PROVIDE INCENTIVES THROUGH TRADING ZONES

The best way the outside world can help is to provide incentives for reform. Richer countries, which have come together in large trading zones, have a very powerful instrument to encourage, rather than force, reforms.¹⁵ If they offer membership in their trading zones conditional on certain market infrastructure’s being built, they create the political incentive to undertake those reforms and not postpone them indefinitely. By using the carrot of the opportunity to trade with a large group of countries (like the European Union or NAFTA), they make reform politically appealing for the developing or transition economy and thus credible.¹⁶ It is impressive how much Turkey is trying to change, not only its economic structure, but also its respect for human rights, as exemplified in its treatment of the Kurds, so as to qualify for membership in the European Union.

There are, of course, countries that do not fit naturally into any such zone. Nevertheless, the broad principle of providing incentives for reform again applies here. Developed countries could do a great deal for the cause of markets, both in their countries and around the world, by stopping subsidies to their domestic agricultural sector and reducing the degree of trade barriers in goods like textiles. Farmers and small entrepreneurs in developing countries, who have a better chance of growing rich if protectionism in developed countries is reduced, can be a great force for creating vibrant, open markets in their own countries, much as they have been in the developed world.

Public Awareness

Throughout the book, we have argued that organized vested interests drive government policies. We have also claimed that promarket forces, while in a majority, are weak, dispersed, and typically no match for antimarket interests. Then at whom is this book, especially this chapter, aimed? What hope do we have that any of our recommendations will be implemented, since they are not meant to favor any organized interests?

Our conviction of the power of narrow interests does not blind us into thinking that the public and its beliefs do not matter. The antimarket reaction during the Great Depression was made possible because the public was all too willing to believe that the market was fatally flawed. Similarly, the promarket wave in recent decades has thrived on stories about the wastefulness of the government. The wheel is turning again with stories of corporate scandals and greed. The truth, clearly, lies somewhere in between. Unfortunately, the truth is usually complicated. One reason politicians ignore the public interest with impunity is that they believe the public is often not aware of what that interest is and cannot be bothered to find out. If these politicians are right, then this book may have some educational value but little else.

If, however, the public is willing to listen provided economists are willing to make an effort to communicate their ideas, then books like ours have a chance of influencing our world in a small way. Our purpose has been to show that even though government intervention is necessary for the functioning of markets, the nature of the intervention has typically gone toward favoring the few, against the public interest. Our purpose is to make more people think like economists do, to make more people see the Japanese car registration fees, which are set to effectively prevent cars that are more than five years of age from running on the streets, as a disguised subsidy to car companies rather than simply sound environmental practice.¹⁷

If the wider public sees the benefits of free markets and understands their political fragility, it will be harder for narrow interest groups to push their own agenda. It will become easier for public-spirited politicians (we do not deny that there are some) to propose sound, politically feasible reforms. And the world will become a fairer and better place.

Summary

Given that there are political forces arrayed against the market, how can a promarket government put in place measures that might weaken those forces? We have offered some suggestions in this chapter. We called for an integrated approach, which addresses both the incentives of the parties involved and their ability to influence policy against free markets. Specifically, we propose measures that would result in efficient but not overly concentrated ownership of productive assets, instill flexibility in the labor force to adapt to change, provide a safety net in cases of extreme distress, and create the external competition that will prevent the regulatory apparatus from becoming overly oppressive.

None of the measures we have suggested is outside the realm of possibility. We propose them not because they are individually original but because they have some chance of being enacted, and as a package, they will bring greater structural stability to the market economy.

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CONCLUSION

AFTER TWO DECADES of massive privatization, sweeping deregulation, and widespread liberalization, it may seem absurd for us to claim that free markets could be in danger. In fact, events such as the collapse of Enron are interpreted as evidence that markets have become too free. After all, in the “good old days” of regulated public utilities, such problems did not arise.

In this book, we argue otherwise. Not only are markets not too free, but they cannot possibly become too free: markets are always shackled and suppressed, because they rest on very fragile political foundations. While everyone benefits from competitive markets, no one in particular makes huge profits from keeping the system competitive and the playing field level. Even capitalists do not gain from defending it. Indeed, in their continuous quest for government protection from competition, they often turn out to be capitalism’s worst enemies. Without a strong political constituency supporting them and under the continuous pressure of vested interests, markets are always too restricted, never too free.

This is not to say that the markets do not need rules. Our ideal of free markets is not the anarchy of the jungle or the Wild West but a transparent, level playing field where everybody has a fair chance of participating and those who provide the best value for the money prevail. In order to become a level playing field, markets need rules. Often, these rules emerge from the competitive process—as in the formation of self-regulating associations—but sometimes, they need to be imposed and enforced by a superior authority. Without properly enforced rules, the law of the jungle, not that of the playing field, prevails.

While the absence of rules makes the playing field uneven, too many rules of the wrong kind might make it uneven again, especially when these rules are introduced (as so often happens) under the pressure of incumbent firms. A truly free and competitive market occupies a very delicate middle ground between the absence of rules and the presence of suffocating rules. It is because this middle ground is so narrow that capitalism in its best form is very unstable. It easily degenerates into a system of the incumbents, by the incumbents, for the incumbents. Through much of history, this is the form of capitalism we have experienced, and unfortunately, this is still the form of capitalism prevailing in many parts of the world today.

But a truly competitive market is not just a utopian ideal; it is within our reach. With better financial markets, which give people a chance, and intense political competition, which keeps vested interests in check, in the last two decades, we have experienced the benefits of moving toward that ideal. The greater availability of capital is slowly redressing many of the evils of capitalism—the tyranny of capital over labor, the excessive concentration of industry, the unequal distribution of income in favor of the owners of capital, the lack of opportunity for the poor . . . People have more opportunities to strike on their own, and even when they work within a firm, they are treated better, since firms have become less authoritarian places in which to work.

But all these achievements are far from irreversible. The markets are not perfect, nor is the regulatory superstructure overseeing them. Aberrations like Enron do occur, and some revisions in the system of corporate governance are called for. But the anger of workers and investors who have lost everything should not become the excuse for massive intervention: historical experience suggests that intervention at such times is invariably misdirected. The current storm will blow over—hopefully, without much damage—but what is to prevent a serious crisis from setting back the development of markets for another fifty years?

It is only in recent years that economists have started paying attention again to the institutions underpinning markets. Hence, it is perhaps not surprising how little the public is aware of their political fragility. But too many economists play with elegant models of perfectly competitive markets without asking questions about how markets come about, how they prosper, and how they die. Maybe this bias is simply because most prominent academic economists live in countries where markets function. But it stops them from worrying about the future of their own market economies. And it prevents them from having more of an impact in countries that desperately need sound economics.

When, ten years ago, economists from the West were called to advise countries facing the difficult transition from socialism to the market, they saw their task as primarily that of creating basic institutions. For example, they thought that once state-owned assets were transformed into private property, many of the other institutions necessary for a market economy would follow. But economic institutions neither arise nor flourish unless there is political will to back them. And by political will, we do not mean support for the privatization process only, but also the creation of groups that will benefit from free markets and have the clout to support them politically. This is what Henry VII and Henry VIII did, probably unconsciously, when they “privatized” the land expropriated from the church and the nobles. This is what did not happen in many countries in Eastern Europe. We need to understand the political underpinnings of markets better so as to build greater support for them.

Unfortunately, the battle for markets does not have to be fought only in transition economies. It has to be fought every day even in the most developed countries. Markets need political support, yet their very functioning undermines the support. As a result, the market is a fragile institution, charting a narrow path between the Scylla of overweening government interference and the Charybdis of too little government support.

The greatest danger for the market democracy today is not that it will lapse into socialism, but that it will revert to the relationship system, suppressing competition under the excuse of reducing risk. But we cannot avoid this by preaching a hands-off attitude for the state. Not only will we risk leaving the necessary infrastructure underdeveloped so that the market works poorly and access is limited to the privileged few, but we will also leave the market overexposed to the political backlash from the inevitable market downturn. It is precisely because we need a balance of forces that no single mantra will work.

Instead, we offer a balanced set of proposals, which taken together will fortify the political foundations of the market. The proposals ensure that incumbents have little incentive to oppose markets; that even if incumbents want to hamper competition, they have little ability to do so; that the public does not fear or resent the market overly; and that the public at large sees the vested interests of those who oppose them.

But perhaps most important is the message of the overall book. Politicians disregard the public interest because the public is often unaware of what that interest is. If books like ours can raise public awareness, they reduce one important cost of collective action—the cost of understanding the issues—and force politicians to pay attention. If we have succeeded in convincing the reader—at least, in part—then this book has fulfilled its objective.

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NOTES

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