4.8 The Balance between Markets and Intervention

The Balance between Markets and Intervention

The discussion regarding the benefits of free market contra government intervention policies is present throughout the economics course and it is extremely important, also in relation to Development Economics. This is an area that requires you to be able to integrate the knowledge you have acquired from studying each individual topic in order to have a debate about how Economics affects the world around you. In relation to Development Economics, the discussion focuses on the policies to be used by less developed countries in order that they may achieve economic growth and development? Is liberalisation and free trade, as proposed by the Washington Consensus, the way forward, or is government intervention and market regulation the true route to long-term economic success?

Market-oriented policies

Market-oriented policies are policies that aim to allow the market forces of supply and demand operate freely. As you will remember from Microeconomics market-oriented policies ensure efficient distribution of resources and incentive for improvement thanks to constant competition. In addition free trade between countries can result in access to world markets, economies of scale and the utilisation of comparative advantage.

The advantages associated with foreign direct investment have been discussed already . Remember that deregulation and low taxes encourage MNCs to establish in a country, and this, in turn, creates employment opportunities and transfer of technology. A drawback of a growth strategy focusing on attracting FDI is however the potential long-term harmful effects as the MNC transfer profits out of the country rather than reinvesting it. Hence, the LDC may indeed lose out due to the presence of foreign rather than domestic firms.

Adoption of free market policies tend to benefit the urban rather than the rural sector. This is only natural seeing that the economy will be moving towards higher level of economic growth. Because most of the products produced in the rural areas, i.e. primary commodities, are income inelastic firms will seek to commence production of manufactured goods and services instead. As this happens, industrialisation and simultaneous urbanisation occurs. While economic growth will occur at a higher rate than before and while exports increase, it also creates greater inequality. Indeed, in many of the major cities in China, such as Shanghai and Hong Kong, living standards are already as high as in Western Europe, while rural China has, in many respects, been left behind.

Interventionist growth strategies

Interventionist policies are policies favouring government intervention to steer and regulate the market. There range of such policies is vast, including the implementation of minimum wages as well as the provision of education and building of infrastructure, libraries, theatres and museums.

Few people would completely deny that government intervention is useful in creating economic growth and development: the debate is rather about the extent to which the government should intervene in the market. For example, as discussed in relation to supply-side policies in Macroeconomics, the government often takes on the role of educating the workforce. This not only boost aggregate demand in the short run, but also has the effect of increasing potential output in the long run as the quality of the labour factor of production is improved.

In addition, in the majority of countries it is the government that builds and maintains infrastructure. Good infrastructure is a precondition for production to occur as firms need to be able to produce and deliver their products to consumers. A country without decent internet connection, poor roads, intermittent power cuts and restricted access to fresh water is unlikely to attract any FDI, and domestic firms will simply be unable to produce much, even if the workforce is educated. This is the reason why the World Bank and the IMF, generally opposed to government intervention, favour and encourage government projects to build infrastructure.

While a social safety net is often a distant dream in many developing countries, the beneficial effects of implementing such policies should not be underestimated. If a farmer knows that a decent harvest is the only way to keep him and his family alive, he is unlikely to try any techniques except for the ones that have been used for generations. The provision of a social safety net however encourages more adventurous behaviour, and in trying new techniques, the farmer can potentially find ways to improve his harvest considerably. Without the safety net however, he would never have dared to try these techniques in the first place, due to the consequences of failure. Government intervention in this way can thus indirectly improve innovation and development.

Evaluation

As in many other cases, the best way is often a combination of the two extremes. A market-based approach has obvious benefits, but on its own it would fail to take the long-term perspective of the economy into account. Problems of externalities, the provision of education, infrastructure and welfare must often be dealt with by the government rather than private firms as the latter have profit-maximising objectives that compete with objectives of economic development and social welfare.

A key term in relation to policies to achieve economic development is good governance. Good governance relates to the process by which decisions are made and implemented. It is a useful concept since the formal requirements can remain relatively stable while the substantive content of good governance depends on the context. For example, the U.N. has stated that good governance is, among other things, participatory, effective and efficient, transparent, accountable, equitable and inclusive and in accordance with the rule of law. In other words, in no situation should decisions by governments be made bearing in mind just the welfare of a few individuals. Instead, decisions should always be for the benefit of all, it should seek to identify and satisfy the current and future needs of the people of the country, it should do so using transparent techniques, and the people responsible should always be accountable for what they do. Finally, the rule of law must never be compromised. If good governance is encouraged and implemented, developing countries would be able to avoid many of the problems faced in the past, and they can instead look forward to a bright and promising future.

Summary 

• Market-oriented policies are policies to encourage the free operation of market forces.

• Market-oriented policies include the liberalisation of trade, privatisation and deregulation in order to promote the efficient allocation of resources.

• Market-oriented policies fail insofar as they create income inequalities and when there is market failure.

• Interventionist policies are policies encouraging government intervention in the market.

• Strengths of interventionist policies include a long-term perspective in improving the quality of the factors of production, including investments in infrastructure and human capital.

• Interventionist policies are harmful to the extent that they result in excessive bureaucracy, corruption and poor planning for the future.

• The best way is often a combination of both market-oriented and interventionist policies. This can be achieved by good governance: a broad term relating to the formal framework of a healthy decision-making process.