Friday, September 19, 2014
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No Third Way to the Market

SAN FRANCISCO - Today, the "market" is said to be either utterly triumphant or a grave threat. Politicians everywhere quest for a "third way" around its rigors, yearning for "national champions" in industries like telecoms capable of holding off globalization. The market, however, is simply a mechanism that can be mobilized for any number of purposes. Depending on the way it is used, the market may contribute to social and economic development or inhibit it.

Using or not using the market is not the crucial distinction. Every society - communist, socialist, or capitalist - uses the market. The crucial distinction is private property. Who are the participants in the market and on whose behalf are they operating? Are the participants government bureaucrats operating on behalf of "the state"? Or are they individuals operating on their own behalf?

Once, on a visit to China, a deputy minister asked "Who in the America is in charge of materials distribution?" The question took me aback, yet it was natural. For it was almost inconceivable that a citizen from a command economy could understand how markets distribute materials among millions of people for thousands of uses untouched by political hands.

Introducing greater private market mechanisms may be partially or completely frustrated by too limited a change, which is something to be watched out for in today's supposed takeover boom in Europe. Take American airline deregulation of 20 years ago. It enhanced competition, resulting in reduced prices and new services. The volume of air traffic increased.

Although US airlines were "privatized" - freed from extensive state control - airports were not. They remained government owned and operated. So, as deregulation boosted demand flight delays multiplied in airports. Government blamed private airlines. It required them to report delays. Efforts to bring market forces to bear by, say, auctioning gates and flight times, were stymied, in particular by airlines with vested interests. The best solution would be to privatize airports, as Britain has done and as Italy and Poland are thinking about doing.

Privatizing some areas of manufacturing while keeping prices under government control is another half-way wheeze. The failure of prices to conform to their market value makes private operation, even if efficient, socially wasteful.

In India's Punjab there was a plant producing bicycles. Government rationed steel to users rather than selling it at a market price. The bicycle producer could not get the amount of steel needed at the official price. However, there was a private market in finished or unfinished steel products. So the bicycle manufacturer supplemented his rations through buying semifinished steel products and melting them down - hardly an efficient way to convert iron ore and coal into bicycles.

If the "Third Way" is to mean anything, it should focus on ways to overcome political obstacles to widening the market. Not only is there a danger that such obstacles will frustrate attempts to free the market but, equally, that overcoming political obstacles will destroy the advantages of freeing the market. The challenge is to overcome such obstacles without incurring those effects.

An American example here concerns privatizing the post office. The US Postal Service has a monopoly in first-class mail through a statute which makes it a crime for others to offer common-carrier first-class service. Privatization has been creeping in at the margin in the form of United Parcel Service, Federal Express, and others. Email and other technological developments now also play an increasing role.

Repeated attempts to repeal the Postal Service statute always brought violent protests from postal employee unions, Postal Service executives, and rural communities that fear being deprived of services. On the other hand, few people have a concentrated interest leading them to favour repeal. Entrepreneurs who might go into the postal business don't know in advance that they will do so. Hundreds of thousand of people who would doubtless obtain employment in new private firms also do not have the slightest idea in advance that the would do so.

Once, I urged a congressmen to repeal that statute. He replied, "You and I know the powerful groups that will testify against such a bill. Can you give me a list of people willing to testify and work in favour of such a bill?" I could not, and he never introduced the bill. Powerful vested interests had been built up in the postal monopoly; opposition to it was scattered.

One way to overcome opposition to privatization is to identify potential opponents and cut them in on the deal by means of, for example, stock ownership, a kind of populist capitalism at which Mrs. Thatcher was skilled. A pitfall to be avoided here comes in sweetening the deal by converting a government monopoly into a private monopoly - which may be an improvement but falls far short of the desirable outcome.

The US Postal Service illustrates that pitfall as well as the fallacy that mimicking the form of private enterprise can achieve the substance. It was established as a supposedly independent government corporation that would not be subject to political influence and would operate on market principles. That has hardly been the outcome, understandably so. It remained a monopoly and never developed a strong private interest in efficiency.

The problems of overcoming vested interests, of frustrating rent seeking, apply to almost every attempt to change government policy, whether the change involves telecoms privatization or reducing farm subsidies. This "Tyranny of the Status Quo" is the major reason that political mechanisms are so much less effective than free-market mechanisms in encouraging dynamic change, and in producing growth and prosperity.

Few rules exist for overcoming this tyranny of the status quo. But one is clear: if a government activity is to be privatized or eliminated, do it completely. Do not compromise by partial privatization or partial reduction of state control. That simply leaves a core of determined opponents in place who will work diligently (and often successfully) to reverse the change.

Read more from our "Milton Friedman at 100" Focal Point.

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