The Most Significant Market Failure

I do not like the term “market failure” in general since the underpinnings of virtually everything that is labeled as a market failure (e.g., monopoly) are really institutional problems created by government. David Friedman pointed out to me that there is one serious market failure, however: markets have failed to prevent the concentration of coercive power and the creation of states. Indeed, the state might be inevitable, as Randy Holcombe suggests, so I agree with him that a very important question for libertarians has to be, how can we make it as small as possible, in order to limit its intrusions and disruptions? That still does not mean that libertarians should not try to find ways to make it go away, however. Entrepreneurs are continually finding ways to get around state-made impediments. Perhaps someday someone will discover a way to eliminate the state altogether. I am not the kind of institutional entrepreneur that is likely to discover this ultimate innovation, however. Therefore, I see my agenda as something quite different. My goal, as a libertarian of the anarcho-capitalist persuasion, is to try to undermine the myths about the state. One way to do this is to show, both theoretically and empirically, that the kinds of things the state allegedly MUST do can be done by non-state institutions, and furthermore, that the state actually does relatively badly those things that it is allegedly suppose to do. Indeed, the typical “market failure” justifications for the state are, as Randy has explained elsewhere, ex post rationalizations for state actions that developed for very different reasons. My own focus has largely been in the area of law.

I cannot explain, in a relatively short blog post, the intricate mechanisms and processes that actually provide rules and order, or how the state tends to undermine and interfere with those mechanisms and processes. Instead, let me propose a simple (indeed, simplistic, since the true relationship is much more complex, and would require many pages to describe) alternative explanation for the correlation between per-capita GDP and government share of GDP that Dani Rodrik cites in support of his contention that “Prosperity is achieved when states are effective in setting and enforcing the rules of the game, not when they wither away.” After doing this, I will offer a very brief discussion to suggest how my explanation is consistent with both the data and history.

Assume that the state is a parasite living off its host — the economy. When the economy is small the state cannot extract much from it without destroying it. Therefore, the state must also be very small. If the economy grows and becomes stronger, the parasite also is able to grow. Indeed, the parasite can grow faster than the host once the host achieves a size that allows it to produce a surplus. Note that this simple “model” predicts the statistical relationship that Dani cites as evidence that the state and the economy are complements. Certainly, a growing economy can provide a surplus that can be extracted through the use of coercive power, allowing the state grows, but it does not follow that a growing state is the reason the economy grows. In fact, the economy could grow faster if the state could be more effectively controlled (e.g., as Randy suggests), or if the parasite could be eliminated all together, as I suggested. As I indicated above, this is a very simplistic story. We could add an assumption that the state parasite actually serves a desirable function, for instance, in that it may protect its host from even more deadly parasites (other states), and there is clearly something to this, at least in some cases. The point is, however, that the correlation between the size of the economy and the size of the state’s share of the economy does not prove that a relatively large state causes a relatively large the economy.

Now let’s consider this simplistic version of the state-economy relationship with history. Dani quotes Pete Leeson’s remark that “Most of the world, for most of its history, has existed without effective governments.” Then he contends, “Indeed. That is why most of the world for most of its history has remained poor, with lives that are nasty, brutish, and short.”

The implication is that the rise of the state was necessary to allow the world to escape the Hobbesian jungle. But this ignores the fact that life under most states, both historically and today, is nasty, brutish and short. Those of us who are lucky enough to live in North America have been sheltered from the reality of the parasitic state to a substantial degree for several reasons (e.g., until recently North Americans were free to move out of the states control into the frontier which remained anarchistic so the state could not effectively prevent exit; we have not faced the same degree of threats by other parasites [e.g., states or would-be-states] that most of the world has had to deal with, being surrounded by large oceans, so our state has not had the same kinds of excuses to expand, being surrounded by large oceans; after the rebellion against the state of England the rebels created constraints on their own parasite that did not exist anywhere else and while many of those constraints have broken down, it took a long time for that to happen).

Furthermore, this Hobbesian argument ignores that fact that the areas of the world that have enjoyed the greatest economic development and accumulated the greatest amount of wealth are those parts where, after centuries of warfare and revolution, the relevant states have been sufficiently constrained for long enough to allow the economic host to begin to flourish. This is the idea behind the economic freedom relationship with economic well being that Pete Leeson discusses in his blog post. Unfortunately, once an economy becomes strong, the opportunity costs of rebellion and other efforts to constrain the state become higher and the temptation to use the state as an internal wealth transfer mechanism get stronger, so resistance to the state can decline. When that happens, the state grows faster, and the economy can collapse under its weight unless the state is rolled back (New Zealand is a recent example that comes to mind).

Thus, while I agree with Randy that anarchy may not be a stable equilibrium, I would also stress that states do not create stable equilibria either. True, the United States has survived for well over two centuries now, but only by engaging in a very bloody civil war, many international wars and “police actions” and so on. This brings me to my final point in this blog comment (I will submit another one shortly to address Dani’s contention that states are necessary because voluntary associations are inefficiently small): one that has been best explained by Robert Higgs, I think.

My simple story about the state as a parasite clearly is an incomplete story, as states tend to grow as a result of crisis. The state thrives on threats to the host, real or perceived, because that justifies its growth. States are institutions of warfare (predation, plunder, protection rackets). As the technology and institutions of war change, state boundaries change, bringing changes in the internal institutions of the state. Those states that are successful in warfare grow as Higgs demonstrates. Under these conditions, Randy’s argument against trying to eliminate the state seems to turn back on itself. While one might imagine in theory that a constitutionally constrained state could be created that might be stable, states themselves do not exist in a stable equilibrium. In a world divided into states, a stable equilibrium appears to be at least as unlikely as a stable ordered anarchy.

Also from This Issue

Lead Essay

  • Anarchy Unbound, or: Why Self-Governance Works Better than You Think by Peter T. Leeson

    Everybody seems to know we need government … But pirates didn’t! How did they manage without the state? In this issue’s thought-provoking lead essay, Peter T. Leeson, the BB&T Professor for the Study of Capitalism at George Mason University, explores what pirate “constitutions,” credit institutions among 19th century African bandit traders, and the well-being of Somalians after the collapse of the Somalian state have to tell us about the possibility of practical anarchy. It works better than you think, Leeson concludes. “As long as there are unrealized gains to realize, people will find ways to realize them” – state or no state.

Response Essays

  • Anarchy Bound: Why Self-Government Is Less Widespread than It Should Be by Bruce L. Benson

    Bruce L. Benson, author of The Enterprise of Law: Justice Without the State, argues Peter Leeson’s defense of anarchy is too moderate. Governments in developed nations, Benson maintains, are not better than ordered anarchy. Drawing on Franz Oppenheimer’s classic account of the state as a protection racket, Benson argues that the state only seems necessary because it offers “solutions” to problems the state itself creates. Benson claims that even well-constrained states are essentially parasitic, leading him to conclude that “even when a relatively ‘good’ government exists, there still is way too much government and not nearly enough anarchy.”

  • The Limits of Self-Enforcing Agreements by Dani Rodrik

    Harvard economist Dani Rodrik is willing to accept a number of steps in Peter Leeson’s argument for anarchy, “but [Leeson’s] bottom line … represents a huge leap of faith.” Citing the work of several important thinkers, Rodrik argues that “the problem with self-enforcing agreements is that they do not scale up.” Both theory and data show that complex, well-functioning social and economic systems require the enforcement of rules by government. “Those societies in which markets work best are the ones where the reach of the state is longer, not shorter.”

  • Anarchy From a Policy Perspective by Randall G. Holcombe

    Florida State University economist Randall Holcombe argues that even if Leeson is right about anarchy, it doesn’t much matter. “Regardless of its merits,” Holcombe writes, “anarchy has no prospect as an actual policy option.” The bottom line is that government is popular in developed nations. Furthermore, anarchy may not be a “stable equilibrium,” in which case it might “coalesce into governments … potentially more oppressive and more destructive than those we see in prosperous areas today.” According to Holcombe, if we’re going to get a government anyway, the best approach to policy is to “make it smaller, less intrusive, and more libertarian,” not to make it go away.

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