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Thursday, May 27, 2010

Two Structural Reasons Why Government Fails

The strongest case for the market.


In my last two columns I urged freedom lovers to avoid two kinds of mistakes when making the case for freedom.  First I argued we should not assume that politicians and bureaucrats are evil or incompetent.  Last week I explored conspiracy-theory thinking and suggested that it too is problematic because it dangerously assumes that a small group of people really can control social outcomes.  In both columns I suggested that pointing to the “structural” problems with the State is a better line of attack.

In response to questions from readers, this week I’ll discuss what those structural problems are.  I see two fundamental problems:  the “knowledge problem” and the “Public Choice problem.”

“Knowledge problem” was coined by the late Austrian economist Don Lavoie in his work on the socialist calculation debate.  Ludwig von Mises and F. A. Hayek argued, each in his own way, that the fundamental challenge facing socialist planners is to fill the role played by market prices, which serve as surrogates for the pieces of knowledge held by the millions of individuals who supply and demand goods.  Market prices, as Mises pointed out, serve as “aids to the mind” by guiding entrepreneurs and consumers as they appraise possible future outcomes and then engage in economic calculation in making decisions.  Hayek’s contribution was to argue that what enables prices to do this is their capacity to serve as proxies for the deeply held knowledge and preferences of all market participants, whose buying and selling generate the prices in the first place.

What complicates this further is that a good deal of the relevant knowledge is tacit, meaning that even those who possess it cannot specify what they know.  How do you keep your balance on a bicycle or know when to pull your foot off the clutch in a manual transmission?  You know how to do those things, but explaining in detail exactly what you do is impossible.  The advantage of markets is that they allow us to make economically relevant tacit knowledge available to others through buying and selling in the market.  This knowledge can’t, however, be communicated to planners either verbally or through statistics.

The bottom line is that socialist planners attempting to abolish markets, but interested in efficiency, would have no way of knowing what people value, so they would be unable to determine what outputs to make from a given set of inputs or which inputs to use to make any particular output.  They would not be “planning;” they would be stumbling around in the dark and the result would be economic chaos and poverty.

Applied to Intervention

This critique holds not just for attempts to substitute planning for markets completely, but also for any government attempts to intervene in specific markets.  Granted, the smaller the scale, the less dramatic will be the damage, but the underlying problem remains: Even the smartest, best-intentioned people would be unable acquire the knowledge necessary to improve on the market.  This is the major structural problem government faces – and notice that it does not require assumptions of malevolence or incompetence. It also shows why conspiracy theories are most likely to be false.

The Public Choice problem refers to the fact that many arguments for government intervention assume that politicians and bureaucrats are selfless and public-spirited, concerned only with doing what is best.  In the real world, though, we know that politicians often act in their self-interest, just like market participants do.  Unlike the market, however, political institutions do not channel self-interest into unintended consequences that benefit the public at large.  Self-interested political action leads to undesirable unintended consequences.  Think of how politicians’ desire to get reelected by spending more on their constituents and keeping their taxes low leads to larger budget deficits even though none of the politicians may have intended to run deficits.

Faced with the knowledge problem, it’s no surprise that politicians and bureaucrats will turn to self-interest.  Once they realize that knowing what the public interest is and how to achieve it are hopelessly complex, trying to get reelected or keep their jobs becomes an unsurprising next step.

The Public Choice problem assumes only that office holders and government workers pursue their self-interest as frequently as people are assumed to do in the market, not that they have evil intentions. The perverse outcomes they produce are often unintended. And that is the difference between the Public Choice problem and the malevolence principle.

Together the knowledge and Public Choice problems provide the structural critique of government that enables classical liberals to avoid the pitfalls of assuming malevolence, incompetence, or grand conspiracy.  This structural critique is robust precisely because it applies even if we assume politicians and bureaucrats are incredibly smart and well-meaning.

Considering that politicians are no smarter than the rest of us and that some of them might well wish to do harm, it should come as no surprise that government is even worse than what we expect when we make the most generous assumptions possible.


  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.