10 April 2015

The state and the market are set for another needless collision course


As the commemorations for the start of World War One fade, and with those for the conclusion of World War Two on the horizon, we grow increasingly aware of another war that plagued the twentieth century. In fact, it was a war that lasted significantly longer than either of these two, and which framed the politics, economy and society of the entire century: the war between communism and capitalism. For those living through it, it wasn’t always clear what the future would hold. A Marxist revolution rocked Europe and state intervention spread. Even the US succumbed to the forces at work. If you were a betting man, you might not have put your money on capitalism. Of course, if you had, you would have been rolling in it. By the end of the century, the Berlin Wall had fallen and China was well on the road with pro-market reforms.

Now, in what looks rather like the beginning of a rerun of the last century, the battle between the left and the free-market has once again erupted – and not only in response to the financial crisis but also in reaction to the longer-term phenomenon of rising inequality to which Piketty has drawn attention.

The increasingly popular argument is that the free-market model has been pushed too far, leading to a supposedly “inevitable” outcome in which the rich get richer and the poor remain poor. According to some, this rising inequality is the natural state of capitalism with the implication that the state should use its power to wade into markets: to regulate them, to tax them and to redistribute.

On the other side, free marketeers are on the defensive. They rightly point out that a good part of the recent increase in inequality has not come from free markets but, in fact, from their departure: from monopoly businesses, including (but certainly not exclusively) big banks. This “big business” economy is inimical to any free-market way of thinking. If we want to tackle inequality, we would sometimes do best to introduce more competition – more markets – rather than introducing more regulation and redistribution. That would help temper any unfair rewards at the top and ensure a better deal for those at the bottom. In other words, what we seemingly need is a good old dose of Thatcherism.

As the barricades are raised, the state and the market are set for a collision course of the kind experienced in the last century. As the election looms, we stand in watch to see whether we could be returning to old-style Labour or to an economy in the hands of the more market-oriented Conservatives. Like the past, we may very well end up lunging from one extreme to another in a repeat of the 1970s and 1980s.

If we want to avoid this repeat of history, we need to admit that the divisions of old – those between the state and the market – are, in fact, redundant. Neither side of the current political divide offers a complete solution as both are fettered by this out-dated “state versus market” way of thinking about the economy. The result is that there is a major gap in the political “market” – the question here in the UK will be which political party sees fit to fill it.

The party that does will be the one that has the common sense to recognise that the boundaries between the state and the market are much more blurry than we have tended to think. Markets are not “natural” and simply do not function well independently of the state – at least not in our modern sophisticated world. The markets that we find in rich economies are a result of law and order and state-funded infrastructure. The businesses that operate within these markets benefit from certain legally granted rights, such as limited liability. In other words, our markets exist by careful design. If you truly want to see free markets without a state, try those of drugs and prostitution, where a few people end up very rich and a lot of people end up very dead – or, if not dead, exploited. These should not be the kind of markets that we aim for.

Understanding that modern markets are anything but natural offers new potential for any political party. It means that we should not simply accept as “God-given” any current market outcome and react ex-post through redistribution – something that risks “incentives” and, with it, prosperity. The state – in reflection of what we as a democracy want – can improve the very design of markets, thereby influencing the market outcome itself and, as a result, reducing the need for Robin Hood. So much of the politics of the twentieth century was built upon an unnecessary premise of state versus market. Let’s not go after the same red herring in the years to come.

Even if we do set the same course as in the past, let us at least admit one thing: that neither the state nor the market is perfect. Markets can fail – as can the state. For every example of state failure that exists, someone somewhere will be able to cite an example of market failure. At the moment, we just keep adding to one or other list – playing a game of trench warfare – without really agreeing that both can be as good (or as bad) as each other. Our choice should not be between a party that is critical of markets at every turn and another that places ever more faith in them.

The successful economies of the future will be those that achieve more balance than either old-fashioned Labour or blind faith in free markets would allow. In essence, and to cut to the chase, they will be the ones that adopt what I will call a simple but sure-fire three-point prosperity plan: Firstly, harnessing the potential of markets where possible (where markets do work well), but realising that they do not work well in all cases and need to be well designed. Secondly, plugging the gaps that markets cannot themselves fill (such as funding “blue-sky” scientific research and ensuring health-care coverage where private insurance markets fail). And, thirdly, those which recognise that whilst capitalism has the power to bring a tremendous wake of improvement for the economy as a whole, it will also generate losses for some.

The first two points are straight forward, but let us dwell for a moment on the third. As any economist knows, whilst markets generate a net gain, they can also frequently generate what our textbooks have termed “losers”. These losers are those left behind as the economy advances, such as those workers who are made obsolete by advances in new technologies or by globalisation, and the sectors that decline to make way for the expansion of others as the economy changes and progresses.

The standard (and of course correct) conclusion is that we should not let the “losers” stand in the way of change and adjustment. Since the gains will exceed the losses to the economy as a whole, it is best to forge ahead and then to compensate (or help) the “losers”. Unfortunately, we have all too often done the former and not particularly worried about the latter. Whether it is the unemployed coal miners and cotton spinners of the past, the unskilled workers of the present or, in the future, the doctors, lawyers and journalists who are (we are told) to be replaced by robots, we must do what we can to help and support those disrupted by progress – such as through adult education. If we are to harness the good of capitalism, we also have a responsibility to those who are left exposed.

Rather than returning to the battlegrounds of state versus market – of old Labour versus Thatcherism – let us make the twenty-first century different to the last. If we are to avoid past traumas, we need a political party that can think beyond the traditional boundaries and that can therefore be more level-headed about the economy. Whether that party is “new” New Labour or “new” Conservative, not only will the economy feel the benefit, but it will also create more scope (and release time and energy) for other issues that matter to our society. Let’s not fight an old political war when there are so many other things politicians could be addressing.

Dr Victoria Bateman is an Economic Historian and Fellow in Economics at Gonville & Caius College, Cambridge.