The Role of Government and the free Market

The coronavirus pandemic has been an unprecedented event in recent world history. Nations and their rulers have taken public policy measures not seen since World War II to combat the health, social, political, and economic havoc that has resulted from the pandemic. These measures range from isolating people with the virus, discriminating between vaccinated and unvaccinated people, closing businesses and public spaces, and increasing public spending.

The government’s actions have brought to the forefront of public policy debates about its role concerning the individual, society, and the economy. The latter is of paramount importance because our economic system is one based on the free market and the pandemic has focused intellectual thinking and debate on the role of government.

As an actor in the free market, the government must have a role limited to the rule of law, constitutional powers or responsibilities, and areas where it is burdensome for the free market to provide services. To be able to analyze this role, we must first examine how the government acts within the market.

For many of us who believe in freedom and free markets as the foundations for a free and healthy society, to speak of the State as an actor in the free market represents a threat to that aspiration; however, the State is a fundamental part and the most powerful actor within the free market and its actions have an effect on supply and demand, the other actors and their actions within the market. The State acts in three diverse ways in the free market: as a regulator, as a buyer and as a benefactor.

The State as Regulator

Government as the main regulator within the free market can be understood if we see the state as a civil association. In this association, individuals consent to rules of conduct that permit coexistence and cooperation among themselves to pursue their own conceptions of the good life. The role of government in this association is to enforce the laws to which the individual has consented. These established rules are legitimate and generate a legal obligation to follow them, which are the basis of what we know as the rule of law.

This rule of law allows the government to act as a regulator in the free market. The government participates in the free market as a regulator so that individuals, in turn, can participate in the market freely and in coexistence. An example of the State as regulator is its role in the preservation and enforcement of contracts; without such legal security, individuals would not enter into contractual relationships with each other, for fear of not having legal relief in any breach of contract.

The government has always acted as a regulator, which has important effects on the free market. The first effect is that it creates the legal field that will govern the transactions that occur within the market. The State establishes the rules of the game, and it is by means of these rules that all the other actors perform their tasks within the market.

Second, government regulations govern which actors can act and how they act in the market. Antitrust laws are an example of how the State seeks to ensure that the number of players in the market is considerable and not restricted to a few. In addition, regulations or the possibility of regulations influence the economic and strategic plans of market players.

The last effect of the regulatory state is on supply and demand in the free market. Government organizations such as the U.S. Food and Drug Administration regulate which products are valid to enter the market, thus affecting the supply to which the consumer has access to the free market. Likewise, the Department of Consumer Affairs affects demand, for example, when it monitors or freezes the prices of products in the economy.

The State as a Buyer

As a civil association, the government has to use tax revenues to carry out its responsibilities. These responsibilities are enumerated in constitutions or bills of rights and others arise within the realm of politics. These responsibilities require the government to impose taxes and, more relevant to the market, to acquire resources with public money.

The buyer state is thus an actor that affects the free market through its spending patterns to fulfill its responsibilities. An example that is extensively used to explain the role of the buying state is that of the creator and sustainer of the national defense market. This depends primarily on the government’s responsibility for national defense; consequently, business in this market depends on research, development, and production contracts that the State enters into with defense companies.

The buyer state has two primary free market effects; the first effect is one of supply and demand; the feeding of students in public schools illustrates this effect. The responsibility to provide meals to students in school creates a demand in the free market. The government satisfies that demand by purchasing products. In addition, there is a public policy to purchase primarily products made in Puerto Rico; this means that it also creates the supply that will be used to meet this demand.

The other effect of the State as a buyer is that it determines which actor enters and continues in the market. The defense market is an example of the State determining which defense companies enter the market and, by awarding contracts, which remain in it; this is evidence of the importance of the State’s purchasing power for businesses and their strategies within the lines of business they pursue.

The Welfare State

The government’s responsibilities require it to acquire personnel and materials to carry them out, but the State’s investment in fulfilling its responsibilities also includes granting monetary benefits to citizens. This is what we know as the welfare state and what we call the redistribution of wealth.

The welfare state is best illustrated as a social and economic safety net for citizens, especially the disadvantaged. This safety net provides citizens with mainly monetary benefits for food, housing, health, etc. Citizens use the benefits for their particular needs, which results in a monetary injection into the market.

The most prevalent example in Puerto Rico is the Nutrition Assistance Program (NAP) better known as the food stamps. NAP provides nutrition to a substantial portion of the Island’s population, but it is also an example of corporate handout; this is because many small businesses and large chain supermarkets depend on the NAP card population for their sales volume and livelihood.

This example illustrates the effects of the welfare state on the free market. First, it influences how many businesses operate in the market and how they do so. Many businesses and individuals, such as supermarkets and property owners depend on the use of these monetary benefits by citizens. In addition, many market participants design their business and investment strategies based on the amounts of money and benefits provided by the welfare state.

Consequently, the welfare state also influences supply and demand in the economy. The monetary benefits provided to citizens satisfy the demand that exists in the areas where the benefit can be used. In addition, individuals and businesses see in these benefits opportunities for profit and wealth creation; therefore, we see an increase in the supply available for beneficiaries to use these benefits.

These three diverse ways of how the State acts in the free market reveal that there is no market in which the State does not intervene, and this is not the focus of the political debate. The debate centers on what is the theoretical framework for determining the roles of government in the free market. The political, economic, and public policy perspectives on this issue are diverse, and the thinking of F. A. Hayek shows the way forward to delineate these functions, as we will see in the next article on this topic.