Role Of Government Intervention In Free Market

Introduction

In a free market system, government takes the view that markets are best equipped to efficiently allocate the available resources, and allows the market forces to determine prices through the concepts of supply and demand. The government’s role is to protect private property rights, to uphold the rule of law and to maintain the value of the market currency (Riley, 2007).

However, markets may not always find the efficient allocation of resources due to a number of reasons mentioned briefly below. Such a situation is called a market failure (Riley, 2007). The failure of markets to efficiently allocate resources is often cited as a justification for government intervention in a supposedly free market. Although this theory may be a

These include direct instruments such as the promulgation of legislation and regulations to regulate a market, the direct provision of goods or services by the state. Intervention may also be indirect, with instruments such as subsidies, or tax relief or targeting of certain sectors (Riley, 2007).

However, as mentioned above, government intervention is not immune to the same imperfections as that of the free market. Indeed, it may be said that this imperfection is in fact amplified as the government administration is far further removed from the market in which its decisions are applied, as such suffer from inferior information compared to economic agents (Caccomo, 2008).

Heavy handed government intervention in free markets has been accused of stunting the development of economies especially in the 1970’s and 1980’s, with Krueger (1990:3340) holding that if market failures had indeed been present, that they were significantly outweighed by the “colossal government failures” due to over regulation of markets and corruption festered bureaucracy. As a result, it would be wise for policy makers to be cautious when deciding on government intervention in the free market. This raises the question of whether Market Failure Theory should be used as a justification for government

This is as Market Failure Theory easily identifies externalities and, according to its proponents, acts as a clear beacon for markets which require government intervention.

However, externalities are omnipresent in the real world. In an example by Zerbe & McCurdy (1999), a homeowner fails to plant flowers in his yard, even though the increase in property prices in the neighbourhood would outweigh the price of the flowers. The homeowners actions cause an externality. It is clear that not all externalities require intervention from the state. Yet if Market Failure Theory is to be followed, state intervention forcing the homeowner to plant flowers would rectify the problem of the market failure. However, government intervention is not always desirable, even in the case of market failures.

In fact Caccomo (2008) holds that government intervention itself causes further externalities, and economists’ reliance on externalities as justification for government intervention “verges on intellectual fraud, as everything generates