Incentives and pluralism

This excerpt from my book Market Solutions for Social and Environmental Problems concludes a brief survey of the current ways in which policy is made, its flaws, and the consequences of those flaws. It precedes the chapter introducing Social Policy Bonds.

Incentives and pluralism: the best features of the private sector

The aspersions cast on government need to be balanced by praise for what, at least in the west, we take for granted: the maintenance of law and order, defence against invasion, freedom of expression, and a generally rising standard of living and of health. We suspect that our national governments could do these jobs more efficiently but we ought to recognise that they do on the whole succeed in supplying these vital public goods and services. Similarly, they do a reasonably good job at raising revenue through their tax policies.

But there does appear to be a contrast between government's performance and that of the private sector. Deregulation of western economies and lower barriers to trade over the past three decades or so have vastly increased the range and quality of affordable goods and services. The freer operation of self-interest in the private sector has made many individuals very wealthy indeed. But the less well off and unwaged have gained little, at least in relative terms, and people from all backgrounds suffer from what they perceive to be a deteriorating social and physical environment. Many social and environmental objectives remain as remote as ever, despite large - and, in many cases, increasing - sums of taxpayers' money spent on trying to achieve them. And, as we saw in the case of perverse subsidies, appalling policies can persist indefinitely. Rather than ensuring their swift termination, our political system tends to give their beneficiaries the resources to lobby in favour of keeping them going. These policies, and especially their persistence over decades during which their deficiencies have been widely documented, fuel a suspicion that government could do a lot better. They underpin the contention that governments in the rich world have succeeded in part by transferring some serious social and environmental problems to the developing countries, to the commons, and to future generations.

It is likely that one reason for the failings in government's performance is that there are not sufficiently large numbers of influential people whose prosperity depends on its success. In the private sector, the success of an enterprise is identically equal to the success of its owners. But the motivation is very different for those agencies, whether they be public sector or non-governmental organisations, who take on the task of solving our social and environmental problems. The vast majority of spending on social and environmental programmes is carried out by bodies whose success is barely linked to the welfare of those who are their intended beneficiaries.

Unfortunately governments rarely set explicit targets in the form of outcomes that are meaningful to ordinary people. Their policies are driven by a whole host of factors - anything except outcomes in fact. Very often we hear politicians trying to defuse criticism of public sector schools, or hospitals, or whatever, by pointing to an increase in the budget for these organisations, as if increased spending will automatically lead to improved outcomes. Beholden to existing institutional structures or variants thereof, they cannot imagine that favourable outcomes can be achieved other than by continuing to do existing activities more intensively, whether by increasing funding for existing organisations or by creating new organisations in the same image. In effect, our policymakers sacrifice many worthwhile policy goals to the priorities of institutions.

There are pointers as to what are existing organisations' true priorities. We need only listen to the spirited, and often ingenious, defence of perverse subsidies presented with straight faces by the organisations that stand to lose most if they are withdrawn. Or discover that about half of the funds allocated to humanitarian relief and development aid organizations stays with these bodies

Such a mismatch between incentives and social goals becomes even more damaging when it perpetuates its own dysfunctionality. It then becomes a self-reinforcing process, which means that the already significant differences between actual policy outcomes and the desired outcomes of natural persons will widen over time. They will continue to widen until we radically re-orientate the way in which we formulate social and environmental policy.

In my view, such a re-orientation in the first instance means targeting and rewarding meaningful outcomes, rather than activities or institutions. That would be a necessary first step, but it is not sufficient. The other necessary step is to ensure that resources are allocated in ways that can most cost-effectively achieve societal outcomes. This is where markets enter into the picture.

Diverse, adaptive solutions

Targeting outcomes; yes. Providing incentives to achieve these outcomes; yes also. But even that combination would not suffice to ensure effectiveness and efficiency. When the distance between government and people is large, as it is in our highly specialised economies, national or global policy decisions about resource allocation are essentially central planning. Central planners think they know best how to solve economic, social and environmental problems, and their policies embody this assumption. Central planning is ponderous, uniform and slow to adapt, while the sort of complex issues - climate change, violent political conflict, crime and poverty - that we are discussing need exactly the opposite approach. Identifying these problems, articulating them and funding their solution does need centralised global or national bodies, but actually solving them requires diverse adaptive approaches, not central planning.

Markets are diverse and adaptive. Markets encourage people and firms to try different approaches, and also to assess the results of these approaches. Markets also hold people accountable for the results and ensure that ineffective or counterproductive approaches are terminated once they are seen to have failed. They both generate and make good use of a phenomenal information-processing power that central planning simply cannot emulate.

Unfortunately, many believe that market forces must inevitably conflict with social goals. This is partly because a large part of what passes for the 'market' in current parlance is anything but: it's more like large corporations and governments distorting the market to their mutual advantage. But it's also because the negative impacts of production unleashed by market forces are growing more numerous and more significant.

So it is important to remind ourselves that market forces and self-interest can serve public, as well as private, goals. Often, these private goals coincide with social goals, so that, for instance, the market routinely performs vital tasks such as food distribution and the provision of such indispensables as home medicines, baby needs, furniture and other consumer goods. These are exceedingly complex tasks, which would be impossible for central planners to co-ordinate. But they are undertaken continuously and reliably by a multiplicity of agents operating in reasonably competitive markets. They are accomplished in ways that fulfil not only the private goals of the firms and consumers involved but also society's goal of efficient supply of goods and services. This feat results from the combination of the self-interest of large numbers of market players, and their ability to react appropriately to ever-changing circumstances.

Governments tend to be centralist in their instincts. In practice, this has meant that market forces are rarely allowed to play a significant role in organising the production and distribution of those goods and services that governments supply. Government agencies also operate in a non-competitive environment, which discourages self-evaluation.  Since the governments of the developed countries now spend a third or more of their economies' national income, these are significant deficiencies. The manifold complexity and large scale of such global challenges as violent political conflict or climate change, the proliferation of intricate, obscure relationships between cause and effect: all point to the need for a pluralist solution. No single approach, no planning by a single body, however large, is going to work. We need to find a way of ensuring:

• that the pluralism evoked by market forces allocates the resources we devote to accomplishing our social and environmental goals,
  

• that any organisations that might arise are entirely subordinated to the achievement of these goals, and
  

• that rewards given to those who achieve these outcomes are linked to their success in doing so.
  

The next chapter, and the rest of this book, describe one such way.