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COYLE Markets State and People

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COYLE Markets State and People

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Oscar Guillermo Garcia Rivas
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MARKETS, STATE, AND PEOPLE MARKETS, STATE, AND PEOPLE ECONOMICS FOR PUBLIC POLICY DIANE COYLE PRINCETON UNIVERSITY PRESS PRINCETON AND OxFaRO oprrghe © 2020 by Prneton University Ps Pied by Picton Uniecey ess 41 Wiliam Set, Peon, New Josey 08540 ‘Oxford St, Wook Orde OX20 1TR pesipincetnede AILRighes Reserved ‘Names: Cov Dito, autor, Tier Marea and ool: conosfor pb plicy ia Coyle Descpo:Pieon:rron Usieny Pe [202] pclae de, eoufes LCS 2019018378 SBN 998069138081 (ateee} Sabjcts: LCS eons pli | Eamonn Casticaton: LOCHDS7_ C583 20201 DDC 3389-423 Cro arable seep os go 2019019274 ISBN (toot 975-0691.1995-4 ih Library Cataloging Palation Data ise Etc Sra Caro, Chae Ale, and Hanah Past ‘Prodan Etora Ken Cif “oweand uke Detpn Leite Dooce Prodan Finan abc: Stale Lene and Kae arg Thomsoo Corer Jer Mean : hea The de! City. 170, Teper aed Thisbook bs en cops in Soran Din Po Printed aif paper : Feit the Unie State of Amrce moss76s4aa1 CONTENTS. Price vt (CHAPTER 1. The State andthe Market 1 (CHAPTER 2. Making Markets Work: Regulation and Competion 44 (CHAPTER 3. Tie Governments Role in Production 98 CHAPTER 4,Cllestve Choice 137 (CHAPTERS, Bebaviorl Policies 172 [CHAPTER 6. Poverty Inequality andthe Role ofthe State 202, CHAPTER 7. Goveenment File 256 CHAPTER. Evidence and Fconomic Polisi 297 Acknowledgments 337 Appendix: Consemer Surplus and Wilingnas to Py/Wilingness To decept 339 (oes of Technical Terms 343 Index 49 PREFACE Economics has a powerful nfence on ou ives, largely because it iss influential in shaping government’ decisions and these dec- sions affect every area of human activity. The increasing power of| economic thinking is reflected by the substantial increase in the ‘umber of economists employed by governments and public secror agencies in recent years. Many, perhaps most, policy decisions are justified on economic tems. ‘Whether there should be so much government influence on out lives is ofcourse a matter of debate and che partisan divisions over this question are about as wide as they have ever been, However, ‘one ofthe points I make in this hook is that any individual decision affcts ether people because we live in communities and societies. So even those who argue for “lst” government need to consider how collective decisions get made. Traditionally, mackets have been presented as an alternative: ether the state or the masket proves to be the best way of organizing a given economic activity ose of choices. Butthis isa misleading way of thinking about how societies aa collectively use the available esoarces to achieve the best pos sible outcomes for their members. In every country andl community, a mixture of private markers, government action, and non: {governmental organizations determines economic outcomes. Good, public policies recognize that sometimes these alternative modes substitute for each other, and sometimes they support each other, Regulations are che scaffolding necessary for markets to operate, Strong social norms may make regulation unnecessary and markets ‘work better Similarly, normscan make policies more efictive—for inscance,a small tax on plastic bags anda regulation liniting smok- ing in certain public places have proved powerful policy interven tions because they operate in a context of changing social norms, ‘What’ more, market and governments often “fil” in exactly the same circumstances, Because of fundamentally diffcale choice. Markets, governments, and socal norms or preferences ae labels we give to diferent modes of organizing ove society. ‘Another important element of public policy wisdom isthe ee: ‘ognicion tha the “best” policies are no purely technocratic dec sions, because they involve values and ethical considerations. This includes societal choice about what the “best” option mean, because ‘conflicts of interest are unavoidable in all economies. Economist rightly ery to make thee advice as evidence-based and objective as possible but should nor over-claim. Part ofthe reason for the polit «al confrontations we ae cuerendy seeing in many Western counties ispent-up anger about the repeated asertions tha the judgiment of “experts” must override everything ele. Experts do know beter sbout many things than the average citizen, or even che average politician, but there are trade-off in terms of values as well a in terms of economic interests There is along teaditon in economics ‘of debating "socal welfare” and social choices it has been less prominent in recent times but is showing signs of revving now. AA third point l emphasize here is that history and geography ‘matter, So do ideas. Even ifthe right policies or approaches com: ‘mand consensus oraa be identified with ufcent catty, circum stances change, The economy changesits character overtime, ates and preferences change crises occur—all of which means that there ate big differences berween the policy choices made indifferent ‘countries and ae differen times. There isa mutual influence between ‘events, economic ideas, and policy approaches, especially when che ‘changes are significant. The Great Depression is an example of a ‘tsi that profoundly changed economic thinking and political ‘outcomes, and the 2008 financial crisis will prove to have been sinilarly decisive. Major technological shifts havea similar effect, and the continuing influence of digital technologies wil also prove tochange the way collective decisions ought ro be and wll be made inthe fowre ‘A book about economics for public policy could potentially «cover a vast amount of territory. Ths one leaves out alo, includ: ing some areas of policy such texts would traditionally cover such 1s macroeconomic polices or the large literature on taxation, The focus here is on areas of applied microeconomics. It isa largely nos-tecinieal book so should be accessible to people who have not studied economics, so long as they skip the equations, butt also gives those who are or have been economics stidents& mach broader perspective than they might grin che classroom on the issues policymakers face. Each chapter has an extensive set of suggestions for further reading, including more technical refer- ‘ences. The examples are drawn from many different countries, although mainly the developed economies, as developing econo” mies have distinct features and challenges, Having said that, am a British economist and policymaker, a good deal ofthe discus- sion about the historical ebb and flow of policy approaches i o- ‘ced on the UK, ‘The ist four chapters cover how societies organize the use of resources, Chapter I sets ou the fundamental economic, including economists’ approach to what is rermed social welfare, or what i means to say thece isa beter economic outcome. Chapters 2,3, and 4 consider the operation of markets; the choice about when to hhave che state engage directly in economic production orto regulate those markers where itis diffcut for competition vo occur; and the circumstances when non-market and non-state organization of co: nomic activity can occur. ‘The second half of the book addresses a numberof key cuttent challenges to policy-making. One, discussed in chapter 5, isthe challenge the discoveries in behavioral economics pose €o how economists need to thnk about policy analysis. Thisisa ively area of research with many untesolved questions. The second, addressed in chapter 6, the pressing problem of povery in rch countries, the threat co middleclass jobs, and the discontent being eased by increasing inequality. These isues are the result of technological changes, globalization, and political choices; they help account for ‘the current era of politcal turmoil throughout the West. perennial allege isthe ubiquitous and alltoo common presence of gover ‘ment failure (the subject of chapter 7}—bad decisions with unin: tended or counterproductive consequences area constant in public policy. The final chapter considers the role of evidence in shaping ‘economic polices: how itis used in practice, how it shouldbe used, and its imitations. MARKETS, STATE, AND PEOPLE HAPTER 1 The State and the Market ‘This chapter sets the seane by considering on ofthe fundamental issues in public policy economics: What are the relative roles ofthe _government and the privat sector, oF market, im the economy? Economic theory provides some tools for analysing the question, 450 the chapter sets ont some of the basics of what is known at twofareeconomics—in arbor words, the analysis of economic ff cieney andthe criteria for assessing whether something makes & Ssodety better off or not. (Readers who have previously taken mi ‘croeconomics courses will be familar with this) The theory, taken teal implies that competitive markets wil deliver the highest social welfne; but there ar ta pill in taking too simplistic viaw of economic theory, based ait ison some strong assumptions. (One pital is concluding that the more markets can be relied on the better fact, there are peruse “market fires.” The opposite ‘ones concluding shat itis posible forthe goverment to work out ‘how to correct all market failures for government failure is wide spread too. In fact, practicing economists use the theory ae Fm work for analyzing policy problems rather than asa guide to solving ‘them. Besides, when it comes to policy choices, economic analysis. alone isnot enough, or there would be none ofthe ansibar political debate about the proper roles of state and marke. So the chapter also discusses the way political or historical events and economic ‘thinking influence each other, helping to explain the variations in ‘overnment interventions inthe economy overtime and across ‘countries. It concludes by looking, i the light of this context, the examples of specific types of market failure: externalities and public goods. 2 chapect gue 1.1. Tl goverment spending incsing mers govern expe ‘ares an ent of GDE Sorc: IME Fa ais Depatnest tad ‘on gaph = hepesarordndstaoppbiospendng, Governments intervene in the economy in many ways. For instance, government spending sa reasonably high share of national income in all dexeloped economies, berween 28.7% (Ireland) and 57% (Finland) in 2015, while the sizeof this expenditure elaive tothe economy has trended up overtime, as well moving up and dowa, in business cycles (gure 1.1) The spending goes on many services defense, the legal system, police, education, health, pensions, local government services, roads and ineastracice, state pensions, wel fare or social security benefits, subsidies for certain activities or industries, and more. Almost as much (although usually les, a5 budget deficits are the norm) is eased in eevenue ehrough a wide range of axes, licenses, and charges. All these ways of raising re enue affect the choice individual households and businesses make because they affect people's incentives, Some ofthe taxing and spending is intended to redistribute money from rich ta poot. The excess of expenditure over revenue is pid for by money borrowed in the financial markets, and this government borrowing can affect incerest rates paid by private sector hortowers for thei loans TreStaeanstmeMaraet = 9 ‘To focus just on he governments taxing and spendingisto miss age par ofits intervention inthe economy, though, Governments also write and enforce laws and regulations tha govern how bus ‘esses are run and how consumers re protected. Competition policy aims to stop businesses from growing too powerful athe expense ‘ofconsumers, or regulators. Employment law isintended to protect ‘workers fom exploitation or discrimination. Government bodies ‘enforce technical and safety standards. Professionals of many kinds are required t hold licenses o operate their practices, in che interest ‘of consumer protection. Therefore, governments can affect when and how people work, who businesses employ, what we can buy ‘and te pice we pay how goods are manufactured, what informa: ton has to be handed over tothe authorities, and mach more, Box 1.1 lists many of the ways the government influences the economy, Ieisnot easy to measure the scope ofall these kinds ofnteevention, ‘or compare countries, ut examples such asthe length ofthe rale ‘book for financial services orthe tax code in many countries suggest hasbeen steal increasing. In any cas, the governments deeply involved in economic activity Sometimes economic policies seem intusive, and people often react in unanticipated ways to specific government action. High ‘taxes ate never popular and have in the past been far higher than ‘now. In 1966 the highest (marginal) rate of income tax was 91% inthe United States and 98% in the United Kingdom. No surprise the Beatles wrote their song “Taxman” (on the 196 album Re- volver) complaining about the tax burden. Swedish popstar Abbas Bjéen Ulvaeus revealed (in 2 2014 book) that they wore such ‘outrageous costumes because the cost oftheir clothes could be set against their tax due as long asthe outfits could not be worn ia ‘everyday life. “In my honest opinion we looked like nat in those years. Nobody can have been as badly dressed on stage as we were” he wrote, Businesses constantly complain about the bueden of regulation, but also constantly cll for mote government inves ‘ment in research or in infrastructure such as bridges and roads or subsidies fo innovative products, Sometimes policies are enticely counterproduetve while other policies are astonishingly effective see box 1.2 Box 1.1. Examples ofthe scope of government involvement in ‘the economy Spending on services suchas health, education, housing, de- fens, policing, pensions, waste collection, lighting, parks, o- a serves, oad, asic, prisons, and mach mote “Taxatioalicesing—mlile axe, fos, atone Subsidies and ax incentives for specified acties “The “welfare sate"—benefis, pensions income rdiribaion Regulation—of many actives Compeiion poliy—mrgee contro, market investigation Public ownership, and als pivazation of public corporations ‘contracting ou of public activities, private Sans niitives Shaping markets—egal feamework, takeover ele, jtllac property aw Geaning patents, copight Seting techni standard Persuasion and “choice arcitectare”—public est nfrma tion campaigns Tovesenent inaseactue esearch) Box 1.2. Policy titres and successes “The Can for Clunkers scheme was inode in the US in 2008, incended to boost the revenues of the stoping auto mance by encouraging Americans to trade ia thee Od care fr environ mentally leaner new models. Ke cot $3 bilion in sbsiies of up +0 $4,$00 to people who traded thei “lurker” fora new fos ffcient aco In theory the progam would hit wo tages a tis lus for the manufactures and a contibuioa to combating imate change and polation by geting older gar guzlers off the road TheStaeandtemariet + 5 {contin frm previo ps) Howevesthe program led to people bringing forward the purchase cof a new car—and trading down toa cheaper model, ie 1 the weak state ofthe economy athe sme. The scheme actualy reduced the indusuy’s revenues by an estimated several bilion doles com pated 10 what chey would have been without The new cts wer less damaging environmentally, but ata “green” policy Cash for ‘lunkees was not costfcive le was withou question a policy Slur” ‘On the other han, smal taxes on plastic cari bag se ike « bighly effective policy. Even wen low, they deamaticaly ede ‘he quar of single-use bags shoppers use, may of which other vine end up land. The also aise sevens forthe govern ‘ment in an uncontroversial way. In Washington, DC, Scat tan reduced he use of atryout bags by 60%, reland intoduced a 22 (eazo) cet nn 2002, eich lino clined hse A pence barge a the UK reduced urge by 85% and encouraged the overs ‘ment to propose doubling he eto 10 pence. The am ofthe charg iso reduce his nom-bioderadable source of wast, oft hana to wildland che poiy is highly effective inthis esos. owen, «he substate canvas and other bag ave an environmental impact, ‘09; in thei production and disposal: there may be trade-off even berweenenviconmenalaima** "Mask Hoes, Steven Ls Pl ng Jeremy Ws (2017), "Can for Corliss Whe enue Rese Spring Ameren Econom oma Applied Beas 39.3: 1-35 ‘The UKs epeiene (epungorailgoeomennewytic hag -ilesi-ig sven npemaes dow 86sine Sp charge) nl 0 Trends hpi dene govt lenicemaetopicsvaeiet ‘plac hppa asa a to US ces sch a Washingon, DC lpsowe de ovhteddetaledeinelddoldocamen09%208L 205 nd veiw Fa 208be pl (contd on expe) + chapter In traditional public economies courses, government activities axe divided inco three “branches”; sabilization, allocation, and ds- tribution. The fs ofthese concerns macroeconomic policy, aiming for a high and stable level of employment and steady growth and inflaton, This book does not cover macroeconomic stabilization [Nor doesit cover much of another staple of traditional courses the structure of taxation and sources of x revenues, which are atthe hear of fiscal policy analysis Instead, the fous here ion allocation and distribution: What is produced hows, and by whom? And how ‘shat is produced distributed among different members af aciery? The fundamental issue here is therefore the collective we and con- sumption of esourees by large numbers of individuals in socieey— how isthe economy organized? Economics poses these as questions of efficiency and equity (in other words ines). Often econo- mists focus on the efficiency questions, acing aif they can bean lyzed in isolation from judgments about distribution or fairness butit is impossible in practice vo draw any policy conclusions with ‘ut making value judgments. Almost any policy change creates winners and losers, ‘The starting point here i therefore to ask hove a society can or nize production and consumption—the economy-—in the best ‘way. This might seem to be a factual kind of question, but in many ‘countries its ofcourse politically contested, People have conflicting views a any moment in time, and the modes of economic organi zation societies choose vary’ at different pots in history and in di ferent countries. ‘Which activites should be done by the government, which by the market, or in some other way? [And, by the way, what do we ‘mean by “the government” oe “the market," and what other ways are there? These questions willbe explored farchet) If the govern- ‘ment is involved, what isthe best way for itt ty to achieve some socially desirable outcome: public ownership, public provision of services, regulation, taxes, subsidies, of some other policy instr ‘ment? (And iit clear what outcome is desired or ae there compet. ig, even conflicting, aims?) The way economists have answered these questions has changed considers overtime, This is de 10 signifcanc evens sach as financial crises or wats, and because pol TheSlalandthe Market + 7 tis responds to evens. leis also because economic thinking changes, as ideas respond to events and to political tend, too. Tracking changes in eonomic thinking is important beause the reasons for change illustrate some fundamental dilemmas in determining public policies Iris also importan because a key message inthis book ie that, on many policy issues, economics does nat have answers that are right forall ime. The right answer is, ulimately, i depends—on, ‘context and on politi ehoies. At the sme time, economic analysis can provide analytical and empitical insights ro inform these con ‘ingent choices. The aim of publie policy economics isto combine this technical rigor with sensitivity tothe specific context. Social Aims Evaluation of success and flue in policy has to begin with its ulimae aims. Societies are driven by different sims or values at ilferent times. Some of these, such as patsiotsm, national power, ‘orhono have litle relation 1 economics, and might even damage the economy The aims where economists can contribute something twthe discussion ae efficiency equity ot fies and mutual insur «ance agains life's uncertainties, and pethaps also social cobesion ‘or civie participation, and freedom. ‘These aims can conllict with each other Cleaey, some of them are not only economic but sso ethical questions, Economics has tended to assume that answers to the ethical or politcal questions, requiring value judgments, cn largely be separated feom answers tthe purely technical economic ones. The assumption snot always juste, although itis surely desirable vo conduct econamic policy| analysis in as impartial a manner as possible. ‘One important potential trade-off berveen social aims, the one ost often discused in economics texts, is berween efficiency and esi. the government wants ro redistribute income fom ich to oor by taxing che fozmes, it can bring about « more equal society but pethaps at the cost of discouraging some Feople from working ashard, or discouraging some investment, ands shrinking the size ‘of economic output and incomes compared to what they would 8 chapter! ‘otherwise have been. The tax causes some loss of efficiency. But many other things influence effort and output. So alternatively, it might be thata very unequal society discourages work effort bythe oor—why bother to be productive if most of the gain goes 10 Someone else? In which case, there is no simple trade-off between efficiency and equity. Efficiency and equity are two key rationales for much sat in- tervention in private economic activites (“he market) * effcney whenever either individual or rearker aluresoceue— “failures” meaning sub-optimal decisions because of externali- ties natural monopolies, public goods, or simply non-raional choice (all explored below); + equity whenever enough people in society have a preference {or redistributing resources—redistribuion that can be ether ‘monetary payments or the provision of publi services, such as education, health, oF housing ‘Mauch ofthe analysis in public policy economics sts aside the dis tribution question co stare with, asking: Fora given income distribu sion, what isthe mos efciont way for society to use its resources? ‘What wil deliver the greatest socal welfare? This book starts the same wa, returning to distributional questions in chapter 6, Fram: ing the analysis like this also begs the question about the efficiency ‘of goverment intervention, Chapter? focuses on government fil ure, While here are many examples throughout the book asi if) of government policies gone wrong, ne of the themes is that there are inherent difficulties in oeganizng an economy to achieve broad and possibly conflicting aims, and in some contexts both govert- ‘ment and market solutions will “fai” Another theme, following from this is that it isa mistake ro think of the government” and “the market” as alternatives, Societies have a range of organizational structures involving a mixture of pivate and collective choices the latter sometimes taken by “official” public sector bodies and some- times by “unofficial” community agreement; chapter 4explores this fucther ‘The rest ofthis chapter covers the question ofthe appropriate roles of the government and the private setor (state and market) in the economy, the main issue in 20 mach political debate about cconomic policies. On certain assumptions, economic theory justifies the competitive marker asthe “bes” way of organizing production and consumpsion. The next sections consider what “best” means ‘and what assumprions lea to the presumption in favor of markets, eis worth emphasizing her that although economists working on public policy have this theoretical equipment atthe back oftheir ‘minds all ae aware that it provides no more than a sel frame ‘work for organizing their choughts. No one thinks consumers and producers behave in reality as they do in these abstract models, Git of economics often mistakenly chink practioner take the abstract theory at face value, whereas public policy economics in practice is firmly rooted in empirical eaiy. With tha warning in ‘mind, the next sections introduce the theoredca basics of what is referred to somewhat confusingly) as welfare economic. Efficiency ‘The frst question isthe criterion for preferring one way of organiz- ing production and consumption inthe economy over another ‘What does ic mean to say an activity is fie? The specific mean- ing sed in economics isknown as Foeto efficiency (after the Italian ‘economis Vilredo Pareto, 1848-1923), {An allocation of resources is Pareto efficer if nobody can be made better off without somebody eke becoming worse off. A Pareto improvement isachange that makes some people beter off without making anyone else worse off This requires definition of “worse off or “bette of" The criterion used is each individuals own evaluation oftheir welfare. Social ‘welfare must then in some way be the aggregate of the welfare of the individalsin the sociery—a question discussed below For now it seems reasonable to agree chat a change helping someone and harming no one isan improvement. [Note that a Pareto improvement might—or might not—lead to Pareto «ffcent outcome; but the economy isat a Pareto efficient point, theres no posible of a Pareto improvement. What's more, the criterion is agnostic about the dstbution of cesoutces; even in very unequal socien i insists that i is not an improvement £0 make one rich person worse off even if many poorer people are beter off Pareto efficiency is related to key concepts in microeconomic theory. The annex to this chapter ses out some ofthis background, whichis covered in all che seandacd microeconomics textbooks, i ‘wll be familiar to anybody who has aleeady studied economics, and rather mysterious to anybody who has not yt become familiar iued with some ofthese nuts and bolts of economic theory It docs not help chat different textbooks give slghly diferent definitions “Here I try to make the ideas a intuitive as posible, Pareto efficiency consists ofthe following + Productive efficiency: Given the kind of resources avilable {such as land or mineral, labor, machines) and their relative prices, and given che state of technology, is output as high as ‘canbe? Is the economy operating on its production possbil- ties frontier? + Allocative (or consumption o exchange) efficiency: Given the production of different goods and their lative prices ate the goods produced going tothe people who most value them? ‘Are people on their highest possible iniffrence curve? ‘The definition used somesimes focuses om allocative efficiency lone, sometimes both allocative and productive; and sometimes i adds 2 thied element *+ Product mix {oc output) efficiency: Do the goods being pro- duced correspond tothe goods people want to buy ori there another combination of goods produced with the same re sources that would make people beter off (put them on a higher indifference curve)? Together the theee components cover how effectively resources ace tamed into produets, whether the products correspond to peo: ple’ preferences, and whether, through exchange, they goto the people who value chem most-Ifany ofthe three ie not satisfied then atleast one person could be made bette off through use of re sources in production, mix of goods being produced, o¢ exchange fof products) without making anyone else worse off This seems reasonably intuitive as a concept of ecency. Ieis important co note that the terminology ean mislead people Jno thinking Pareto efciencyis ony a technical eoncep. Afterall, iti silent on questions we would chink of as ethical sues, particu larly the distibution of resources. This is correct in the case of| productive efiieney but not entirely when it comes to allocative efficiency, which assumes that “beter” means satisfying people preferences, whatever they ae (and also that it is posible o ag: iregate up fom individual preference satisfaction to social welfare, “Bifciency’ sounds lke is only about positive questions, matters offact but Pareto efciency’is normative involving a value judgment in assuming he satisfaction of indivial preferences is the ight t- terion for assessing economic policy outcomes. Pareto Efficiency and the Competitive Market Equipped with the notion of Pateoelfceney anda set of assump- tions, itis possible to prove two fundamental theorems of welfare ‘The frst theorem states that if a competitive market equilbrsim exits then is Pareto ecient. Otherwise people would beable to undertake exchanges that increased ther tiiry—so it could not hhave been an equilib to stare with. The competitive prices mea- sure the (marginal) increase i welfare for one more unit of each good. As long as marker exchanges possible, people can eade with each other unt all he potential improvements in thee welfare have been eapeured. This theorem isthe underpinning ofthe instinct in favor of competitive markets 35.2 henchmark, although hie depende ‘onthe validity ofthe assumpsions, which ate discussed further below. ‘The second theorem says that given an inital allocation of re- sources thee is ast of competitive prices tha support the Pareto

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