What economic role should the state promote in a market economy?

Written by: Vito Tanzi


Vito Tanzi, renowned economist and author of Termites of the State, discusses the industrialized world's economic development during the 20th century to today...


What economic role should the state promote in a market economy? This is the most important and difficult question to answer in economics. Libertarian economists would limit that role to an absolute minimum. Liberal economists would argue for a larger role; a role that would attempt to stabilize the economy and to redistribute some income and wealth, while providing protection to particular categories of citizens. Libertarians would give a lot of weight to individual liberty, while liberals would stress the promotion of social welfare.

During the Industrial Revolution, governments were generally expected to follow policies that classical economists described as laissez faire. However, some historians have argued that the laissez faire policies followed reflected not so much an explicit political choice but rather a policy forced on governments by the circumstances of the time, namely still little democratization and difficulties to raise the tax levels necessary for more expensive policies. A “bureaucratic state” capable of implementing a larger government role did not yet exist.

As countries became richer, more developed, and more urbanized, governments acquired more competence and more degrees of freedom in raising taxes and in creating the needed “bureaucratic state”. Many countries had become more democratic and voters were asking for a larger government role, which included dealing with growing needs originating from greater urbanization, new technologies, and other developments. For example, railroads, cars, and planes needed new infrastructures and new rules. Larger and more crowded cities and large industrial enterprises required regulations not needed by the citizens who had lived in sparsely populated rural areas and had been engaged mostly in agricultural and self -employed activities.

The economic role of the state grew through the 20Th Century when new public programs were created, higher taxes were collected, and new regulations were imposed on citizens and on activities. Many governments’ objectives were pursued with the major policy instruments. Governments’ actions became progressively more invasive and more complex, creating concerns that they were damaging economic efficiency.

In the 1970s strong reactions developed against the higher government role leading to the supply side revolution, and to a growing role for the market. In some countries it also led to the election of highly conservative governments. The last two decades of the 20th Centuries saw attempts by governments to scale back the earlier government expansion. By that time, both the activities of governments and those of the market had become much more complex, facilitating abuses by individuals who were well placed, better informed, less honest, or simply more greedy.

Because of technological development, globalization and other developments , many market transactions no longer reflected the transparency and the desirable characteristics that pro market economists, such as Hayek and Friedman, had attributed to them. Many market transactions came to reflect asymmetry in information. This led to abuses also facilitated by the number and complexity of spending programs, tax laws and regulations. Many governments’ activities became subject to cronyism, rent seeking, and other manipulations which, in part accompanied by policies introduced because of the supply-side revolution, made income distributions increasingly unequal. This led to questions about the fairness of market economies and to calls for populist policies. In the 1920s Keynes had argued that the then existing situation, which resembled the current one, required new knowledge and new arrangements. This is clearly the case today.

These are some of the many themes discussed in Termites of the State.

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About the Author: Vito Tanzi

Vito Tanzi, an economist of international renown, served for twenty years as Director of the Fiscal Affairs Department of the International Monetary Fund in Washington, DC with which he was affiliated for nearly three decades. Dr Tanzi is the author or editor of over 25 books, including Government Versus Markets (2011) and Public Spending in the 20...

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