The Economic Perspective

In the previous section, you were asked to think about the ways government influences your life each day. From a purely practical perspective, people have come to rely on government to provide a wide range of services. An economist, however, would likely argue that simply because people rely on the government for particular services does not mean that the government is the best provider of those services.

Indeed, the American political tradition is deeply rooted in the notion that government should do as little as possible, especially when it comes to regulating the economy. So profound was this belief that for much of the 19th Century laissez faire was the most popular economic doctrine in the land. In short, the notion of laissez faire meant that the government should keep its hands out of the economy unless it was absolutely necessary to intervene in order to protect life or property. Under this doctrine, government regulation of wages or prices or any form of income redistribution (such as welfare) were considered inappropriate, even morally wrong because leaving the economy alone, proponents of the doctrine maintained, would produce the greatest levels of prosperity and happiness possible.

Adam Smith and the Free Market

This hands-off view of government was championed by Scottish economist Adam Smith in The Wealth of Nations, written in 1776.1 Smith argued that as people interacted in a largely unregulated economy, the pursuit of self interest at the individual level would produce favorable results at the societal level. Smith wrote that, each individual pursuing his or her own interests,

. . . intends only his own gain, and he is in this case, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. (emphasis added)

In other words, Smith believed that the "invisible hand" of the free market economy would promote the common good more effectively through the actions of a selfish, profit-maximizing individual than it would from an individual who gave exorbitantly to charity. An individual who maximizes the amount of money in his or her own bank account, the theory went, would contribute to the good of society by expanding its wealth, providing wanted goods and services, creating jobs and spending money. Indeed, even rigid rules protecting employees, i.e. laws that are supportive of strong labor unions, are generally perceived in the United States as detrimental to the economy. Some have even given credit for the current booming economy to Ronald Reagan's busting of the Air Traffic Controllers strike in the early 1980s and the decline of labor union strength that followed.2 

However, in both Smith's times and today, profit maximization is often perceived as greed while philanthropy is perceived as the more noble use of one's money. When Ted Turner announced in 1997 that he was giving one billion dollars to the United Nations, for example, his name and face were on the front page of every newspaper and at the top of every news program. Those of Adam Smith's persuasion might argue, though, that Turner's real contribution to the "wealth of nations" was not his gift to the UN, but his leadership over the creation of a multi-billion dollar empire which has included at one time or another the Turner Broadcasting System (TBS), the Cable News Network (CNN), MGN/UA, the Cartoon Network and the Goodwill Games. Similar claims could be made about other billionaires who have made "megacontributions" of their own. Bill Gates has contributed more than $28 billion of his own money to the Bill & Melinda Gates Foundation, which focuses on alleviating health and education problems around the globe. Warren Buffet has publicly committed to giving another $31 billion to the foundation over the next several years. Such massive contributions will undoubtedly make an impact on the problems at which they are targeted.

Nonetheless, it was self-interest and not charity on which Smith based his best hopes for society. In logic stunningly similar to James Madison's in The Federalist No. 10, Smith argued that persons holding government positions could not always be counted on to act in the public interest. It was better, then, to trust in something more enduring: self-interest.

So, Do We Need Government?

If we accept Smith's views, the kind of government we need is a very limited one indeed. Is our government too large? Does it produce inefficient outcomes in the economy that limit our prosperity? Public opinion is mixed on government's role in the American economy today. In a Pew Research Center poll, 81% of those surveyed believed that the free enterprise system is a "major reason that America has been so successful in this century." 76% of those surveyed agreed that the "strength of this country today is mostly based on the success of American business" and 89% said that they "admire people who get rich by working hard."3

In contrast, the same survey suggests that Americans are ambivalent, if not supportive, of many forms of regulation and government intervention in the economy. 55% agree that "people should be willing to pay higher prices in order to protect the environment" and 61% believe that "it is the responsibility of the government to take care of people who can't take care of themselves." Similarly large numbers of Americans are suspicious of large corporations with 73% indicating that "there is too much power concentrated in the hands of a few big companies" and 58% believing that "business corporations make too much profit."

So how do we reconcile these seemingly conflicting opinions with Smith's views and the current level of government intervention in the United States economy? Is there an economic justification for the current extent of government activity?

While the average observer might peruse a list of government incursions into the economy and conclude that the exceptions we have made to the laissez faire model are all but random, economists have formalized the exceptions to the rule by identifying six circumstances under which government intervention is justified:

1. monopolies
2. the under-provision of public goods
3. externalities
4. incomplete markets
5. information shortages
6. high unemployment and inflation rates.

In these six circumstances, economists maintain that the free market economy fails to provide the most efficient results for society. Consequently, government intervention in the economy is not only justified but essential to the public good. More about market failures, including definitions and examples of the six types.

Non-Market Failure and Government Intervention

Barring market failure, is there any justification for governmental intervention in the economy? Some economists would say no--as long as the market is functioning properly it should be left alone. However, there are economic reasons other than market failure that might justify the government's involvement in the economy. Even when the market operates efficiently, there are huge disparities in the distribution of wealth and income in the United States. One of the most significant undertakings of the federal government is the redistribution of income and wealth through programs such as welfare and Medicaid.3 These programs which benefit the poor are paid for by the wealthy. Some people believe that these policies are unfair, depriving wealthy taxpayers of the the money they have earned through their hard work and good fortune. Others maintain that those who are wealthy are wealthy at least in part because they live in a free society which allowed them to pursue their wealth. Part of their "costs" of obtaining wealth, then, should be supporting the society in which they live with taxes. Public opinion on income redistribution is mixed. While 79% of those surveyed in the Pew Research Center poll cited above agreed that "poor people have become too dependent on government assistance programs," 61% believe that it is the responsibility of the government to take care of people who can't take care of themselves."4

Tax policies and the redistribution are discussed in greater detail later in "Social Policy" and "Economic Policy."

A final possible economic justification for intervention in the economy is that the market assumes that people will behave rationally, that they will make decisions and choices that promote their own interests. However, there are some people who make decisions that may be contrary to their own interests. For example, driving a car without a seatbelt or riding a motorcycle without a helmet is dangerous, but people persist in engaging in these activities. Other dangerous behaviors include drug use and driving a car without insurance. Partly because political leaders want to "protect" people from themselves and partly because these dangerous behaviors often do economic and bodily harm to other people, the government requires people to do such things as wear seatbelts and helmets and carry liability insurance on their automobiles. Drug use is illegal. While most people accept such laws as reasonable limits on their freedom, some people believe that placing such restrictions on individual behavior is an example of government overstepping its bounds. The regulation of dangerous or "bad" behavior is discussed in greater detail in "Social Policy."

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NOTES
1. Smith, Adam. 1937. The Wealth of Nations. New York: Modern Library. (First published in 1776.)
2. Thomas L. Friedman, "An American in Paris," The New York Times, 20 August 1999. Web Edition-Op-Ed.
3. The Pew Research Center. 1999 Millennium Survey.
4. Ibid.