Market

Theoretical Approaches to Markets and Governance

The relationship between markets and governance has been envisioned variously by neoclassical economists, new institutional economists, and political economists.

Neoclassical economists begin with the standard market perspective. Ideal markets are Pareto optimal mechanisms for allocating resources toward production and consumption. A number of assumptions define ideal markets. These assumptions can be violated in practice. Violations lead to inefficiency. Identifying violations and what to do to restore efficiency constitutes the neoclassical discourse.

In this discourse, liberal economists often emphasize that problems in markets stem from outside interference (or interventions) that distort the signals received by market agents. The appropriate policy response is to structure governance to allow market agents to receive the correct signals and to decide for themselves based on these signals. In cases where production and consumption decisions are not made in markets, the appropriate policy response is to introduce markets so that efficiency can be increased.

Opposed to the liberals, welfare economists emphasize that markets seldom do well on their own. The appropriate response is to make markets efficient with help from nonmarket agents such as government regulators. When they deem nonmarket agents incapable of correcting markets, welfare economists can argue for altogether abandoning markets in favor of alternative modes of production and consumption decision making such as government or other hierarchical mediation.

Outside the neoclassical discourse, new institutional economists emphasize that particular rules and regulatory organizations are critical to how markets operate. Property rights and their enforcement are particularly important. In addition, institutional economics emphasizes that costs associated with transacting in markets decide whether markets or alternatives are the efficient mechanisms for organizing how resources are used. Important alternatives include hierarchies and networks.

Political economists emphasize the political underpinnings and consequences of markets rather than free market assumptions. In this perspective, markets are primarily about distributing resources among groups or classes in society. The ways markets are governed enshrine particular bargains among dominant social actors and perpetuate the power of these actors. Political economists show that political bargains also lead to alternatives to market-based resource distribution such as the state or corporatist institutions.