An Effective Market
One of government’s key roles is to ensure an effective market.
In meeting this responsibility, government’s specific functions must be rooted in helping the market to achieve its own fundamental purpose.
The American market—like any true market—has one fundamental purpose.
The market exists to efficiently allocate consumers’ resources to the products and services that consumers most desire, primarily because their cost is low and their quality high. By channeling buyers’ resources based on consumer preference, cost, and quality, the market can reward the most creative and productive firms, drive out the less creative and less productive ones, and—in Adam Smith’s words—increase the wealth of the nation.
Can is the operative word. The market will achieve its fundamental purpose only if eleven conditions exist. There is little disagreement about nine of these conditions...summarized in the sidebar.
But the market will be truly effective only if two additional conditions are met: no cost externalization and no subsidies.
No Cost Externalization
When businesses “externalize” costs, they undermine the effectiveness of the market.
"Externalization" of costs is fancy economics talk for:
- Polluting the environment by fouling the air, dirtying the water, or dumping toxic waste;
- Injuring workers by tolerating unsafe working conditions, or failing to disclose risks;
- Sticking it to consumers by selling dangerous products, or imposing monopoly prices; or
- Duping investors by peddling false information, or hiding relevant facts.
Since the New Deal, federal regulation in particular has done much to reduce “externalization” that harms the environment, workers, consumers, and investors. But cost “externalization” remains a serious market problem on all fronts.
The final condition for an effective market is: no subsidies for politicians' preferred types of consumption or investment.
It is very tempting for politicians to use government to push consumers aside, and themselves pick the economy’s “winners” and “losers." They typically do so by doling out subsidies—tax dollars, tax breaks, and other government favors—to politically favored economic sectors or even individual firms.
It may seem harmless. But using government to manipulate the market not only corrupts the market: it also weakens the market's effectiveness.
Subsidies for politically favored economic sectors or firms take many forms. They may be direct cash handouts. To hide subsidies from the public, politicians often deliver them in the form of tax breaks—or "loopholes—such as: sheltering certain types of income from taxation; allowing deductions that have nothing to do with generating income; or allowing credits that reduce the final tax bill due to spending on politicians' favorite activities. Sometimes, subsidies crop up as loan guarantees, or granting a legal right to producers to set aside competition and combine together to fix quotas.
But whatever mask they wear, all subsidies have one thing in common. They sabotage the market’s ability to perform its most essential function: allocating the nation’s resources to what America's consumers--individuals and firms--believe to be the most desired, low-cost, high-quality products and services.
Instead, displacing what economists call "consumer sovereignty," subsidies divert the nation's resources towards the pet economic sectors and pet firms that politicians most want to benefit...regardless of the true cost and quality of what the favored businesses produce, and regardless of the favored firms’ actual productivity.
As a result, the more efficient firms that do not reap subsidies face a harder time attracting customers, raising capital, earning revenue, and making profits. Meanwhile, subsidized firms, under weaker pressure to meet the demands of individual Americans and ordinary firms because they are "cushioned" by subsidies, can get away with inefficiency.
Add up the accumulated impact of government subsidies on market efficiency, and the nation’s overall wealth shrinks.
Sadly, during the original New Deal and the decades that followed, governments at all levels have used subsidies to manipulate the market on a massive, costly scale. At the same time that New Deal market regulation policies generally increased the nation’s well-being, the huge government subsidies that the New Deal writ large simultaneously injected into the market's economic bloodstream undermined America's prosperity.
We have grown into a very wealthy nation despite the New Deal's mistaken legacy of deploying subsidies to manipulate and distort the market. Imagine how much wealthier the U.S. would be if the federal government had trusted American individuals and firms--unfettered by politically inspired subsidies--to guide the market's shape and direction.
Fair, Free, and Efficient
Only by ending cost “externalization,” and by abolishing subsidies for specific types of consumption and investment, can the United States achieve:
- A fair market that lets firms and economic sectors compete on a level—because it is a properly refereed—playing field;
- A truly free market, in which unmanipulated Americans'—both individuals and firms—make the hundreds of millions of choices that, as if “led by an invisible hand,” should drive demand and supply, set prices, and decide the economy's winners and losers; and
- An efficient and productive market--one that accomplishes its fundamental purpose of allocating resources efficiently, spurring creativity, rewarding entrepreneurs, lowering prices, improving quality, and expanding the nation's wealth.