Economists have been systematically biased in our approach to public policy, focusing on a set of results of economic theory – on the power of markets – while ignoring that same theory about the conditions under which markets fail. Citizens have relevant information about these market failures that economists do not. Just as markets were described by Adam Smith as institutions capable of aggregating economic information dispersed among millions of actors, information on the effectiveness of public policies for the public good is aggregated by the political institutions of the political market. . Politics provides a market test for public policies that economists must learn from.

I came to these conclusions while working on an article recently published in the Oxford Encyclopedia of Economics and Finance on the political economy of reform. As part of international policy dialogue and advice to governments, reforms generally involve liberalizing markets, relaxing regulations and reducing subsidies. The poor performance of public agencies in the provision of services and in the management of enterprises is used to advocate for privatization. Utilities whose revenues do not cover operating costs, and which cannot borrow in financial markets for long-term investments, are the evidence used to argue for increased tariffs and corporatization. utilities. Politics is seen as an obstacle to getting that sound, technical advice implemented as policy.

Politics provides a market test for public policies that economists must learn from.

The technical solutions of privatization and liberalization proposed by economists to the obvious problems of public enterprises, utilities and other public agencies can ultimately be attributed to the so-called fundamental theorem of welfare economics. Simply put, the theorem says that competitive forces in markets will produce better incentives and better results than state control. Yet by focusing on one powerful result, economists have ignored the conditions under which the result holds: the need for state institutions to establish and protect property rights and facilitate trust in contracts. In addition, economists have paid too little attention to arguments in our own discipline for the role of public policy in addressing market failures and ethical concerns related to inequality. In the classic graduate textbook of public economics, Jean-Jacques Laffont concludes that the economist can only define optimal policies from the point of view of a particular function of social welfare. Since social protection functions are defined in political markets, technique is political.

What is the social protection function that underlies the traditional policy prescriptions described as the “Washington Consensus”, or some version of it? Sustained economic growth that increases the size of the proverbial pie is at the heart of this function. Policy reforms aimed at promoting growth are seen as supporting the privatization of public enterprises; deregulation of “over-regulated” industries; financial liberalization (reduction of state ownership of banks, for example); trade liberalization and support for exchange rate policies (to facilitate a globally connected market economy); tax reforms (to ensure debt sustainability); and the shifting of public spending from “meritless” subsidies (ie, it seems, subsidized consumption of energy, water, etc.) to health and basic education. for poor households. But how do policy advisers know what is “over-regulated,” what meritorious subsidies are versus unfounded subsidies? By running growth regressions and simulations for macroeconomic policies and randomized controlled trials for macroeconomic policies? The more policy prescriptions are pinned on regressions and growth forecasts, and randomized controlled trials of small interventions, the farther away they are from economics, let alone politics.

Citizens of poor countries – where international organizations exert significant influence on policy – have long complained about pro-market reforms that are not accompanied by sufficient consideration of market failures and inequalities. The response of international organizations has been to design communication strategies to help citizens understand the economic arguments. Now citizens are also on the streets in rich countries, and calls are being made to reform capitalism and restore confidence in government. The time seems to have come to move beyond the market-versus-state debates of the past decades and find common ground using the same logic of economic theory that called for markets to advocate for strengthening state institutions.

The reform needs of the 21st century are institutional, to enable governments to support markets where they work and intervene when they do not.

It is not useful to approach the political economy of reform by identifying the winners and losers of piecemeal liberalization reforms (delete this subsidy, privatize this utility), then look for credible ways to compensate the losers or persuade them not to block reform. This approach has not been proven. Instead, political economy research should be used by policy makers and their advisers to pursue institutional reforms.

There is a growing economic theory and supporting evidence on trust and institutions. The old problems of the principal agent in the enterprise or society are developing in the context of public sector organizations. State institutions can be viewed as complex principal-agent issues that have multiple balances, each underpinned by a different set of beliefs or expectations about how others behave. This is the theory that could help find solutions to the urgent problems of the 21^st century, such as managing scarce water resources, adapting and preventing further catastrophic climate change, preventing the spread of disease in a globalized world, and reducing violent conflict and forced displacement of people. These are issues where markets do not exist or fail. A general prescription to push markets as solutions – as some see the case of water privatization, for example – is neither helpful to governments nor true to the economy.

Problems such as water, climate, disease, conflict and refugees have technical aspects unique to each other, but can also be viewed through a single lens – as issues involving millions of actors with beliefs. and different preferences, acting in uncoordinated and often costly ways. Economics is unique among the social sciences in that it has specialized in examining the outcomes and “equilibrium” dynamics of these types of interactions. We need more economics to understand how institutions can be designed to solve the problems of externalities, public goods and credible redistribution that restores trust in markets and government. The reform needs of the 21st century are institutional, to enable governments to support markets where they work and intervene when they do not. The new market that calls for economic analysis is politics.