In the field of welfare economics, markets, through the ‘price mechanism’, are thought to ensure that goods (and services) that are desired, referred to as ‘private goods’, are produced in adequate quantities. And, state-sponsored transfers of wealth from the rich to the poor, enable equal participation in these markets. There is,   however, a class of goods that cannot be produced by this mechanism but are essential for its successful operation. This is because these ‘non-private’ or ‘public goods’, such as ‘good regulation’, ‘national defense services’, and ‘being a good citizen’, all have the features, in varying degrees, that everybody automatically benefits from their presence and their ‘consumption’ does not reduce their availability.   There is general agreement, therefore, that enabling wealth transfers and the creation of ‘public goods’ through tax financing, represents an essential role for a welfare-maximizing government.

Successful operation of the ‘price mechanism’ also requires the presence of ‘well-behaved’ and ‘well-informed’ consumers. And, even where the government is paying for the creation of ‘public goods’, the measurability of the resultant outputs is essential.  However, it is not clear that, for example, when it comes to preventive health care, consumers are necessarily ‘well-behaved’ or ‘how good a citizen a child is becoming’ is measurable with the required level of precision.  These are all referred to as ‘market-failures’, and also require government intervention in order to maximize citizen welfare.

Using a two-part characterization, we offer an analytical approach to help frame the choices for governments regarding the various roles they can play.  The framework suggests that goods in which the ‘price-mechanism’ is effective (‘low public good characteristics’) need not be paid-for by the government. However, the approach towards them would need to be calibrated depending on the levels of ‘market-failure’.  Where ‘market failures’ abound, government would need to take a more active approach in directing the provision of the goods with, where necessary, even using taxation like tools to compel ‘poorly behaved’ consumes to pay for the service.  Where ‘market failures’ are few, as in the case for most goods, light touch regulation and ensuring competitive markets would be all that is necessary to produce welfare maximization. Where the ‘price-mechanism’ is ineffective but where measurability is high, such as in the case of spraying of insecticides, government-provision would not be needed. Here government could pay markets to provide. In the very small number of areas where the ‘price-mechanism’ is ineffective and measurability is low, as in the case of primary education, the government would need to both pay and provide, taking great care to address the challenges associated with provision by the public sector.

Historically many countries started with providing only the most basic of ‘public goods’, and, only as the need arose, slowly expanded into other areas. Today, most countries pay the private sector to provide ‘public goods’, while state provision is limited to areas such as law and order, national defense, and primary education, where only the government is best suited to provide the service. Curative healthcare, despite being a ‘private good’, suffers from very high levels of ‘market-failure’ and most governments intervene aggressively to direct the evolution of the health system.  Most require citizens to contribute through additional taxes or compulsory insurance, and then use these pooled funds to purchase services on their behalf from the private sector, while exercising strong control over all aspects of the system.

Given India’s starting point, where the state was positioned as the primary provider of most goods and services, in many sectors the role being played currently by the government is at considerable variance from what the above framework recommends. This misalignment may be one of the important factors holding back the faster growth and development of the Indian economy but the choice of the best path towards full alignment with the framework is not an obvious one or, even where obvious, an easy one to take.  A gradual and much-needed alignment is however starting to become visible. In ministries such as Civil Aviation, where the ‘good’ is essentially ‘private’ in nature and ‘market-failures’ are few, the transition to an entirely optimal, as was most recently demonstrated by the UDAN program,  ‘regulate’ and ‘direct’ approach, is clearly apparent.  In other ministries and areas of the economy, the process of transition is much more gradual or in some, has not yet begun. 

This article was originally published in the Hindustan Times on June 6, 2018.