Theoretical foundations and boundaries for government intervention

Market failure and economic power out of control

Economic power refers to the relative ability of an economic agent to control and influence other agents using the resources they hold. In market transactions, agents develop new market rules through long-term dynamic games, which reallocates economic resources.

Scope and manifestation of economic agent’s power

The essence of economic power is the right to freely allocate economic resources. “Freely” is emphasized here because economic power is reflected by the agent’s ability to control or influence the activities or behavior of others. The greater the agent’s economic power, the greater their freedom in disposal behavior, such as handling resource (factor) exchanges. On the contrary, the smaller the power, the lower the economic status of the agent, the less right they will have to freely speak, and the weaker their relative bargaining power, which further reduces their freedom in market transactions.

In classical economic theories, markets are divided into goods and factor markets, where the economic power agents are firms and consumers, respectively. In the factor market, consumers exchange production factors for goods and gain consumer surplus. In the goods market, firms exchange products for factors and gain profits. In an ideal state, through the market mechanism of resource allocation, goods and factors can reach equilibrium whereby both sides are relatively satisfied. Although the market mechanism can make adjustments to economic activities at the micro level, it cannot effectively address macroeconomic issues. The market mechanism can strengthen market agents’ utilitarian goals but cannot overcome the external diseconomy. Additionally, market mechanisms can achieve economic efficiency but cannot achieve the diversification of social goals. Intervention by the government in its role as general administrator and a special economic agent is particularly necessary.

As the arbiter of and a participant in economic activities, the government already influences the economy beyond the traditional conceptual thinking of “small government.” With the development of the market economy, the degree of connections and constraints between firms increases, and monopoly power suppresses market efficiency. These dynamics suggest that the government should assume more responsibilities. Governments should conduct traditional general administrative functions and be accountable for economic growth, full employment, price stability, the balance of international payments, and fair social distribution. Although issues unresolved by markets may remain unresolved by the government also, it is normal for a government to participate in economic activities as both an administrative and economic agent.

Therefore, market agents include the firms and consumers described in traditional theories, and the government. The operation of the entire economic system is the result of interactions and dynamic games among the power of governments, firms, and consumers.

Consumers, firms, and government are all agents of economic power, but the sources of their economic power differ. The concept of government can be explained in both a broad and narrow sense. In a broad sense, the government includes power branches (the legislative), executive branches (law enforcement bodies), and judicatory branches (the judicial bodies). Government in the narrow sense refers to national administrative bodies including central and local government. In this book, the term government is applied in a narrow sense and as the concept of “big government” in a market economy. According to Yang (2003), the theoretical frameworks for the existence of government can be classified into the violence theory, contract theory, and evolution theory. Regardless of the theoretical framework, the existence of government corresponds to government power from the mandate of a political organization, and its basic functions and responsibilities are to provide public goods and promote social welfare. Based on this, government is linked to public interests.

In theory, public interests represent the interests of all members of society, which are represented by government interests. Thus, the power held by government stems from trust in and authorization given to a government organization composed of minorities in the society. The government, as an agent, uses its unique position of power to supply public goods by intervening coercively in the market economy through microeconomic agents. According to the concept of economic power, firms are economic power agents that derive their power from the scarce resources under their control. Such resources can be core products, production materials, or core technology and talent; even the core competence factors such as market share that can bring sustainable competitive advantages are likely to become a source of a firm’s economic power. In market transactions, to obtain a stronger position, firms often form alliances (interest groups) to win dominance in the rights to negotiate and speak in the games played with government, other firms (groups), and consumers. Consumers as individual economic power agents and possessors of labor factors exchange labor for consumer goods in market transactions. Therefore, consumer’s economic power stems from their own purchasing power or the quality of their own labor. As a group, consumers obtain their economic power through organizations. The power of an organized consumer group has always been greater than the sum of power of each individual. Compared to a single consumer, a consumer group can organize and leverage its economic power with respect to transactions to lift their economic position and status. In this way, consumers can provide a relatively high level of welfare.

Consumers, firms, and government have various sources of economic power, and the content and form of their power differs. Under the conditions of a modern market economy, government is representative of public interests. The government’s basic functions are to maximize public interests and to correct market failures. In performing its functions, a government’s direct involvement in economic activities falls into the category of economic power. For example, government becomes the demand side of the market through government procurement. A government can also be an important supplier in the market if it provides public goods by establishing state-owned firms, holding shares in firms, or if it develops infrastructure and high-tech products. However, governments often act as a socio-economic administrator that indirectly intervenes in economic activities. In performing its basic functions, a government’s indirect intervention in economic activities falls under the category of executive power. For example, governments set up market rules, regulate market order, and increase transfer payments. Without administrative intervention in the market, a government’s basic functions cannot be performed. Compared with advanced economies, the government in China is more tempted to intervene in economic activities using executive power. For example, the Chinese government once coerced the military forces to substitute their vehicles with First Auto-Work (FAW)’s “Jie Fang” trucks, which saved FAW from becoming insolvent. This is a typical example of a government’s direct intervention into economic activities. Recently, the Chinese government offered a 4 trillion RMB investment plan to stimulate the economy, which is another example of direct intervention in economic activities using a government’s economic power.

The economic power of firms stems from the use and possession of resources. The more resources a firm has, the greater its economic power through which the firm can gain more profits. This is because the greater the economic power of the firm, the stronger the firm’s bargaining power when transacting with the government. Hence, the firm can be subject to favorable government policies. Similarly, when transacting with other firms, the firm with greater economic power can easily claim a dominant position. Even in consumer transactions, the products of a firm with greater economic power are more easily accepted by consumers due to factors such as branding and firms gain more profits consequently.

Consumers typically affect and control the distribution of labor through their own endowments. Consumer’s economic power mainly includes the right to claim labor returns, the freedom to choose goods, and the right to social security. The right to claim labor returns means that consumers are free to choose how much labor they are willing to sell according to the labor market price for returns. The freedom to choose goods means that consumers have the right to choose whatever consumer goods they like to maximize their utility. The right to social security (also called the distribution right for returns on public goods) means that a consumer can influence the supply of government policies to obtain certain public goods. Those public goods will maintain a certain standard of living for the consumer and facilitate their advancement.

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