Role of government in capitalist economies

You will find that the laissez-faire economic philosophy underlying the capitalist economies has come inform strong analytical justification. This is done by point out that such polices would lead to a Pareto-optimal allocation of resources in the economy concerned. A Pareto-optimal situation exists in any economy if one person cannot be made better off without making someone else worse off in their respective options. Under certain assumptions the proponents of liaises-fire have promoted that such a Pareto-optimal situation will emerge in a free market economy with no government intervention. But the assumptions made inderiving the Pareto-optimal solution from laissez-faire economic logic are far from reality. Further, the actual results in coutnries following laissez-fare economic polices reveal serious drawbacks. You will hence find that on both these counts, even confirmed protagonist of laisse-faire favour economic intervention by government. We take up these issues one by one now.

a) Unrealistic assumptions

Three basic assumptions underlie the justification of a laissez-faire economic philosophy. Firstly it is assumed that markets are characterised by perfect competition. Secondly, it is taken for granted that there are no externalists. Thirdly, not all types of goods can be taken into account in the analysis. The meanings and implications of each of these are discussed below.

(i) Perfect competition : Perfect competition has a number of characteristics. There are a large number of buyers and sellers each buying and selling only a small quanity of the product. The product produced is perfectly homogenous and both buyers and seller are guided solely by economic considerations. There is perfect knowledge and perfect mobility of consumes and of the factors of production. the net result of all this is that there well be only one price for the commodity at one point of time in a market. Further no single buyer or seller can affect the price or the demand or the supply, as the case may be, by his independent action.

You can see by now that the actual situation in most market is a far carry from this. MRs Joan Robinson and E. Chambrlin had pointed this out even in this late 1930s. They build alternative models of market structure, namely imperfect competition and monopolistic competition. Later writers have gone on to build even more realistic models of market structure. These oligopoly models visualize the existence of a raw large producers in each industry with some of these working even in collusion.
A Pareto-optimal situation in the allocation of resources even does not emerge with laissez-faire polices under any of these alternative and more realistic forms of market structure. Hence we find that government intervention to prevent non-optima allocation of resources, and higher prices, excessive advertising expenditure, etc., under these forms of market structures, is universally accepted.

(ii) Absence of externalities : Externalities are defined as incidental benefits and detriments accruing out of nay economic activity. If your neighbour sets u a motor cycle repair shop, the noise will bother you. The setting up of their repair shop will thus lead to a deter mental externality for the entire neighbourhood. In contrast, assume that one of your neighbours has a beautiful garden. Whenever you pass by the garden, you will feel happy and refreshed. The neighbour cannot charge you for this happiness that he, incidentally, provides you. The setting up of a beautiful garden by someone in the neighbourhood thus generates this beneficial externality.
You will certainly agree that if society’s interest is to be promoted, these externalities have also to be taken into account in determining economic activities. For this purpose, economic activities have to be based on calculations of social cost and social benefit and not on mere private cost and private benefit.

In laissez-faire logic, however, we find that costs and benefits are considered without taking into account these externalities. As a result, the output of those goods and services which cause beneficial externalities will be tool little. As against this the output of these goods and services which have detrimental externalities will be too much. Government intervention to correct this anomaly is therefore an accepted practice even in capitalist economics.

(iii) Public goods excluded : You find that economists make a distinction between private and pubic goods. According to them, private goods posses the attributes of both delectability and excludability. On the contrary, public goods are conspicuous by the fact that they have neither of these attributes. We will not proceed to explain each of these attributes.
Assume that an item has the attribute of delectability. If so, the use of threat item an individual will reduce the total available supply for use by others, to that extent, at least temporarily. A goods is excludable if a person not paying for it can be prevented from enjoying it. You notice that the goods that we buy from the market posses both these attributes. In contrast, many thins that we collectively consume like street lighting are devoid of both. For a private goods, market mechanism determines the price to be charged and the quantity to be produced. But the market mechanism cannot help us on both these counts in the case of public goods. Public goods are hence the responsibility of governments the world over.

B) Lacunae in performance

You will agree with the statement that the proof of the pudding is in the eating. It is indeed true that some countries following laissez-faire economic polices have attained very high eels of growth in terms of per captain real income. But it has also to be admitted that the laissez-faire economic pudding has actually turned out to be somewhat less tasty than it was supposed to be. In fact, three serious lacunae have been noticed in the economic performance of free market economies. Firstly, these have been experiencing periodic ups and downs in national income, employment and prices. Secondly, thee are hug inequalities of income and prevalence of considerable poverty. Thirdly, there is also enough reason to believe that such economics do not make adequate provision for the future at least on two counts, namely in promoting developing and in making development environmentally sustainable. We no take up these three issues one by one.

(i) Cyclic Fluctuations : periodical upward and downward changes in national income, employment and prices have characterised free market economies. The laissez-faire economists over refused to accept this reality and went on harping the theme that there is an automatic tendency towards full employment in a free market economy. An extreme downswing- the great depression of the 1930s – made John Maynard Keynes question the view and propound an alternative theory. According to Keynes, thee will be equilibrium at less than full employment in a free-market economy. His view, with minor modifications, have come to be accepted by a large number of countries.
Hence government intervention through a combination of monetary and fiscal polices is considered essential for free market economics. The purpose of such polices it ego ensure stability in national income, employment, and prices.

(ii) Inequalities : Developed free market economies are characterised by considerable interpersonal inequalities of income and wealth. This causes concern because people in the lowest income groups are often found to be living in poverty. It is also seen that distribution is not equitable between different regions within a nation. Some regions are pockets of poverty. Further, there is usually a gender bias in distribution. The majority of the poor in developed free market economies are often found to be women.
A little analysis will convince you that this is not very surprising. It is true that there is a direct relationship between effort and reward in a free market economy. But the effort is judged by the means of production that an individual or a region has. If these are not initially distributed equitably, inequalities arise and are likely to get compounded over time.
Hence, we see that measures to lessen extreme inequalities in come and wealth are part of the agenda set before the governments of free market economies. And in these measures, particular attention is paid to the removal of poverty in the less developed regions and of the less advantaged groups. The last two aspects of the dsitributional issue have come into policy focus only in the part few years.

(iii) Inadequate provision for the future : Generally, we also fid that a laissez-faire economic policy does not result in adequate economic provision for the future. This is so from two important points of view. Firstly you will agree that most Third World countries cannot attain a high level of economic development without he adoption of specific policy measures in this regard by their government. Secondly, inter-generational equity in terms of attaining environmentally sustainable development is conspicuous by its absence in almost all countries of the world. These points, we believe, need to be discussed in slightly greater detail.

Developing countries need a lot of investment in area like heavy industries and infrastructure. These arras need substantial capital and yield returns only in the long run. Further, they are often highly risk and are, often in the form of pubic goods with a good deal of beneficial externalities. Moreover, the political, social and economic institutional structure in these countries is far from congenial for the promotion of economic development. It is therefore accepted that without the government playing a positive role, these institutional constraints cannot be overcome nor can heavy industries or requisite infrastructure come up.

As regards the environment, we find that in private cost-benefit calculations in free market economies, this aspect never used to be taken into considerations This is hardly surprising because leaving a better environment for the succeeding generations ahs become an economic policy objective only in recent years. Even centrally planned soloist economies have a miserable record on this count. It must however to be admitted that environmental impact assessment is a gray area even today. There are umpteen problems in working out the cot of detrimental externalities on the environment resulting from economic activity. But the environmental aspect is being increasingly recognised the world over. As a result, even in free market economies, governments insist on project getting environmental clearance.