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Monday, 23 May 2011

The Illusion of Free markets

Dani Rodrik on the outdated economist’s illusion of free markets :

Raised on textbooks that obscure the role of institutions, economists often imagine that markets arise on their own, with no help from purposeful, collective action. Adam Smith may have been right that “the propensity to truck, barter, and exchange” is innate to humans, but a panoply of non-market institutions is needed to realize this propensity.

Consider all that is required. Modern markets need an infrastructure of transport, logistics, and communication, much of it the result of public investments. They need systems of contract enforcement and property-rights protection. They need regulations to ensure that consumers make informed decisions, externalities are internalized, and market power is not abused. They need central banks and fiscal institutions to avert financial panics and moderate business cycles. They need social protections and safety nets to legitimize distributional outcomes.

Well-functioning markets are always embedded within broader mechanisms of collective governance. That is why the world’s wealthier economies, those with the most productive market systems, also have large public sectors.
In other words  government is a necessary beast, and the real challenge is how to ensure that beast serves the village and does not turn into relish. Rodrik believes the key to that is democracy with helps aggregate preferences across individuals and improves accountability. All sensible, but I would argue further that democracy itself needs to operate within a value system if the process is to be efficient and durable. In short, we need “strong religious and cultural” institutions as third element of the tripod. We have viable societies, when those societies are built on strong markets, strong democracy and strong religious / cultural institutions. Emphasis always on the word strong. The role of government is to play an active role to ensure these three elements are kept strong by appropriate intervention.

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