This is an evolving draft on why we need a mix of both markets and state, and why one is not inherently better than the other. Do let me know your thoughts. The article can be summarized as follows: It is too complicated for the state to run the entire economy by itself, and we need private players and markets. But the problem of corruption in statism does not vanish in market-economy. It merely morphs into a new problem of having to constantly keep a watch on anti-competitive practices. In addition, even with a competitive and free market, we are not assured of equitable growth and we need the government to constantly intervene and to support weaker players, so as to provide a level-playing field.
To clear a common misnomer: Free-market vs Statism argument is not the same as Socialism vs Capitalism arguments – one can have a state-directed capitalism (Dirigism) or a free-market socialism. You can think of a smooth curve connecting capitalism to socialism: a private company whose equity is shared 75:25 by 1000 shareholders and its individual owner is a more socialist (and less capitalist) than a company whose equity is shared 25:75. Cooperatives (whose members own almost equal equity) is an example of total free-market socialism, while a company whose benefits goes to a single individual is an example of total free-market capitalism. So even those, who believe in free-markets as the solution to achieve eventual equitable development, are socialists. The other (usual) kind of socialists are statist-socialists who believe in state-directed equitable development.
We know the usual perils of total state-controlled socialism: At its most fundamental level, it boils down to the fact that the system becomes too complicated for the state machinery to plan and control in a top-down approach. Decentralization (Swaraj) is a means to reducing complexity, but it is not sufficiently reduced as to run an entire economy through a decentralized government. In free-markets, this issue of complexity does not arise since individuals act on their own, with competing incentives. But, as we will see later, the hope for equitable growth through completely unregulated markets is as much a blind-belief as in total statism. As as aside: Another oft-quoted reason against statism is lack of incentives for innovation. But this is misplaced. In principle, a democratic government always has an incentive to innovate in order to maximize benefits to electorate per rupee spent or per policy, so as to stay ahead in next elections. It is a different matter than once-in-five-year representative democracy is not enough of a check, and we need more participatory democracy.
Problems galore in both systems:
Statism can breed corruption in the way government functions but this problem does not vanish in unregulated markets and merely gets transformed into a new problem. A truly free market needs regulatory oversight in the form of strong competition regulators who can check collusion, predatory pricing, cartel formation etc, each of which is as hard to keep a watch on as checking corruption in total statism. It is hard to detect when two local wholesale procurers can collude, over chai or phone, to not outbid each other beyond a certain agreed price. Similarly, it is hard to detect whether a giant seller, with deep-pockets, is selling below his cost price in order to force other small sellers out of business only to raise prices in a latter monopoly. It is for this same reason that paid media continues to flourish even in a brutally competitive media market, since they see more value in colluding on this than competing through exposing each other.
We will also need another anti-corruption agency to keep a watch on competition regulators to prevent them from being bribed by anti-competitive players. In India, many do not even know about the existence of competition regulators. It is so compromised that even blatantly anti-competition deals like Jet-Etihad and Reliance-Network18 barely raises eyebrows. Reliance gas pricing scam is another recent example where, for lack of a gas market in India, the government should have better regulated Reliance’s gas auctions, but did not. In contrast, even in free USA, competition regulators have routinely broken down conglomerates like Bell Labs, Microsoft etc, and have denied merger proposals like the recent AT&T and T-mobile deal.
Equitable growth through unregulated-market
As I mentioned earlier, the belief that unregulated free-markets can bring about equitable development is blind. There are two components to a market – (1) individual buyers and sellers (of any goods or services) and (2) the interconnections (market linkages for producers, linkages to investment capital, education capital etc).
Role of network architecture:
Let us consider a simple trading market. Assume a static network structure and assume that there is no disparity between individuals other than in the way they are connected. There have been several experiments on the relationship between network architecture and growth of wealth. Consider the networks in the figure below, where individuals exchange goods, say milk (unfilled circles) and wheat (filled circles), by starting out with equal amount of their products, and the exchange rate is dynamically market-determined during each trade. At the end of several steps of trades, it was seen that the better-connected individuals got increasingly favorable exchange rates at the cost of individuals who were less-connected. This confirms our hunch that, to reach an equal-opportunity society we should move towards uniformly connected individuals.
Evolution of network architecture:
But networks themselves are not static but evolve over time. The growth of networks themselves is a highly dynamical process. The growth models of real world networks is one where better connected individuals more strongly attract newer connections than less-connected individuals (Barabasi-Albert model of growth of real-world networks). This, together with the earlier results of network game theory experiments provides mathematical validity to the problem of “rich getting richer (at cost of poor, since wealth is fixed)” in totally unregulated market.
Role of variations in market players:
That was the case when individuals started out identical. Now consider real-world scenarios where, not every individual (every milk producer and every wheat farmer) is the same. There are some with better education, bigger farmlands, more cows, more money to invest, belong to established trading castes etc etc. Such variations in individual capabilities add to the effect of network variations and network growth variations in exacerbating inequalities in unregulated-markets.
Gatsby curve: Income inequality affects Income mobility
Empirical evidence from Great Gatsby curve also supports the above results. The more inequal a society is, the harder it becomes for someone to succeed and move up the income ladder, even if presented with equal market opportunities. In the following figure from wiki entry on Gatsby curve, higher gini implies higher income inequality and higher inter-generational income immobility translated into increased barriers to converting opportunities and to move up the income ladder (India’s gini coefficient is ~0.39).
This makes a strong case for governments to provide social support to neutralize this inequality of converting opportunities. So, it is wrong to dismiss all social welfare as mere doles that make beggars out of poor people.
As an aside: If government is seen as just another player in the market, staunch libertarians argue that even the role of social welfare should be left to choice – ie. people should be allowed to donate to any charity of their choice than to be forced to pay taxes to government which then decides on how to spend it (even if some charities are tax deductible currently). In that case, some people might decide neither to do charity nor to pay taxes. But this is a slippery slope, and a next logic stop down that slope would be “who decides what is criminal and what is legal?” when morality varies across individuals and natural evolution allows literally everything under the sun (including physical assault, sexual assault, murder n robbery etc etc) and religious texts have their own versions of what is moral and what is immoral.
There is also the oft-quoted excuse of trickle-down effect which says, even if rich get richer, as time goes on, the benefits of development trickle down from rich to the poor. This is also just a belief that is not substantiated. There is a field of physics called percolation theory which studies how some thing (be it wealth, an idea, an epidemic etc) percolates in a network when that thing is dropped at a few selected locations. In our case, we want to know how wealth diffuses through society when its major source is at points of rich players. Mathematical results from this field shows that the percolation depends very strongly on the structure of the socio-economic network just as in the case of trading experiments above: The wealth percolates down to the poorest players only for a very narrow and specific class of networks (called networks at critical point), while for a vast majority of others, wealth does not diffuse and stays clustered among the richer class. So, it is clearly unwise to give away land and natural resources at below-market rates to wealthy individuals, because it is much more likely to not diffuse than to diffuse. For a mathematical review of this topic, see “Critical phenomena in complex networks”
It is clear that it is too complicated for the state to run the entire economy by itself, and we need private players and markets. But the problem of corruption in statism does not vanish in market-economy. It merely morphs into a new problem of having to constantly keep a watch on anti-competitive practices. In addition, even with a fair and free market, we are not assured of equitable growth and development and we need the government to support weaker players and intervene in network linkages, so as to provide a level-playing field. It is also clear that merely giving away free land and gas to corporates in the name of trickle-down effect is not evidence-based.
Before I finish, let us look at trends of income inequality (remember: higher gini = more inequality) in USA, which has one of the most free markets (source: OECD table).
Some might say that beyond a certain level of development not everyone has the same drive to develop more and hence inequality will creep in. But, if you take the average standards of living, USA is still not at a place where it can be complacent (in inequality-adjusted HDI ranking, it figures at 23). It is not the highest even in per capita income. So, you cannot say that majority of Americans dont have enough motivation to prosper. The personal wealth of the Walton family that owns Walmart is equal to the combined wealth of the bottom 40% of all Americans! (source: Politifact)