Government Is Largely Guesswork

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Arnold Kling, with his characteristic deep insight, recently described “the straw-man argument against libertarianism and for technocracy.” This straw-man argument has, Kling explains, the following steps:

1. Libertarianism relies on markets.

2. Markets are optimal only under conditions of perfect competition.

3. The conditions for perfect competition are rarely satisfied. 

4. There are many instances of market failure.

5. Therefore, libertarianism does not work.

Kling then adds:

Step (2) is a swindle. It sneaks in the assumption that markets have to be optimal in order to be preferable to government intervention.

Instead, long ago I offered the aphorism “Markets fail. Use markets.” That is, I readily concede that the market economy is not at some theoretical optimum. The question is what will lead to improvement. I believe that government intervention will often make things worse. Meanwhile, entrepreneurial innovation and creative destruction tends to solve economic problems, including market failures.

One of the commenters on Kling’s post, Matt Gelfand, then offered the following:

Let’s flip Arnold’s line of reasoning around to examine the merits of government action.

1. Government action relies on government actors behaving in the public interest.

2. Governments are optimal only under conditions of perfect altruism of government actors.

3. The conditions for perfect government are rarely satisfied.

4. There are many instances of government failure.

5. Therefore, government does not work.

There are many examples of market failure that cannot be overcome by libertarian market processes, and I believe libertarians would agree with at least some of them. They usually involve “public goods” where competitive actors would be duplicative and inefficient. Thus, a system of laws, the justice system, national defense, public safety (police, fire firefighters), airline safety, and numerous other examples are more efficiently handled through the polity rather than markets.

Despite at least one of commenter Gelfand’s examples of ‘good’ government actions (namely, regulation of airline safety) being highly dubious, my purpose here isn’t to challenge the listed examples of ‘good’ government action. Instead, I’ll argue that Mr. Gelfand, like many others, mistakenly assumes that the market and government are symmetrical to each other in a way that they are not.

Of course, any desired outcome can, in principle, be pursued either with voluntary action (the market, broadly conceived) or with coercive action (government). In this simple way the market and government are indeed symmetrical to each other. But there the symmetry ends. The logic of the market’s operation differs categorically from the logic of government’s operation. These differences are rooted in, but extend beyond, the fact that only in markets is all action voluntary.

The single most important difference separating market action from government action is this: Unlike decision-makers in government, decision-makers in markets have access to detailed and reasonably reliable information about the net effects that any of their decisions are likely to have on all affected parties. In addition, decision-makers in markets also are uniquely incited to take those actions, and only those actions, that produce the largest possible positive net effects on affected parties.

The fact that the information available in markets is imperfect is indisputable. Also indisputable is the fact that even well-informed market actors often err. But equally indisputable, if not as widely recognized, is the reality that markets have (as an essential feature of their operation) a built-in process for detecting and correcting error, and thus taking into account over time as much relevant knowledge as possible. No such process exists in government. Because of this categorical difference, any supposed substantive symmetry between market action and government action is imaginary.

The foundational (if not the only) advantage of relying upon markets rather than upon government to supply, say, shoes is that only in markets is there a reliable source of information about which varieties of shoes to produce and how to produce these varieties efficiently – that is, how to produce these varieties of shoes in ways that leave as many resources as possible available for the production of goods and services other than shoes.

The amounts of their incomes that consumers choose to spend on Crocs, Nike sneakers, and Gucci loafers registers the intensity of consumers’ demands for each of these kinds of shoes relative not only to consumers’ demands for other kinds of shoes but also relative to their demands for all other goods and services available for sale.

The prices of each of the different varieties of shoes convey at least two critical pieces of information. First, the prices of Crocs tell entrepreneurs just how much consumers are willing to pay for Crocs compared to how much consumers are willing to pay for sneakers and loafers, and compared also to how much consumers are willing to pay for hamburgers, honey, housing, books, bananas, baseballs, and every other good or service currently for sale on the market. Second, the prices of Crocs relative to the prices of the inputs that might be used to produce Crocs tell entrepreneurs both if consumers’ desire for Crocs is high enough to justify using resources to produce Crocs, and, if so, just how many pairs of Crocs to produce.

If, as is usual, there is some unexpected change in the market (for example, consumers’ suddenly lose their taste for Crocs), consumers today will not be served as well as possible. Ditto if entrepreneurs as a group commit some error (for example, fail to notice the high consumer demand for blue suede shoes). Too many resources today will be devoted to producing Crocs while too few resources are used to manufacture shoes of blue suede. As a result, the prices of Crocs will fall relative to the prices of other goods and services, while that of blue suede shoes will surely soon be noticed by profit-seeking entrepreneurs to be high enough to justify increased production of this particular style of footwear. Such price changes, and more accurate recognition of existing prices, render what might be described as today’s inefficiencies (or market ‘failures’) as, also, today’s profit opportunities. Guided by prices, entrepreneurs will profit by shifting resources out of the production of Crocs and into the production of other items, including blue suede shoes.

Entrepreneurs who are insufficiently alert to market realities as revealed in the prices of both inputs and outputs, or entrepreneurs who are too incompetent to act profitably on market information, suffer losses. These entrepreneurs thus wind up ‘controlling’ fewer resources, with greater amounts of resources coming to be ‘controlled’ by entrepreneurs who are more alert or more competent.

The self-interest of entrepreneurs combines in the market with the self-interest of consumers and input suppliers – and also with the ability of consumers and input suppliers each to say ‘no!’ to offers they judge to be unattractive – to cause opportunities for improving the allocation of resources to be revealed in market prices. Again, such information is never revealed perfectly. Nor is it ever acted on with only unalloyed expertise. But the very essence of the market process is to reveal such information and to incite everyone in the market to act on it.

No such process of information revelation is available for government action. Precisely because government intervention into markets is intended to disregard or to override market signals, government officials, if they are to improve the welfare of citizens, must have access to information that is superior to that which is available on markets. But government officials, in fact, not only have no superior source of information, they have no good source of information at all. The best they can do is guess.

This absence of information available to government officials is an especially acute problem for those officials who fancy themselves able to improve the economy’s performance by nationalizing industries, by using subsidies and protective tariffs, and by imposing ‘corrective’ taxes here and there. But this absence of information is ubiquitous throughout all government affairs. No matter which projects government undertakes as a government, its officials cannot really know, in the way that market participants know, just what to produce, how much to produce, and how best to produce it.

Even the local government that supplies policing services paid for with tax dollars has no solid information about just how much policing to supply and how best to supply these services. Consumers don’t express their demands for government-supplied policing by voluntarily spending money for it, with the ability to change the amounts they spend in response to changes in the quality of, or the desire for, the service provided. While grotesque government incompetence on this front might prompt changes for the better, through the ballot box or through people voting with their feet to move to other jurisdictions, for many compelling reasons the sorts of information revealed in elections or by moving from jurisdiction to jurisdiction have none of the details, nuance, richness, or timeliness that characterize the information conveyed in markets. Politically conveyed information is so thin, noisy, and out-of-date – and, hence, so unreliable – as to differ categorically from market-conveyed information.

As the policing example suggests, the lack of reliable information available to government actors to use to carry out various tasks doesn’t imply that there are no tasks appropriate for government to undertake. Sometimes political instinct tells us that this or that task, if left to private market forces, would likely be performed even worse than if it is assigned to government. And sometimes this instinct might be correct, although there’s no way to verify this conclusion.

Whatever is the case offered in support of government action, a respect for honesty should compel those who make this case to admit that government officials who carry out the prescribed action are neither guided nor incited by the kinds of detailed information that guides and incites market actors. Unlike actions taken in markets, even the best government actions carried out in the most appropriate circumstances are guided by little more than guesswork.