Question

The neoclassical economic theory basically assumes that a free market is the best way to maximize social welfare. Political interventions in the market in the form of the instrument proposed here generally reject representatives of this direction. Market interventions must always be justified from the perspective of neoclassical economic theory.
1. What arguments can be used to justify market interventions from this perspective?
2. To what extent does this apply to the above political measure?

Answer 1

1. The Neoclassical and the Keynesian economic theory present one of the most prominent and widely discussed economic debates or contentions in the world in the 20th century. Neoclassical economics essentially justifies the establishment and prevalence of a free market based economic system which should be practically guided or operated by the free and autonomous forces or components of market demand and supply devoid of any government intervention or any external manipulation for that matter. In this context, from a perspective of economic welfare and social efficiency of any market outcome in the economy, many of the pioneers of the free-market system such as Milton Friedman or Von Hayek contend that inefficiency or economic inequity of any market outcome can be naturally rectified by the self-corrective mechanism through the interaction of various demand and supply-side aspects which had been originally envisaged by Adam Smith as the "invisible hands" and this can naturally lead to the maximization of economic welfare and market efficiency. However, on the other hand, in many circumstances, the social efficiency and economic welfare of any market outcome are eroded or hindered by several external and internal factors or attributes which evidently warrants active or indirect government interventions to restore the efficient market equilibrium or raise the economic welfare in any market.

Among these factors or attributes causing negative welfare impacts or social efficiency market outcomes, negative externalities play a typically prominent role which is often uncompensated or unrecognized under any self-corrective free market mechanism. Most commonly in Public Economics and Welfare Economics, negative externalities refer to the undesirable or negative impacts or effects of any transactional or market outcome which reduces the social efficiency in any respective market. Some of the common examples of negative externalities include industrial pollution, commercial contamination, smoking, and so on which cause immense health detriments thereby adversely impacting the entire society. Under a free-market system, the normal market equilibrium fails to account for the overall social cost of these externalities and only ascertains the private market outcome thereby affecting the social efficiency of the market outcome. In this context, government intervention becomes imperative to reduce the adverse impacts of the negative externalities and enhance the social efficiency and welfare of the market outcome either imposing externality taxes on the market entities causing the negative externalities as a form of compensation or enforcing other regulatory measures on the level of negative externalities. Hence, it essentially accounts for the social damage or cost of any negative externality and enhances the overall social efficiency of any concerned market outcome. Secondly, various kinds or market instability such as high levels of price volatility of any particular product or service, inefficiency in the factor or input markets, credit market inefficiencies, inequitable and unequal price or profit transmissions among the various agents of the product/service distribution chain, and so forth. These factors or occurrences can practically lead to unequal or inequitable distribution or allocation of the economic welfare of any market outcome which usually cannot be corrected through the free market mechanisms and hence, necessitates government interventions or measures. In this regard, some of the measures that could enhance the economic welfare of any market outcome might include price control measures, rationing system of the concerned goods and services, price support system or appropriate subsidies, etc. All of these measures are ideally intended to readjust the allocative or distributional outcomes of the economic welfare of any market outcome and ensure the maximization of economic wealth and efficiency in the market.

Thirdly, in several instances, the free market system can evidently fail to adequately fulfill the needs and demands of the consumers or buyers of certain products and services due to various adverse or inclement supply-side factors. This can reduce the economic welfare of the consumers or buyers due to allocative inefficiency or rather insufficiency in the market. Therefore, as a remedial measure, the government has to step forward and provide these goods and services to people or consumers in a socially efficient and economically optimal way, which is often not possible through free-market outcomes or any private market solution. These goods and services are universally recognized as public goods such as national defense, water and sewage services, public sanitation, transportation services, healthcare, education, and so on. Fourthly, free-market mechanisms also evidently fail to address the environmental concerns of any market outcome which is somewhat related to negative externalities. However, the environmental damage or detriments caused by the various market or economic activities such as the production/manufacturing and consumption of various goods and services thereby causing a decline in the overall social efficiency of free-market outcomes. Such concerns are very much relevant in contemporary times amidst growing contention between economic growth and environmental degradation. Hence, direct or indirect government intervention often becomes critical in addressing the environmental consequences of free-market outcomes and raising the overall social efficiency of level in the market by manipulating or controlling detrimental or undesirable economic behaviors and activities in any market.

2. In light of the justifications behind economic interventions of the government in any market setting, as discussed in part 1. of the question, it is important to consider the parameters or the practical limitations under which the government measures need to be implemented in the market and to what possible extent. First, it must be noted that the fundamental need for government intervention in any market essentially arises from market failures under the free-market economic system and all the above-mentioned contingencies practically constitute a market failure, which cannot be evidently rectified naturally by the free-market mechanisms. However, to what extent the administrative intervention/s or measure/s are justified and needed depends on the overall impact of the respective market failures and the role of free-market mechanisms in mitigating those failures. For example, it is possible to alleviate or compensate the social harm or health damage caused by industrial pollution caused by any company or firm through a private settlement or negotiation between the concerned firm/company and the affected entity or the common people residing near the factories or industrial emissions under certain specified conditions or assumptions. In this regard, the government intervention or measure to resolve the externality issue might become unnecessary depending on the effectiveness of the private solution or settlement between the concerned parties or entities. Furthermore, the comprehensive or overall welfare consequence/s of any market outcome is the main concern of any government intervention or measure. Any policy or measure to enhance the economic welfare of any particular market entity might possibly result in welfare loss of the other thereby affecting the overall social welfare distribution or balance. Therefore, in this context, the subsequent effectiveness or efficacy of any government measure or intervention in the market is also practically contingent on the net welfare trade-off due to the same. Furthermore, as absolute rationality of the respective market entities and complete market information are some of the argumentative basis behind the effectiveness of the free-market system from the Neoclassical perspective, any discrepancy in these conditions or assumptions can also determine the extent to which any government intervention or measure is justifiable, particularly in this context.