The Hindu Business Line : Free market is a means, not an end

It is true that India’s growth over the past decade has not greatly reduced social inequalities. But without continued fast growth, it will never be possible for those from the weaker sections to enjoy a better life. The government bears a heavy responsibility for ensuring that the economy’s potential is maximised and the fruits equitably shared.

Devendra Mishra

Faith in the inevitability and invincibility of the free market has reached new heights. This faith has been termed by economist Dr Joseph Stiglitz as “market fundamentalist”. Unfortunately, the idea of the “free market” can be misleading. The pairing of the words “free” and “market” suggests that markets somehow exist autonomously, as states of nature, and that in the absence of human interference they will operate smoothly and effectively.

The scope of the free market implies that human actions undertaken to influence market outcomes represent unwarranted “interventions” that artificially constrain a naturally functioning system, in the same way that building a dam constitutes a human intervention to create a lake from what used to be a river.

Human creations

In fact, markets, like dams are very much human creations. Ultimately, markets are competitions that occur between people seeking to maximise their own advantage while exchanging resources within particular arenas according to specific rules. By building arenas of competition and defining the rules, societies necessarily regulate competition and constrain outcomes.

The proper role of government, then, is not to withdraw from economic affairs but through its actions ensure that needed markets exist, that appropriate arenas are constructed to enable necessary transactions, that all members of society have the same formal access to markets (i.e., they are not subject to discrimination on the basis of personal characteristics), and that citizens are reasonably protected against the deleterious consequences of potential market failures.

Timing and sequencing

In his critique of the Washington Consensus, Prof Stiglitz pointed out that to construct well-functioning markets, timing and sequencing are everything. Governments necessarily play an important role in building the infrastructure (legal, institutional, and cultural that enable the effective functioning of markets), as well as in creating the human capital (through investments in health and education) upon which economic growth ultimately depends.

Unless the necessary infrastructure and human capital have been created first, one cannot expect to achieve prosperity and stability by suddenly opening an economy to unencumbered private exchanges.

What is meant by “triumph of the market”? Markets are portrayed as if utterly abstract structures divorced from human beings that have been imposed on them by a malevolent few. Despite the excesses and bad taste of the “super-rich”, the distinctive feature of the market is mass prosperity. What the triumph of the market means in practice is that individual choice, not centralised direction, represents the most efficient means of distributing goods and services, the most democratic and most ethical.

As the late Joseph Schumpeter noted, “The capitalist achievement does not typically consist in providing more silk stockings for the queen but in bringing them within the reach of factory girls in return for steadily decreasing effort.” Markets are not a process but shared acts of millions of people. They are the real collective.

Human chessboard

A government should be devoted to both of Adam Smith’s most seminal works, the more famous The Wealth of Nations and the lesser known The Theory of Moral Sentiments, published almost 20 years earlier. The second tome contains the immortal message of Adam Smith, which governments would do well to never forget.

“The [man of system] seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard: he does not consider that the pieces upon the chessboard have no other principle of motion besides that which the hand impresses upon them; but that, in the great chessboard of human society, every single piece has a principle of motion of its own, altogether different from that which the legislator might choose to impress upon it.”

The have-nots

Today, there is regular talk of inclusive growth gaining currency from the fact that most of the population has yet to gain much from the economy’s recently improved performance.

The affluent urban elite that has prospered from the international success of industries such as outsourcing are vastly outnumbered by the hundreds of millions of rural poor, who are increasingly flooding into the cities. And although India has succeeded in reducing the number of people in absolute poverty, most remain trapped in abject conditions.

The country’s child malnutrition rate is twice that of sub-Saharan Africa and diseases such as dengue and polio are on the rise. Basic education is starved of resources and quite inadequate to equip India’s fast-growing population for employment outside small-scale agriculture.

The literacy rate of less than 70 per cent trails that of China. And the lack of modern infrastructure risks throttling the economy’s future development. Those deficiencies are not just an affront in themselves but the widening gap between a small group of “haves” and an army of “have-nots” poses a serious threat to India’s social cohesion.

It is true that India’s growth over the past decade has not greatly reduced social inequalities. But without continued fast growth, it will never be possible for the nation’s downtrodden masses to enjoy a better life. The government bears a heavy responsibility for ensuring that the economy’s potential is maximised and the fruits equitably shared.

The State consumes too large a proportion of national resources which is suffocating individual potential. The State should not only be smaller but also considerably smarter. It has to focus on its enabling role and have the humility to make space for, or to solicit the support of, markets to match its objectives. The State must be about ends, not about means.

We all live in astonishing times, where the fusion of a market ethos with staggering technological change opens an array of possibilities. The government should be in the vanguard of this wave.

In the end, there is simply no way to know, a priori, the correct formula for institutional reform and economic growth. The magical powers of the market like those of governments cannot be unleashed without a realistic appraisal of local institutions and how they can be adapted and modified to create conditions necessary for sustained economic growth, rising human welfare, and stable democratic governance. As studies show “magic without realism usually leads to no good.”

This view recognises government as an instrument by which the market may be created and managed in the public interest. It offers a middle course between the state-centred model of import substitution, industrialisation and the laissez faire model of free markets.

The creation of efficient, effective, and fair markets requires an efficient, effective, and fair government; and a competent, forward-looking state is essential for progress and development in a global market economy. Paradoxically, the road to development leads not around the state, but with the state as an active partner.

(The author is a member of Indian Revenue Service. The views are personal.)