Theoretical foundations for executive power intervention in economic activities

Concerns with market failure can be traced back to the 1930s and the Keynesian revolution in economics. Roosevelt government’s “New Deal” in 1933 was the beginning of western and modern government interventionism in economic activities using executive power. Market failure is a normal state in economic activities. Since failure is the necessary consequence of unfettered economic power, it follows that the solution to failure relies on the intervention plus coercion of executive power. This is determined by a government’s role in economic activities.

The limitation of market's ability to adjust

Whether negative or positive, externalities result in the deviation of resource allocation from the Pareto optimal state. According to Coase’s theory (1991), the root cause of externalities is both the ambiguity in defining property rights and positive transaction costs. Coase argues that externalities can be resolved directly through markets if the definition of property rights is clear without transaction costs. However, in reality, even if the definition is clear, market adjustments are sometimes incompetent because negotiations between individuals are too costly or information is incomplete. Moreover, property rights cannot be defined without government as a third party. The same is true for internalities. Internalities cause efficiency loss. When negative internality exists, the actual market trading volume is below the social optimal level, and the allocation of resources by the market will deviate from the Pareto optimal state. Therefore, government must intervene using its executive power.

In addition to externalities, monopolies, asymmetric information, and the supply of public goods are problems that the market cannot solve on its own. Any form of imperfect competition will shift the social output inward from the production frontier. For instance, when a monopoly firm raises prices leading to a reduction in output, or oligopolistic firms collude to reduce supply, the output of a certain product will be less than its efficiency level, which is detrimental to the economy efficiency. At this point, government intervention is necessary to solve the problem of low efficiency caused by imperfect competition. Moreover, resorting to the market to resolve the public goods supply will not help. Public goods have the properties of non-exhaustibility and non-rivalry; hence, they are special goods with strong positive externalities. Individuals enjoy the utilities brought by such externalities but are unwilling to pay for their consumption. Thus, every agent is inclined to free-ride, waiting for others to produce public goods. Therefore, public goods cannot be supplied by firms and individuals via market mechanisms, and the government must intervene to encourage production.

Additionally, the problem of incomplete information cannot be resolved through market adjustment. Complete information is a basic assumption in microeconomics; that is, every agent’s decisions are based on the full information of all the parties involved in the transactions. In general cases, the price signal reflects, comprehensively, all types of dispersed information. Thus, economic agents only need to react to prices to make the resource allocation Pareto optimal. In reality, however, neither consumers nor producers have complete information required by the Pareto optimal state. Consequently, incomplete information occurs, also known as the phenomenon of information failure. Whether adverse selection or moral hazard, information failure is the distortion of market resource allocation caused by asymmetric information. Incomplete and asymmetric information are the intrinsic defects of the market and cannot be resolved solely by market forces. Government intervention by executive power is necessary.

Economic equity, which is of the greatest concern, is reflected in markets as the exchange of equal value. In firms, economic equity is reflected in distribution based on contributions. However, since the resources held by each economic agent are different in terms of importance, quantity, scarcity, and substitutability, non-reciprocal power structures emerge with different negotiation abilities. Because there is a difference in negotiating power and position, it is impossible for the market to realize economic equity by itself. For instance, labor compensation and the prices of agricultural products in developing countries are illustrative of this theory. For social equity based on initial distribution, this must be resolved by the government through secondary distribution. Ensuring social equity is a government’s natural duty while firms and markets have no such responsibility or function.

< Prev   CONTENTS   Source   Next >