Government Control and Free Market: Need for a Complimentary Relationship

Takamitsu SAWA (Professor, Kyoto University)

Government and Private Sector: The Controversy

It is clear, without the need to refer to Hegel's dialectics, that the very existence of conflict and contradiction is the driving force for development. In a world without conflict or contradiction, Status Quo will be the most likely choice. Market vs. Government, Central vs. Local Government, Rich vs. Poor, Present Generation vs Future Generation, Full timers vs. Part timers--axes of conflict form an intricate fabric.

Focusing on the economy, the driving force for "development" is reformation of the economic system and technological innovation. So called "Structural Reform" is a description of the former approach. Structure means mechanism, and altering the present mechanism is "Structural Reform". Mr. Okuda, Chairman of the Japan Federation of Economic Organizations, expressed this very eloquently by saying, "Structure in an automobile could be considered as the body and better performance can only be achieved by also reforming the engine, thus economy will grow only when structural reform is accompanied by technological innovation."

Whenever economic reform is debated, all of the conflicts mentioned above become highlighted. But the most notable is how government and private sector roles should be allocated. The current structural reform directed by Prime Minister Junichiro Koizumi incorporate a creed to transfer funds and authority from the government to the private sector. The origin of such an ideology can be traced back to the policies adopted by Prime Minister Margaret Thatcher of Great Britain who took office in 1979, then dubbed Thatcherism. The aim of Thatcherism was to promote privatization of crown companies to make the overgrown government into a "small government."

After the first energy crisis, the economic growth rate of developed countries almost halved. As a consequence, developed countries began to suffer financial deficits, while as the tax income ceased to grow, expenditures such as welfare were difficult to shave. Thus, it became necessary to privatize crown companies to gain profit from the sale of equities, to reduce the level of public services, and to privatize or charge fees for certain public services.

Recently people have started to blame John Maynard Keynes for fostering "Big Government", and some are claiming that "Keynes is dead". The essence of Keynesian economics could be summarized as follows.

The market is "incomplete". There is price flexibility as can be illustrated in nominal wages that have downward rigidity as well as frictions in the market, and the predictions of individual entities are incomplete. Therefore, there remains imbalance in demand and supply exemplified by unemployment, and insecurity such as business cycles. To avoid imbalance and insecurity, market intervention by government utilizing fiscal and monetary policies is indispensable.

The Market-based innovation that Thatcher, Reagan, and Japan's Prime Minister Nakasone carried out in their countries in the 80s aimed at making the market as perfect as possible, thereby rejecting Keynes' theory. The logic was that if the market were perfect a small government would be accomplished, contrary to Keynes' assertion that government interventions are indispensable because the market is incomplete.

Necessity of policies to avoid "market violence"

Our experiences of the 90s taught us, however, that the closer the market comes to perfection, the higher becomes the risk of market forces to behave violently. Following are examples of market violence: (1) Expansion of gaps in incomes of individuals and countries; (2) Deterioration of public healthcare and education; (3) Sharp rise and fall of asset values; (4) Currency crises in East Asian countries caused by massive and too frequent transfer of short-term funds; (5) Winner taking everything as a result of a free competitive market, typically seen in the case of Microsoft Windows; and (6) Accounting fraud as seen in Enron and Worldcom incidents.

The believers of market principles who embrace Thatcherism do not necessarily find a problem in the market becoming violent. They see the widening of gaps in individual incomes as desirable. They treat the proposition that "the source of incentive to work is the gap in income", which has never been proven or demonstrated, as if it is an absolute truth. They explain the gaps in national wealth as cause by poor countries refusing liberalization of trade and capital, and argue that through liberalization, wealth will "trickle down" to poor countries. We should not overlook, however, the fact that the widening of gaps in national economies was one cause of the September 11 incident.

The market believers would not stop preaching the effect of privatization, including of healthcare and education. From April 2004, National universities will be converted to corporations. Subsidies for improvement of facilities in public schools have been decreasing over recent years. Prime Minister Koizumi is very eager to privatize education and research institutions as if he were "Japan's Thatcher". Bear in mind, however, that if devastation of public education should be brought about as seen in Thatcher's UK, it would lead to undesirable side-effects such as deterioration of human resources, waste of capable personnel, and high unemployment due to declining academic performance of 18 year-olds.

In the 90s, the United Stated under the Clinton Administration was taking on the role of governing the global market in order to secure low risk and high return investment for US investors. This is what helped East Asian countries from recovering from the currency crisis. There is no guarantee that the Bush Administration, which advocates unilateralism, would continue to play the same role. A currency crisis in a developing country developing into International financial meltdown has become an undeniable possibility.

Legal restrictions by the government are necessary to prevent winner-take-all results and accounting fraud. Both are diseases that accompany the transition into postindustrial society. Winner-take-all has become a norm in the software industry as a product tends to become a de facto standard. Accounting fraud could become rampant in the postindustrial society in which soft industries such as finance, communication, information, and liberalized electric power, become major players of economy, where distribution of goods is not physically visible.

Abandon the dichotomy between market and government.

It is the government's role to appropriately manage such defects that emerge in the postindustrial society. The market and the government are not congenitally in a conflicting relationship and should seek a complementary relationship. Keynes cited the necessity to sort what should and what should not be done by the government. Perhaps "what should not be done" can be classified further into two categories.

One is the area where the private sector can exceed the public sector in terms of efficiency. Railroads, telephone lines, and electricity distribution are in this category. In all developed countries, these businesses were started by public entities because private companies lack sufficient capital to initially lay a network of railroads, phone lines, or electric feeder lines. Once the network is in place, however, it is desirable to privatize the operation and liberalize the business to encourage new entries. Recent discussions of privatization of Highway Corporations and operations of postal services should be pursued along this line of thought.

Another category is those businesses that are too small for the government to attend. Preservation of environment, welfare, school education, and universities are businesses too small for the national government to run. They should be left for local authorities and non-profit organizations (NPO) to tackle. For example, rather than privatize national universities, it is more desirable to hand them over to local governments for them to exhibit their creativity.

Extreme believers of the market principle insist that the government should only take care of firefighting, police, and National Defense. That is, there should be no restrictions whatsoever on market activities. But we should have learned from our experiences in the 90s that a pure market principle society is an unattainable utopia, like an idealized communist society.

We must abandon the dichotomy between market and government, and build a healthy and complementary relationship between them. To preserve a fair society, the government should not hesitate from market intervention. A market principle society that blindly pursues only efficiency will not be a comfortable place to live for most people. It is a core responsibility of a democratic government to build a society where conflicts are moderated and people can live in comfort.

(The original Japanese article appeared in the January 22, 2004 issue of Nihon Keizai Shimbun.)