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8.4 How Politics and Markets Intersect

PLEASE NOTE: This book is currently in draft form; material is not final.

Learning Objectives

  1. Understand arguments for and against government intervention in markets.
  2. Understand why businesses seek protection from competition through government action.

All of this leaves us with a couple of things to think about. First, to what extent should government intervene in the economy? Second, presuming we intend to continue to use markets to determine what to produce, etc., how can we keep government from limiting competition when it does intervene? This second question may seem less obvious, but what history tells us is that markets seek intervention nearly as often as government seeks to intervene.

The Case for Leaving Markets Alone

Some people say that, left alone, the market will eventually sort all of its problems out. The public choiceA school of economic thought that says that government officials are inherently inefficient at economic decision making, because they are too focused on re-election. It also says that government spending is generally too high. school of thought points out that government doesn’t always make good choices, and that people in general are a better judge of what to do with their money. Conservatives, public choice advocates, as well as libertarians, think government should be smaller, do less, tax less, and spend less money. Libertarians don’t see much of a role for government except for national defense and police protection.

Part of the argument here is that people will do what they learn to do, so if you bail them out from stupid decisions, they’ll keep making stupid decisions because there’s no consequence to their actions. So people who, say, don’t save for retirement, will just have to suffer. Others, observing that suffering, will be motivated to save more and sooner.

Public choice theory in particular says that government’s economic decisions are mostly aimed at making things better for government officials, rather than for society as a whole, such as helping officials get re-elected. A fair amount of research has shown that presidents, for example, take steps to pump up the economy just before elections (it also shows that they don’t really have much success at moving the economy forward that quickly). And the steps that government might take—raising government spending to boost demand—might lead to inflation and higher budget deficits down the road.

However government intervenes, whether by regulation, taxation or subsidies, makes markets less efficient—it raises costs, which fall on businesses and consumers. Government is particularly bad at picking winners and losers—60 years of communism showed us just how bad government can be at producing goods and services. Taken to its extreme, government control of the economy limits innovation, raises prices or leaves goods in short supply, and limits incentives for people to work harder.

Why aren’t governments as efficient as markets? Governments simply respond to different signals than do markets. Whereas markets operate largely on the basis of supply and demand, governments by nature have to care about who has a job and whether people have enough to eat. That makes them egalitarian, but it doesn’t always make them very efficient. During the 1980s oil boom years in Alaska, state government, hoping to diversify the state’s energy-dependent economy, spent a lot of money on small business development projects. That included, for example, an entrepreneur who was trying to develop a dog-powered clothes dryer. The state apparently spent so much money (before oil prices tumbled in the late 1980s) that a popular bumper sticker in Anchorage read “Please, God, just once more. We won’t piss it away this time.”

As usual, there’s some truth to all of this. Many people will probably be more careful about things if government isn’t there to bail them out. Moreover, using government to plan economic outcomes, including production and pricing decisions, has a very poor track record.

The Case for Intervention

Government’s decisions are far from perfect, and probably never will be perfect for everybody. And that’s part of the problem with arguing against government interventionGovernment taking a role in helping to determine economic outcomes.. Few decisions, including non-decisions, leave everybody better off. And the people who didn’t think to save for retirement have a cost to society as well as to themselves. For public choice theory to work, people have to be rational—always making the right decision and acting in their own best interests. That’s a big assumption, and you only have to look around (or in the mirror) to know that we’re all rational only part of the time.

And while conservatives may argue that the market will indeed sort things out in the long run, waiting for that to happen has costs as well, in terms of human misery. Odds are, your life isn’t better if your neighbor’s is worse, or we wouldn’t find that the poorer parts of most places on earth have higher rates of crime, drug and alcohol abuse, and people who just aren’t living happy lives. You can, for example, pretty much correlate K–12 test scores with income levels; children from wealthier neighborhoods do better in school.

The people who most famously wrote in favor of the greatest reliance on unfettered markets—Ludwig von Mises, Friedrich Hayek, Ayn Rand and Milton Friedman, for example—wrote at a time when the alternative to a market economy appeared to be communism. Communism didn’t work that well, although, frankly, its political problems (the unchecked power of the state) probably outweighed its economic problems (substandard goods in short supply, and a lack of economic freedom). But is an unfettered market or an all-powerful state the only options available? Perhaps not.

The kind of minimalist government that some folks still call for was also tried, in the United States in the 1800s. Government then, particularly in the post-Civil War era, didn’t do much with regard to the economy. There were no child labor laws, no minimum wage, no workplace safety standards, no overtime, no unemployment insurance, no bank deposit insurance—nothing except the market. The courts largely barred either states or the federal government from regulating anything to do with the economy. As a consequence, there was no social safety net, and if the economy went south, people suffered. In the Depression of 1893, some people simply starved to death. When I end up arguing with libertarian students, which I do, I usually say “we tried a libertarian government, and it didn’t work so well.”

So let’s further consider the case for intervention. The argument for the government taking an active role in the economy has a number of reasons behind it. First, the playing field isn’t very even in a capitalist economy. Everybody doesn’t start from the same point on the track. If you don’t have any money or any opportunity to begin with, such freedom of choice is small consolation. And completely unregulated markets tend to lead to great concentrations of wealth in very few hands, which often means some citizens become much more equal than others. If you live in a state with initiatives, you have already seen wealthy interest groups use the initiative process to get state law changed to benefit them. Consequently, some people favor at least some limited government intervention to address market failures and externalities.

Governments can intervene in market failures through taxes to penalize unwanted activities; through subsidies (such as tax credits) to encourage activity such as pollution abatement; through price regulation; and through regulation of business practices such as safety regulations, anti-pollution laws and anti-trust enforcement. Each of these has costs and benefits, and there will always be argument as to which way the scales tip on every government action.

The argument for doing this is that the market by itself won’t sort out pollution, poverty and the distribution of power. Markets by themselves don’t account for the cost of environmental damage, traffic, rising home prices and loss of open space. They tend to concentrate wealth and power, posing challenges to effectively functioning democratic institutions. But what about government’s storied inability to make good decisions? One might argue that we shouldn’t let the perfect be the enemy of the good. Government intervention won’t ever be perfect, but if it can be better than non-intervention, its lack of perfection isn’t a reason not to intervene.

To my mind, unfettered markets make no more sense than an unfettered state. Again, you’ll have to decide what you think this is right. Do the benefits of government involvement outweigh the costs, or do the costs overwhelm the benefits? You may feel differently than I do, and that’s OK. You get to make up your own mind on this, and you should understand that there are rational arguments to be made both for intervention and for not intervening. Everything the government does or doesn’t do with regard to the economy imposes costs and bestows benefits upon different groups of people in every country. My hope is that whatever you decide, you will have some idea about why you believe that philosophy, and that you understand what it means.

Government to the Rescue?

As much as some business people (and many conservatives) like to complain about government meddling in the economy, a lot of that meddling comes at the request of business. Adam Smith, the father of modern capitalism, recognized this in one of the more overlooked sections of The Wealth of Nations: Left to themselves, businesses will try to use government to rig markets and limit competition. Markets aren’t immune from politics, and a lot of politics is about economics. So much, in fact, that in my mind, it looks like this:

My Second Law of Political Economy: Politics is economic competition, carried on by other means.

How is this true? Well, most pieces of legislation passed by national and local legislatures have some economic impact. Some largely social/moral issues—such as abortion or gay marriage—aren’t really economic issues, but everything dealing with taxes, spending, regulation, monetary policy and economic development has a big economic impact. Moreover, in most nations, firms in every sector of the economy actively seek legislation that helps them and hurts competitors. Such laws are a form of regulationGovernment intervention that prescribes economic outcomes, or requires, limits or prohibits some kinds of economic behavior and/or activity.. For example, licensing requirements probably do protect consumers against bad business practices, but they also restrict the supply of doctors and lawyers and thereby raise the price of those services. This leads to:

My Fourth Law of Political Economy: Everyone favors competition, except when it applies to them.Since you might be wondering, the First Law of Political Economy is the decision will be made in the direction of the greatest value. Usually, that’s money. So, if we look at lots of government decisions, we tend to find that they make those decisions with an eye to what will generate or protect the most wealth. Particularly at the local level, for example, cities are more likely to block development of apartment complexes because they will drive down the value of single-family homes in the same neighborhood. And the homeowners vote more often than the renters do. If you think back to our discussion of interest groups, you may remember the Fourth Law: Economic interests will be politically dominant to the extent that they are economically dominant. So, firms that make a lot of money and employ a lot of people tend to have more political clout than those who don’t. (See below.) The Fifth Law is: All life is politics. In other words, wherever you go, it’s who you know that matters.

For example, a few years back more than a dozen state attorneys general joined in a “consumer” lawsuit against Microsoft, alleging anti-competitive practices. Every state had one thing in common: Each was home to one of Microsoft’s competitors. (I’ve never seen a consumer lawsuit more devoid of consumers.)

So the intersection between government and business is substantial. Economist Robert A. Leone recognized this in his Iron Law of Public Policy: Every government action creates winners and losers in the marketplace. Smart business people know this, and act accordingly. As we’ll see more clearly when we talk specifically about regulation, businesses often seek regulation to limit competition and keep prices higher than they would be without it.

Key Takeaways

  • Government intervention in the economy imposes both costs and benefits.
  • Businesses often seek government intervention to limit competition and raise prices.


  1. What are the costs and benefits of speed limits? What would be the alternative?
  2. Think of something you think government should be doing in the economy, or something you think it shouldn’t be doing. What would be the costs and benefits of that change in government policy?