When looking for solutions to humanity’s problems, conservatives and libertarians tend to prefer turning first to free markets rather than government. The reason for such a preference is often misunderstood, and can be difficult to explain since it appears paradoxical: free markets are often better at serving human needs than governments because free markets make it easier to fail.
As Arnold Kling explains, the best way to deal with failure depends on the institution. An individual needs to fail with a fallback position, a small startup firm needs to fail quickly, and a large, established firm needs to fail gracefully. But government, says Kling, cannot do any of these things well.
Of the many things that governments do poorly, failing is probably the worst. That is why governments rarely produces significant innovations. To produce innovative ideas, products, processes, or services requires testing what works and adjusting what doesn’t until you find the right formula. In a free market, the actions of consumers provide a signal to individuals and firms that they are doing well – or that they are failing.
If a company is failing, they have an incentive to adjust — and are pressured by competitors to adjust quickly — in order to give the customer what they need. They are often faced with a brutal, binary choice: innovate or fail. Government agencies, in contrast, tend to lack such feedback mechanisms and the ability to adjust quickly precisely because they have a low fear of failure. Even if they are unable to innovate and serve the needs of their “customers” they will likely stay in business due to bureaucratic inertia.
Imagine that you have a series of plumbing problems in your house—clogged sinks, backed up toilets—and decide to hire a plumber. Which of these two incentive structures would you choose?
(A) The plumber only gets paid when the problems are fixed.
(B) The plumber will continue to be paid indefinitely for working on the problem, and will continue to get paid as long as the problem persists
Most of us would choose option A since we are more interested in functional indoor plumbing than we are in providing a paycheck for plumbers. Hard-working plumbers should prefer option A too since it respects their dignity and skills. The vocation of the plumber is to solve plumbing problems, not to latch onto make-work projects.
So if most people would choose option A, why does the government almost always adopt an incentive structure that reflects option B?
Over at Econlog, one of the best economics blogs around, Arnold Kling has been reading Acton Research Director Samuel Gregg’s latest and recently released book, Wilhelm Röpke’s Political Economy (Edward Elgar, 2010). Kling underlines how Röpke used ethical analysis to distinguish between the three ways of allocating resources: altruism, coercion, and what Röpke called “the business principle.”
For Kling’s take on this subject, see Econlog.
The book is available on the Elgar site and Amazon.