associated liberties up to recent times. I think we can summarise Smith as being in favour of ‘markets where possible, and state activities where necessary’.  See Warren J. Samuels and Steven G. Medema “Freeing Smith from the “Free Market”: On the Misperception of Adam Smith on the Economic Role of Government”, History of Political Economy, 2005 37(2): 219-226.  Here is a list I extracted from Wealth Of Nations (see by Lost Legacy Blog: 4 March 2010).

Smith’s concept of free markets was not one of the total absence of State regulations.  Far from it. Here is the list extracted from Wealth Of Nations:

• the Navigation Acts, blessed by Smith under the assertion that ‘defence, however, is of much more importance than opulence’ (WN464);

• Sterling marks on plate and stamps on linen and woollen cloth (WN138–9);

• enforcement of contracts by a system of justice (WN720);

• wages to be paid in money, not goods;

• regulations of paper money in banking (WN437);

• obligations to build party walls to prevent the spread of fire (WN324);

• rights of farmers to send farm produce to the best market (except ‘only in the most urgent necessity’) (WN539);

• ‘Premiums and other encouragements to advance the linen and woollen industries’ (TMS185);

• ‘Police’, or preservation of the ‘cleanliness of roads, streets, and to prevent the bad effects of corruption and putrifying substances’;

• ensuring the ‘cheapness or plenty [of provisions]’ (LJ6; 331);

• patrols by town guards and fire fighters to watch for hazardous accidents (LJ331–2);

• erecting and maintaining certain public works and public institutions intended to facilitate commerce (roads, bridges, canals and harbours) (WN723);

• coinage and the mint (WN478; 1724);

• post office (WN724);

• regulation of institutions, such as company structures (joint- stock companies, co-partneries, regulated companies and so on) (WN731–58);

• temporary monopolies, including copyright and patents, of fixed duration (WN754);

• education of youth (‘village schools’, curriculum design and so on) (WN758–89);

• education of people of all ages (tythes or land tax) (WN788);

• encouragement of ‘the frequency and gaiety of publick diversions’(WN796);

• the prevention of ‘leprosy or any other loathsome and offensive disease’ from spreading among the population (WN787–88);

• encouragement of martial exercises (WN786);

• registration of mortgages for land, houses and boats over two tons (WN861, 863);

• government restrictions on interest for borrowing (usury laws) to overcome investor ‘stupidity’ (WN356–7);

• laws against banks issuing low-denomination promissory notes (WN324);

• natural liberty may be breached if individuals ‘endanger the security of the whole society’ (WN324);

• limiting ‘free exportation of corn’ only ‘in cases of the most urgent necessity’ (‘dearth’ turning into ‘famine’) (WN539); and

• moderate export taxes on wool exports for government revenue (WN879).

Moving our focus to the 19th century, I suggest you consult Murray Milgate and Shannon C, Stimson's, 2009. “After Adam Smith: A Century of Transformation in Politics and Political Economy, particularly pages 252-57. Princeton University Press.  While Adam Smith did not advocate laissez-faire, his name became associated with laissez-faire from political economists after he died in 1790 (Bentham, Ricardo, Mill, Jevons, Marshall who among economists contributed to this false picture), plus parliamentary campaigners (The Anti-Corn Law League, Wilson editor of The Economist, Cobden, and others).  The idea appealed to 19th-century mine and mill owners, under pressure from legislators.   Also some legislators, representing the aristocratic landed interests, who were smarting from manufacturing interests that had conducted a successful parliamentary campaign to repeal the Corn Laws in 1846 (which laws had kept prices of corn high and therefore added to factory wage costs).  But always remember that their versions of laissez-faire was about freedom for merchants and manufacturers, not for their workers or consumers.  Merchants did not favour free trade as such and because Britain enjoyed technological dominance across the 19th-century world, they had less to fear from reducing tariffs on manufactured imports.   These ideas eventually coalesced into Empire Preferences that kept rival imperial competitors out of the colonies.

By the mid-20th century, neoclassical economics had formed ideas of free-market economies (that assumed perfect competition) and had essentially come to dominate international development thinking.  The ex-colonies were managed by domestic elites and local customs had formed local elites that tended to be comfortable in monopoly arrangements that favoured them and their allies.  Developing states experienced much state domination in their economies a few decades ago. China was totally state-dominant; India was riddled with government interventions (national planning) and its economy was a long way from free markets.

The problem is to achieve the right balance between a competitive market economy and an effective state:  markets where possible; the state where necessary.