Understanding how the State works

Bakuriani, July 2008

Outline

The legitimacy of the State: market failures

How the State works

How the market works

Spontaneous orders developing in a frame of property rights and contract (fingers of the visible hand)

An order of “extreme” complexityEntrepreneurship as engine of

discovery (“muscles of the invisible hand)

Evaluation in terms ofProgress (expansion of knowledge and

wealth)Individual dignity

Market “failures”

Production of public goods is not profitableTechnology might lead to monopoly position

(“natural monopoly”)Producers can collude and exploit consumersPrivate decision makers neglect some of the

consequences of their actions (externalities)Unfair trade because of asymmetric

information or lack of outside opportunitiesIncome inequalities

Market solutions to market “failures”!

Ronald Coase: the provision of lighthouseYou get get around natural monopolies so

that their power is not unlimitedExtend the scope of market (externalities)Rely on tort lawAsymmetric information is “normal” and not

dangerous where markets work properlyIncome inequalities are signaling devicesPower of voluntary associations and

insurance mechanisms

Nirvana approach

“The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing "imperfect" institutional arrangement. This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements. In practice, those who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient. [...] “

Harold Demsetz, "Information and Efficiency: Another Viewpoint” Journal of Law and Economics, Vol. 12, No. 1 (Apr., 1969), pp. 1-22

Tools of State’s solutions to market failures

The State is an organizationIt regulatesIt taxes

To produceTo redistribute

In any cases it uses physical coercion

Two questions

How do we deal with the motivation problem?

How do we deal with the knowledge problem?

The logic of the actors involved in State’s choices

From individual preferences to “social preferences”

Behavior of the electorBehavior of the candidates (Role of the

median elector)Behavior of the elected representative

(logic of collective action)Behavior of the civil servant

Can you regulate a spontaneous order?

Logical impossibilityRegulation often does not reach its target

Public housingHealth careEducationEuropean Agricultural policyFlooding in Czech Republic

Regulation has unintended consequencesMerger regulationFood and safety regulation (kitchen, etc.)

Bastiat: What is seen and what is not seen

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Bastiat again… Yet this difference is tremendous;

for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.