The government, and the market,
respective roles in the national economy

By Aftab Ahmad Khan 

The cardinal policy issue facing modern economic systems is the determination of the appropriate role of the government and the market, and the articulation of the rules and considerations to be applied in making the choice. The choice cannot be dichotomized as between relatively perfect, government and imperfect or inadequate markets. The choice is really between imperfect markets, imperfect governments and various combinations of the two.

The crucial economic choice concerns the degree to which markets or governments each with their respective flaws should determine the allocation and distribution of resources in the economy.

This cardinal economic issue is particularly significant for countries in the “developing world” which in reality is not a single entity but a combination of multiple and heterogeneous states, whose diversity is in effect much greater than that within the industrialized or the developed world.

In most of the 145 or so developing countries there has been a strong pro-state disposition, primarily on account of historical association between socialism and anti-colonialist movements in these countries.

Distrust of the markets was also fostered in the quarter century after World War II by the intellectual climate of the time, with the legacy of the great depression and the Keynesian prescriptions at the macro level.

Furthermore the Soviet experience provided support for the view that successful development could take place in the context of a rejection of the market mechanism.

In conformity with the distrust paradigm of the early post World War II decade, as many poor countries became free from colonial rule, drawing up a five year plan became the norm in the newly independent states. Donors of foreign aid as well as the World Bank insisted on such plans.

In formulating elaborate five year plans, it was an article of faith that the state not only had a dominant role in the economy but indeed was capable of playing it. In keeping with the temper of the times, real life markets and prices were not assigned a significant role in these plans.

The noble laureate Prof. Tinbergen in his “Design of Development” set out certain basic characteristics that an economy must possess for it to achieve sustained development. Among these was a government engaged in activity of the sort considered essential to an orderly state such as maintenance of law and order and physical security of persons and property. In addition there must be minimum instruments of economic policy in the hands of the government and these must be properly used. Presumably because he conceived of most governments in the image of the Dutch government, he must have assumed that the state would be effective in its interventions in the economy and above all those in control of the apparatus would behave like platonic guardians rather than as predators, and use it only for furthering the interests of the governed.

In many countries including Pakistan and India, the unity of purpose, idealism and the quality of character shown during their struggle of independence were optimistically projected to the post – independence era of planning for economic development. Unfortunately, the generation of idealistic founding fathers was too old to serve long after independence in some countries.

Besides undue faith in the idealism and vision of leadership, the proponents of the dominant development paradigm failed to realize that the exercise of the instruments of intervention in the economy often in a discretionary and non - transparent manner would erode any idealism that there was to begin with. Lord Acton once said, power corrupts and absolute power corrupts absolutely. Besides corrupting the leadership, the system of interventions created incentives for their avoidance or evasion if they conflicted with their private interests. Worst of all, resources came to be diverted away from productive activities towards those in leadership or bureaucracy who could dispense privileges and rents created by the interventions.

On account of corruption and inefficiency associated with the interventionist state, these days government in most countries is shrinking. The emphasis is now on the market and on the private sector’s efficient use of resources to maintain high growth rates.

Unfortunately in a large number of developing countries, state interventions and planning instead of re-distributing resources to the poor and the powerless, too often coincided with enriching elites, corruption and dictatorship.

In the current swoon over the charms of the market and disillusion with government in the developing world, there is however, a danger that policy makers and economic managers may forget past disappointments with private sector. 

Even when the economic role of the state was negligible, growth was minimal in many countries. Often what was advertised as “free enterprise” or “competition” turned out to be fraudulent mercantilism. In a large number of countries an oligopolistic private sector did not result in efficiency and dynamism but led to exploitation and misallocation. Moreover, even when private capital and fairly free markets were the rule, basic needs of a large segment of the population were not satisfied and democracy and basic human rights were often abrogated.

Precisely because in many ways the private sector had failed in promoting development with equity in the fifties and sixties of the 20th century, many developing countries turned admiringly to planned integrationist strategies.

Taking a longer historical view, some economists perceive a pendulum swinging between calls for strong state (after a time when the emphasis on the market has failed) and calls for a de-regulated private sector (after a period of failed state led strategies). The fact is that neither the interventionist state nor the minimalist state has guaranteed growth with equity. In much of South Asia, Africa and Latin America, neither state nor market has lived up to the expectations of its enthusiasts.

That both “markets” and “non-markets” are imperfect is a theme of growing body of research in economics. Real choice involves blends and balances between an imperfect market and imperfect state. Moreover, experience of a large number of countries across the globe clearly demonstrates the fact that for free markets to work, government institutions must work. Even with cutbacks in the role of government, the state remains a major actor in macro-economic policy making, infra-structure development, environmental protection and social programmes. But because governmental effectiveness in most developing countries is undercut by low pay and pervasive corruption, governments themselves need institutional reforms that will raise productivity and salaries and reduce corruption.

An area of special significance for good governance is that of regulatory administration, particularly in the financial sector where fraud and unsound management have profoundly de-stabilising consequences for the national economy. Regulatory administration is the main instrument available to the government to enforce compliance with nationally established standards in various economic and social spheres with national development objectives. The regulatory systems have to be designed and constantly monitored to ensure that these activities do not become conservative or begin to create bottlenecks in the development process.