State and Market failure - Weebly



State and Market failure

Much is being said these days about the respective roles of the market and the state in the development of an economy. Development as perceived by modern societies is comprised of elements that improve the quality of life of the people. That is possible by an increase in per capita income of the people, absence of poverty, unemployment, gross inequalities, and access to social services or public goods like education, health, nutrition, family planning. It also entails ensuring clean environment for people to live in.

Having spell out the requirements for development, there are areas where market and state succeed and fail.

Market succeeds:

The market, a system where prices, production and distribution are determined by the forces of demand and supply, is capable of fulfilling some conditions of development.

Rapid and efficient growth:

The market is a potent instrument in raising the growth-rate rapidly. It also ensures efficient use of resources, both in terms of their allocation among different uses and the cost of production and distribution of goods and services. The urge for maximizing profits propels entrepreneurs to seek the most profitable lines of using resources, and the least-cost technologies of production and distribution. This tendency is further strengthened by competition among themselves. The competitive environment drives entrepreneurs towards more production, new products and new processes of production. In an economy where private sector is strong or is expanding, higher growth rate is possible, because of the opportunities that this system offers to amass wealth and economic power.

Expanding economy:

The drive towards rapid and efficient growth is further promoted in the case of a market economy, which is open and globalizing. The opportunities for expansion, both in respect of inward flows and outward flows, multiply manifold. The trade, encompassing both exports and imports expands world-wide. So is the case in respect of movements of capital, technology and labour. For a less developed country, the much needed foreign exchange increases substantially because of expansion of exports, inflows of foreign direct investments and foreign institutional funds, remittances of people working in other countries. Foreign direct investment also brings with it advanced technologies in the sphere of production, management, marketing etc. All these help in the reorganization of production in terms of comparative advantage of less-developed countries. It promotes an economy which uses its capabilities in terms of natural resource endowments, abundant labour, and supply to its best advantage. The net result is a rapid growth of the economy.

Market failures

The market though useful in raising the growth-rate has certain serious deficiencies in fulfilling several requirements of development.

1. Limited role in infrastructure:

Events in the sphere of growth where it excels, the market is of little help in building the infrastructure for production and distribution. In constructing roads, bridges, ports, railways, communication etc, private entrepreneurs in general, are reluctant to invest in long-term projects involving large sums of money. The foreign investor may have funds and technology but may, at best, go in only for some segments of the infrastructure like constructing bridges, or some stretches of roads, or some areas of ports or communication net-work. The totality of infra-structure is beyond them. The domestic entrepreneurs of the less developed countries are handicapped by the paucity of funds and technical skills.

2. little alleviation of poverty, unemployment and inequalities:

There is nothing in built in the market system that can eliminate poverty. On the contrary, there is every possibility that it may increase poverty. The experience of several developing countries in the recent past has shown that growth has bypassed the poor. In some, countries their position has been worsened. Connected with this is the issue of employment, particularly of the poor. There is no guarantee that jobs will become available for all the poor while growth is taking place. Private producers, in their pursuit for maximum profits will substitute capital for labour if it pays them to do so. The basic thrust of the market economy is to produce for profits, not for employment generation is incidental.

As regards inequalities, the situation is no better with private ownership of resources as the basis of market economy, the initial distribution of resources among the private owners, “it is taken as sacrosanct”. As such there is no presumption that the working of the market system will by itself, bring about equity in the income-flows arising from the privately owned resources. In fact, with the stronger bargaining power of the big resource owners, there is possibility that the inequality will get accentuated.

3. Provision for social sector:

The market is totally an inept system for the provision of social services, especially to the poor. They have insufficient commercial incentives for their presence in this social sector. This is more so in respect of the poor, who do not have the purchasing power even to pay for their survival.

Another difficulty is that the social sector is not self-financing, that is, the investments in this sector cannot be financed through,” returns” from them either because these are delivered free or at low prices to the masses. For this reason the private entrepreneurs, who depend on market funds are handicapped in seeking funds for investments in this sector. Under these circumstances, it is the public funds (taxes) that have to be made use of.

4. Environmental degradation:

The market is itself an important cause of damage to the national environment and natural resources. The market-price, which guide allocation of resources and influence profits do not accurately reflect the social value of the natural environment. The prices, for example, do not include the ‘cost’ to the economy of the polluting technologies. With no costs to pay for, the natural resources are overused and misused causing damage to the ecology.

State failure:

While there is much that state can do for furthering development, there are certain areas, where it is found grossly inadequate.

1. Weak for directly productive activities:

The state is ill-suited to engage itself in the production of goods and services which are for direct use. These are mostly consumer goods, like food grains, clothing, shoes, watches, radios etc, as also services like trading, entertainment, tourism etc. There are important reasons for this. For example: the demand for them is highly uncertain and cannot be predicted in advance. Thus there is greater degree of risk and cannot be insured. The state which is required to follow fixed, rules and procedures, cannot undertake the production or distribution of these goods and services as per the changing demands of consumers. Besides, the variety of consumer goods and services is so large that the state just cannot cope with all sorts of demand. The same is also applicable to intermediate and capital goods which go into the production of consumer goods. Their demand being derived from the demands of consumer goods faces uncertain conditions. Hence, their production and distribution also cannot be undertaken by the state.

2. Far from efficient:

The state is incapable of organizing production and distribution on an efficient basis. One reason for this is that the government rules and procedures are many in number. They are also complex and time-consuming and require that the projects to be approved at several levels. Very often non-economic considerations weigh with the finalization of projects. All this stands in the way of allocating resources to the most productive uses. The government administrators, good at administering set rules, often do not have management capabilities to run commercial enterprises which require taking decisions outside the set rules. Even in case of public sector enterprises, there is little that one can expect by way of efficiency. These enterprises are further handicapped by the lack of competition among them. They do not look for least-cost methods and technologies for production and distribution, workers are also not subject to discipline, which, results in scant regard for productivity.

These are areas where sate fails and it is found grossly inadequate.

Redefining the role of the state:

In underdeveloped countries, markets are neither adequate not efficient. It is therefore, necessary for markets to develop fully to be able to perform their functions well. Towards this end, the following measures to be taken by the state or government.

1. Appropriate economic environment:

There are two major components of environment which must be provided for, to strengthen the basis of markets. One is the legal frame-work for the conduct of market-transactions. For example, there should be market-friendly set of laws. These should provide for clear property rights, transparent rules governing buying and selling and speedy settlement of disputes. Further ownership rights should be so laid that the owners do not feel restricted in availing opportunities for expansion. Another key ingredient of a developed market is the availability of infrastructure for its smooth functioning.

2. Promoting competition:

Another element of developed markets is the presence of competition among the various economic agents. The efficacy of competition can easily be seen in the most successful economies of the world, namely Japan, South Korea, Singapore, USA, and Europe. Competition in these economies is a generalized phenomenon which encompasses every nook and corner of the economic fields. Competition implies absence of restrictions on economic agents, except such curbs which can be socially justified. While freedom to entrepreneurs is an essential prerequisite for a sound functioning of the market, it is also necessary to provide a regulatory frame-work to keep under check the monopolistic and restrictive practices of economic agents.

3. Healthy macro-economic condition:

For the market to function properly, it is important that the macro-economic conditions of an economy remain in a healthy state. One key macro-economic variable is the price-level. It should be kept stable, with moderate doses of increase in it, to provide stimulants to the economy. This provides a firm basis for investors, producers, traders, etc to calculate costs and benefits of their projects. Another component of macro-economic environment is the balance of payments. It should remain around the equilibrium point, with minor deficits or surpluses to act as absorbers of shocks emanating form the domestic economy or foreign economies. This also will ensure a stable rate of exchange which forms key elements in the cost and profit calculation.

A crucial macro-variable relates to the fiscal affairs of the government. These affairs encompass taxes, borrowing, expenditure, finances of public sector etc. A fiscal policy, that keeps fiscal affairs tuned to the principles of sound public finance, produces an environment conducive to the efficient working of the markets.

Ensuring development-oriented state:

In order to achieve the goals of development, the state has to be one that is adequate for the tasks and functions in terms of economic principles, that is, economizing the use of resources to achieve given ends.

Market friendly approach:

One important consideration, which should govern economic activities of the state, is the need to use the market as extensively as possible. Thus, market should be treated as a device to achieve efficient development. For this, the first step is to promote a market economy. A favourable environment also needs to be developed for competition to take place among the economic agents.

2. Providing for implementation:

In order to perform well, the state needs to provide the means for the achievements of goals. The foremost task is to prepare a blue-print or plan for the economy. Another requirement for the execution of development=related tasks is the provision of resources. The state will have to create an environment that ensures adequate resources, both for the private sector and the public sector. Appropriate policies are also needed to ensure that the development proceeds along the desired path.

3. Raising of efficiency:

Several measures need also to be taken to improve the efficiency of the state and its functioning. One important measure relates to the interventions of the state in the economy. The basic approach in this regard should be to rely more on the indirect interventions, rather than direct interventions. The former works through the market such as changes in taxes affecting income, expenditure and prices, subsidies, changes in supplies or demand etc. these interventions supplement market forces thereby permitting the use of resources to be determined by the market.

The public finance of the state needs to be conducted efficiently. The administrative costs of expenditure, revenue-raising should be minimized to the least. Expenditure on various items should be properly targeted. Fiscal operations should promote efficiency of the economy. The expenditure and income should be kept in proper balance so as to avoid large budgetary deficits, excessive inflation and unsustainable balance of payments. It is also important to ensure efficient working of the public sector enterprises. Efficiency of the state can also be improved in the execution of its projects.

To conclude, the market and the state are two agencies which play a major role by contributing to the cause of development.

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