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States, Markets, and the Good Society Milton Friedman: “there are only two ways to coordinate the economic activities of millions. One is central planning by the government; the other depends on the voluntary cooperation of individuals—the techniques of the marketplace.” Key question: what balance between states and markets (political economy) most enhances people’s capability and contributes to the good society? (57) Market systems Market system = an economy in which production for profit is intended for and coordinated through private exchanges between buyers and sellers ◦ Productive assets are privately owned and employed to earn profits for their owners ◦ Production is geared to produce commodities, goods for sale in the market ◦ Prices are set through market forces, supply and demand Over time, the market system has become more extensive (involving more international transactions) and more intensive (involving more social transactions) States determine how extensive markets are ◦ ◦ ◦ ◦ Taxation on imports Regulations on foreign investment Controls on currency Trade treaties/international organizations States determine how intensive markets are ◦ Restrictions on what is/can be for sale in the market States and Markets Charles Lindblom: “Like the state…the market system is a method of controlling and coordinating people’s behavior.” Market systems require states and cannot exist without them States make market system possible, making ground rules that permit the system to work ◦ States create common currency, facilitate trade and exchange, enforce contracts, supply public goods (transportation, police, courts, etc.), which markets cannot provide Visible hand of state supplements invisible hand of market Market freedom requires state compulsion Markets only as good as rules states make to support them Political economy = balance between political and market forces, critical to creating conditions for the good society As with political institutions, it is important to get economic institutions right Advantages of Market Systems Extraordinarily dynamic ◦ Promote new products, more efficient production methods and technologies ◦ Competition and profits encourages innovation Enormously productive ◦ Leading to rising incomes and living standards Enhance prospects of democracy and political rights; does not ensure democracy and political freedom ◦ Market systems separate economic from political power (potentially countervailing tendencies) ◦ Planned economies combine economic and political power in hands of the state Dark Side of Market Systems Highly volatile ◦ As we know all too well at present, susceptible to periods of boom and bust Volatility can be socially destructive ◦ Unemployment, wasted resources, reduced investment, reduced incentives for re-training ◦ Can lead to sense of powerlessness, insecurity Generate extraordinary inequality ◦ Depresses earnings of those without valued skills; undermines bargaining power of unskilled workers; market position of low skill workers declines ◦ Expands power of those who control scarce resources (skills, capital); market position of those with market power increases Create harmful spillover effects (externalized costs) ◦ Markets encourage participants to adopt a narrow perception of interests; encourage participants to avoid the costs of their decisions and to pass them on to others, to the detriment of society; examples: pollution, global warming/climate change Shifting Balance Market systems require rules enforced by the state to work ◦ Effective rules reduce uncertainty that contracts will be honored, money will retain value, consumers won’t be cheated States also steer economies toward certain goals States intervene in the market ◦ Counteract disadvantages: welfare systems, pollution controls, even out swings in business cycle, etc. Degree to which states should intervene in the marketplace a source of conflict in most societies ◦ Boundary between what should be left to market and what should be determined by states shifts in response to political pressure, and has shifted over time in response to changing circumstances ◦ Post-WWII, state intervention (mixed economies) considered appropriate in developed and developing countries ◦ By 1970s, recession created grounds for new groups (in particular, the business community) to challenge mixed economies; gave rise to market advocates (e.g., Reagan, Thatcher) who criticized the state for spending, taxes, and regulation ◦ Whereas advocates of mixed economies pointed to market failures, free-marketeers pointed to political failures Growth slowed because welfare state undermined work ethic Regulations limited entrepreneurialism Taxes diverted too much income Public enterprises did not perform Globalization Globalization = increasing flow of money (investment), people, skills, ideas, and goods (trade) across borders (market extension) ◦ While there has always been trade, investment, and cultural exchange across borders, there is a qualitative difference today in the volume of international exchange, breadth/depth of connections/transformations, and speed ◦ In part, result of technological change (transportation, communications) ◦ Also promoted by MNCs, governments, international agencies “Washington consensus” (neoliberalism) ◦ Balance budgets, cut spending, open markets to foreign trade/investments, privatization of industries ◦ Supported by large MNCs, US, and World Bank/IMF Made economic assistance dependent on adoption of neoliberal policies Neoliberalism Prescription (to promote efficiency, productivity, growth, rising incomes) ◦ ◦ ◦ ◦ ◦ Too much state regulation Control inflation, limit debt, balance budgets Rely on private enterprise Free trade (reduce tariffs, barriers) “Race to the top” (countries integrate themselves into global economy) Neoliberalism’s critics ◦ ◦ ◦ ◦ Leads to increasing inequality between and within countries Economic crises Environmental destruction Rationale for promoting interests of powerful individuals and corporations at expense of poor people and disadvantaged states ◦ “Race to the bottom” (countries compete to have lowest wages, taxes, fewest regulations to attract foreign investors) Empirical record of neoliberalism ◦ ◦ ◦ ◦ Uneven at best Chile a success story; most are not (e.g. Haiti) Many successful countries diverged from model (e.g., India, China, S. Korea, Taiwan) Even World Bank now concedes one-size-all prescription of balanced budgets, open markets, and privatization inadequate Effects of Globalization On developing countries ◦ Rudra finds greater integration brought more job opportunities for workers in countries at all levels of development; workers in less developed countries at highest levels of economic development benefited most ◦ Effects of globalization on workers in less developed countries conditional upon country’s level of economic development and economic/political institutions Consequences of globalization varies for developed countries as well ◦ Exaggerated differences among them in terms of government spending as proportion of GDP, union density rates, provision of welfare Various outcomes a function of different institutions and governing coalitions Some countries have political capacity to take advantage of globalization, others failed to develop it Only countries that have supportive institutions and governing coalitions can take advantage of it and ameliorate its effects State Intervention: Fiscal Policy Fiscal policy – manipulation of budgets; overall revenues and expenditures ◦ Budget deficits (spending more than revenues) enables states to increase money supply, demand for goods, business investment, and reduce unemployment ◦ Budget surplus (spending less than revenues) enables state to reduce money supply, cool economy, and reduce inflation ◦ States vary greatly in how much they tax and how much they spend ◦ States that tax more (capture larger proportion of GDP) have more influence over how national income is used and distributed in society; states that tax less have less influence over how income is used and who receives it Monetary policy Monetary policy – manipulating rates of interest, cost of borrowing money ◦ High interest rates discourage borrowing and spending (used to counteract inflation) ◦ Low interest rates encourage borrowing and spending (used to fight recession) ◦ Central banks issue currency and manage value in foreign exchange ◦ States vary in influence/control over central bank Some are insulated from political influence (e.g., U.S.) Some are state controlled (e.g., China, S. Korea in 1970s) Regulatory policy Regulatory policy – explicit rules of behavior that firms must follow (manage competition, set industry standards, require certain business practices) ◦ States vary in how much they regulate firms to direct behavior ◦ Standard measure: number of days it takes to start a new business ◦ Another measure is labor relations (rules regarding relations between owners and workers) ◦ U.S. one of the least regulated in the world; American firms have significant power in deciding how to manage their workforce Nationalization Nationalization – state-owned and controlled public enterprises ◦ Enables states to control strategic assets, and to inject social criteria into economy Examples: Mexico and oil industry (PEMEX); China’s public enterprises (jobs/services) ◦ States vary in degree of nationalization Socialist states own and control all means of production (e.g., Cuba, N.Korea) More free-market systems have few public enterprises (e.g., U.S. and Chile) States and Markets Fiscal policy, monetary policy, regulations, and public enterprises only some of the ways states influence/intervene in the economy ◦ In Japan, the state once promoted mergers and cooperation among firms to create firms large, efficient enough to compete internationally ◦ In Germany, the state has brokered agreements among union and employer organizations Each country works out a balance between states and markets through political struggle In general, where markets play a greater role ◦ States do not redirect as much of the country’s income through its budget ◦ States do not exert much influence on central banks ◦ State regulations are not intrusive ◦ Public enterprises are small When states play a more powerful role in determining who gets what ◦ States redirect more of the country’s income through taxes and spending ◦ States exert greater influence over central banks ◦ States regulations are pervasive and directive ◦ Public enterprises control economy’s strategic industries Markets and Capability Which form of political economy (what balance between states and markets) is most compatible with the good society? ◦ What mix of states and markets best promotes physical wellbeing, safety, informed decision-making, and civil/political rights? Markets/states and democracy ◦ Using Fraser Institute data (on economic freedom, i.e., free markets, 82), it appears market systems and democracy are related Liberal democracies have high degrees of economic freedom (more market than state) Market systems may not guarantee liberal democracy, but there are no liberal democracies without them More markets do not necessarily mean more political freedom, but a lack of a strong market system does seem to preclude it Markets and Capability, II Markets/states and literacy ◦ Using World Bank (World Development indicators, 84), literacy rates are not strongly associated with market economies High literacy rates among East European countries Low rates among poor and wealthy countries (e.g., African states and Arab states) ◦ Literacy rates appear to reflect cultural and religious values Markets and Capability, III Markets/states and safety ◦ Type of political economy (balance between state and market) appears to be totally unrelated to likelihood of war States with market-based economies no more likely to be engaged in conflict (with other states or internally, the more common form) than state-led economies Type of political economy seems not to be related to state aggression Unlike with democracies (which usually do not fight each other, democratic peace theory), states with market-driven economies and those with state-led economies will fight with their own kind and any other kind ◦ Using homicide rates (Murders per capita data, 85), little correlation between homicide rates and political economy Type of economy appears to have little influence of safety; citizens are no safter in market-based countries than state-led economies Markets and Capability, IV Markets/states and physical well-being ◦ Using life expectancy data (World Bank, World Development indicators, 87), there is a strong association between life expectancy and market economies Countries with market systems are more likely to live longer, but there are glaring exceptions (striking anomalies) to the rule Cuba and the U.S. have the same life-expectancy Zambians (with a market-based system) can expect to live half as long as Israelis with a strong state-led economy Markets and Capability Market-based economies may improve capabilities a bit, but not consistently so ◦ Democracy may be weak among state-led economies, but not necessarily strong among market-led ones ◦ Countries with market-led systems are not necessarily the most literate Conditioned by intervening variables (religious and cultural norms) ◦ Countries with market-led systems are no safer than those with state-led economies ◦ Market-based systems do appear to correlate with life expectancy, but with significant exceptions Markets are not a panacea; must be supplemented to increase capabilities ◦ Challenge: to develop a balance between states and markets that promotes best qualities of markets (innovation, productivity), while avoiding worst effects (instability, inequality)