Why public markets can’t work

The claims made about the use of markets in the public sector make a great deal of common sense. They are based on the idea that competition will lead to providers driving up their standards to either bring in more customers, or face losing resources.

However, this view of the use of markets in the public sector is deeply flawed. To understand this, you need to take a different perspective on markets than the rather simplified markets=competition view expressed above. Such a few comes from, perhaps oddly, Austrian economics, which can prescribe far more clearly the problems of using markets in the public sector, even if I might wish to part company with the approach when considering their solutions.

Austrian economics incorporates competition into its view of markets, but more importantly also includes failure, creative destruction, freedom and entry and exit, and an emergent and dynamic view of markets based on the use of price signals to co-ordinate activity. It s a more complicated view than the simplistic markets=competition view that dominates public discourse, but more valuable as a result.

In the Austrian view competition is one element that makes a market. But for competition to work, there must be the creative and destructive process that allows firms (or service providers) that are unsuccessful to fail. If providers can’t fail, then there is little risk in being inadequate in the market, and more importantly, the resources tied up in the failing organisation are not redeployed in potentially more successful enterprises. From a market perspective, where we tolerate failure, we don’t allow markets to do their job.

Equally, Austrians (or at least those following Hayek) don’t make the heroic assumptions public market reformers make about the choosers of service being maximising or making decisions under perfect information. This is because the price the market sets for a service is not just an outcome of the market process, it is the means by which market activity is co-ordinated. Providers decide whether to enter or exit based on the prevailing price, and choosers whether or not they will buy or consumer the product or service. Without the price system doing its magic, moving about in a dynamic way, the whole thing breaks down.

The problem with all this is, that public markets can’t possibly work in this framework. They fail even in their own terms – they don’t allow much in the way of competition, and as any economics textbook will tell you, if you don’t have much in the way of competition, you don’t have much of a market as the opportunity for providers to collude and keep prices up is too great. But if we adopt the Austrian perspective we see even more problems. Public markets don’t allow providers to fail, and so they undermine the creative and destructive powers of the market. Second, they don’t allow a price to move in a dynamic way, and so it is unable to be a signal to the market.

This means there are three catastrophic failures in using market mechanisms in public organisations – too little competition, no creative destruction, and no price mechanism. What we are left with is not a market, but a mess.

What we do with this information is where I probably differ from most Austrians, who would advocate the use of a free market in public service – removing barriers to entry and exit to allow the market mechanism to do its magic, and allowing price to determine supply and demand. This is because I simply don’t think it is fair to use markets in areas such as healthcare, where I would suggest, following writers such as Dworkin, that we ought to think of healthcare as an area that access to which is a basic human right. But it is also because there are multiple problems in getting market mechanisms to work in healthcare because we need to restrict entry and exit (do you want to be treated by an unlicensed practitioner, no matter how cheaply?), and that healthcare expertise in short supply, meaning that it is difficult to allow markets to allocate goods without a great deal of societal inefficiency. In short, I can’t see how markets can work in this area.

In sum then, public markets can’t work. We need to be more creative about thinking about we can find alternative means of getting the most efficient and effective delivery of services in areas such as healthcare, but using markets is not going to work to that end.

3 Responses to “Why public markets can’t work”

  1. Futilitarian Says:

    What about the markets currently in place to provide public services? For example, commissioning of Supporting People services based on a combination of price and quality? Would you say this doesn’t work?

    • t1ber1us Says:

      I think it all depends….if both price and quality are out there it can make things better provided price can move dynamically to reflect quality and availability. Support people is a difficult area because many of the decisions will be taken by family rather than the clients themselves, and in conditions where, sadly, it seems that provider failure is a possibility and service inspection isn’t all we would like it to be. That suggests to me markets in dementia care are extremely flawed – we don’t have good information about provision, and price isn’t able to act as a signal. We also might want to argue that some things shouldn’t be for sale.

  2. Cameron Cherrier Says:

    Thank you for sharing this article, this is nice one…. I like it a lot and Hope others might like it as well.

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