Part 2. The changing role of government

Markets lie at the heart of every successful economy but markets do not work well on their own. Government needs to play a role – it conducts monetary policy and provides for national defense, police and fire protection, and other essential public services. When markets fail, government comes in to pick up the pieces.

There are some goods that the market on its own will undersupply. These include public goods, the benefits of which can be enjoyed by all members of society—and among these are certain key innovations.

Efficient markets can still produce socially unacceptable outcomes. Some individuals may get so little income that they cannot survive. In competitive markets, wages are determined by the intersection of demand and supply, and there is nothing that says that the “equilibrium” wage is a living wage. Governments routinely try to “correct” the market distribution of income. Furthermore, there is nothing about markets to ensure that they are humane, in any sense of the term. Market participants may not hesitate to take advantage of their current strength—or other market participants’ current weaknesses—in any way that they can. The government can’t prevent every form of exploitation, but it can reduce the scope: that is the reason why most governments of advanced industrial countries around the world have adopted and enforce usury laws (laws limiting the interest that can be paid) and laws setting minimum wages and maximum hours, setting basic health and safety conditions for work, and striving to limit predatory lending.

Without good information markets can’t work well, and an important part of providing good information is having good accounting systems so that market participants can interpret—in a meaningful way—the data that is being provided. No accounting system is perfect, which is why accounting has given rise to such controversy in this crisis. Cooking the books to hide from investors what is going on—exaggerating income—should be as illegal as doing so from tax authorities (understating income). None of the “off-balance sheet” magic tricks of the past should be allowed. Finally, transparency, if it is to be meaningful, has to be comprehensive. If some channels are allowed to remain in the dark, that’s where all the nefarious activities will go. Vast portions of global capital flow through secrecy havens like the Cayman Islands—it hasn’t become a two-trillion-dollar banking center because the weather there is particularly conducive to banking. These are deliberately created “ loopholes ” in the global regulatory system to facilitate money laundering, tax evasion, regulatory evasion, and other illicit activities.