2. The debate over the role of the government.
The government's role in economic management remains an unresolved issue in the current discussions of economic policy.
The debate began in the early twentieth century, particularly in the context of the argument over socialist economic calculation, and was led by Ludwig von Mises, Oscar Lange, Friedrich von Hayek, and the Austrian School.
Mises argued that rational economic management in a socialist economy is impossible because of the absence of market and price mechanisms. economy Lange disagreed with Mises, offering his Concept of market socialism.
Lange contend that a central planning board can substitute for a market or price mechanism and resolve decentralized resource allocation problems.
Lange's planning board would be able to search for the optimal allocation or discover an equilibrium price vector either through trial and error or a process of successive approximation.
Later, Hayek (1948) joined the debate, contributing to the rising prominence of the Austrian School as we as to the development of the concept of market competition as a dynamic discovery procedure.
Although Hayek recognized the theoretical possibility of economic calculation by the central planning board
in the socialist economic,
he doubted whether such a system would work practically because of the excessive information requirements.
In the Hayekian world, no manmade system can discover optimal outcomes of resource allocation without a process of dynamic competition.
During the 1940s and 1950s, the debate over the government's role in economic management centred on the issue of whether or not a mixed economy and a welfare state are desirable.
The experience of the Great Depression during the 1930s began to cast doubt on the automatic coordination function, and especially the macroeconomic coordination function of the capitalistic free market economy.
As a result, the Keynesian counter - cyclical macroeconomic policy function of the government became a new sub-topic within the debate, overriding the mostly microeconomic issue of resource allocation in the socialist economic calculation debate.
The Keynesian economists advocated government Intervention t remedy the market failures in the macroeconomic level, particularly the unemployment phenomenon.
This increased the popularity for a mixed economy and welfare state, and, as a result, the government's role continued to grow.
Interestingly, the new argument for government Intervention in the macroeconomic level was also strengthened by the development of macroeconomic modeling, which was partly spurred by the socialist planning theory that developed in response to the earlier debate on the possibi'lity of socialist economic calculation.
The government macroeconomic intervention, including the fine - tuning of macroeconomic polices in order to maintain stable output and employment growth, turned out to be ineffective as was proven by various episodes of macroeconomic development during the 1970s and 1980s, such as the oil price shocks and subsequent misalignment of exchange rates.
Perhaps the most notable case was the 'stagflation' experienced by the US economy during the 1970s' when rising Inflation was accompanied by a steadily worsening unemployment rate.
This development completely refuted the trade-off between the two undesirable phenomena which had formerly been taken for granted and thus nullified the Keynesian fine-tuning policy prescription which had been based on balancing the evils of Inflation and unemployment.
These experiences in turn provided an environment for the revival of the liberal tradition: neoliberalism led by Hayek (1984a, 1984b, 1989), the birth of the public choice school led by J.M Buchanan, and the surge of political conservatism led by Margaret Thatcher.
Deregulation or Liberalization of the private sector has become the core of economic reform in most advanced countries in recent years, and the importance of a long-term perspective in macroeconomic policy making, such as maintaining a rule-based policy, has been emphasized time and time again.
It has also been stressed that government failures are due not only to excessive informational requirements, as stipulated by the Hayekan framework, but also to the inherent nature of self-seeking government officials, as seen in the public choice framework.
A new and interesting debate on the role of the government in economic development has also emerged following the rapid growth of the East Asian economies.
This debate focuses on somewhat different concerns from the earlier calculation debate, assessing whether or not the government in an underdeveloped capitalistic market economy can improve upon the market outcome of resource mobilization and resource allocation.
This is why the debate is ultimately reduced to measuring the importance of market failure (or apparent market Institutions) versus government failure (or the government's inability to assume the role of markets or to introduce market Institutions).
In observing the remarkable success of economic development in East Asian countries such as Japan, Korea, and Taiwan over the past thirty years or so adherents of the neoclassical theory emphasize one important lesson that can be learned from the East Asian experiences.
This is the importance of getting the basics right.
They argue that the government should provide a stable macroeconomic environment and reliable legal framework In order to create an environment favorable to the free play of market forces.
According to this critique, minimum Intervention with the lowest degree of relative price distortion is a virtue.
They see that Asian economies benefited the most from a government strategy that followed the lead of the market, rather than trying to actively direct it.
On the other hand, a group of economists known as revisionists attribute greater significance to other aspects of the East Asian success story that have gone relatively unnoticed in the neoclassical analysis.
They observe that the East Asian governments have taken a much more active role in the economic development process than the one envisaged by neoclassicists and thus argue that, despite efforts to do and quite the opposite, the government has actually been leading the market.
Revisionists even go on to argue that during the late industrialization stage, the state should deliberately set prices at market distorting levels In order to create profitable Investment opportunities.
Also emphasized is the existence of market failures in developing economies due to market imperfections such as a lack of relevant markets.
It is thus contended that an active role on the part of the government is necessary to guide resource allocation for the highest growth of the overall economy.
Amsden, one of the staunchest revisionists, even suggests that the central bank may support the priority industries at the cost of macroeconomic stability.
The World Bank (1993) answered the revisionists' argument with the reassertion of an obvious truth : ' For interventions that attempt to guide resource allocation to succeed, they must address failures in the working of markets.
Otherwise, the market would perform the allocation function more efficiently.
Again, macroeconomic stability is emphasized as the most important precondition for extensive economic development.
In sum, the debate on the role of the government in economic development centered around the issue of market failure versus government failure.
Of course,market failure generally reflects the failure of institutions, another form of governmental failure - this time the failure lies In the government's inability to set up the right institutions or, In other words, the rules of the game in the economy.
Therefore, market failure on its own cannot be considered as an automatic justification for direct govenrment intervention.
Rather, the government should try to introduce 'right' Institutions to provide an optimal environment for better economic performance.
Furthermore, In most cases of apparent market failures, it should not go unnoticed that government regulation or its practices of preferential treatment usually turn out to be the major causes of those failures.