Much of the debate around the big issues of our day — from energy to healthcare — hinges on whether one is “pro-market” or “pro-government,” with Cato and the Wall Street Journal op-ed page lining up on one side and any number of PIRGs on the other.

litmus test

Unfortunately, neither side appears to understand the pro-market position. Herewith, my attempt to add a bit more rigor to the debate.

So what does a market look like? At the most basic level, a market is defined by its characteristics. There are various definitions out there, but they all come down to the same basic tests:

  1. No barriers to entry
  2. No barriers to exit
  3. Price transparency (e.g., prices reflect costs)
  4. No participants can independently affect price

Meet these tests and Adam Smith’s magic starts to work, whereby the self-interest of each participant leads to social benefit for all in the form of better products and services, at lower prices. Why? Because life in a perfect market sucks! If you’re running a firm in a market as defined above, you don’t sleep well at night. New entrants keep cropping up. If you can’t stay competitive, you’re going to lose your money. Tiny changes in raw material costs have big impacts on your profits, which you are completely powerless to change. This causes you to do two things:

One, you strive to produce a better product more cheaply than your competitors. When this happens, the customer wins.

Two, you try like hell to get away from this perfect market nonsense. When this happens, the customer loses.

Indeed, any business that respects the interests of its investors (i.e., every business) works hard to tilt the playing field. They seek to establish barriers to entry (for example, by creating patent-protected intellectual property). They try to get big enough that they can affect price, and drive competition away (think Microsoft). And — most perniciously — they seek government intervention to (a) pay for some of their operating costs and (b) erect barriers to exit.

And so the coal industry asks us to pay for their environmental consequences, to make their product appear cheap (and erect barriers to cleaner alternatives). The electric industry gets guaranteed equity returns no matter how economically irresponsible its investments.

We have an easy test of whether your market is truly competitive: when you go bankrupt, who pays? If your shareholders pay, there are no barriers to exit. If the public pays, you’ve got some nice barriers to exit. The 2000 power crisis is instructive in this regard, when both Calpine and PG&E went bankrupt, both to the tune of about $16 billion. In the case of the former, it was unregulated and shareholders footed the bill. In the case of the latter, the cost was paid for by the good people of California. (Thanks, pals!) Is it any wonder we haven’t seen more entrepreneurial joie de vivre find its way into the California power market in those conditions?

So why does this matter? Because policymakers — and the Catos/WSJs of the world — frequently forget about competitive markets and instead simply assume that markets = businesses. Ergo, we see governments outsource functions on the rationale that “businesses are more efficient than government.” Says who? A no-bid contract to Halliburton to provide food and logistics support to the military is no more competitive than an assignment to an in-house government agency. The mere presence of shareholders and profits does not amount to market magic. (Indeed, absent competitive discipline, profits are just a tax on service. Profits are like happiness in that regard. You ought to have the right to pursue them — but they shouldn’t be guaranteed.)

Recognize that there is no natural constituency for the pro-market position. No business asks to make the world safer for its competitors. Nor should it — which makes it all the more critical for government to play this role. Yet it is exceptionally rare for government to do so (in no small part because legislators are lobbied hard not to).

Recognize also that this is just as true for “good” businesses as for “bad” ones. What is an RPS, after all, if not artificial price support for a few select industries? And who supports RPS legislation? Solar, wind, and small hydro businesses, of course — the ones that benefit from the barrier to competition. (They are also the biggest opposition, in my experience, to the shift to a goal-driven structure, since that would level the playing field.) My point here is not to bash an RPS, but simply to point out how pervasive this pro-business/anti-market bias is.

So here’s my request. In this political season, prod your elected (or yearning-to-be-elected) officials to get away from the narrow “business is better than government” nonsense, not because government is better, but because markets are better. And look critically at the motivations of anyone who claims otherwise.