Nominated essay for our essay contest

As part of the Future Markets Consultation, students and young scholars were invited to participate in an essay contest. This essay was nominated in the category of master students. It was written by Malte Hendrixkx, PhD student at the University of Michigan.

The 21st century presents challenges that the European market economy seems unable to resolve, sowing dissatisfaction and opening the door for populists and authoritarian forces. To address these challenges, we must change our conception of the market economy and its relation to the state. Free markets will not miraculously solve or even address pressing issues. Instead of free markets, we must ensure competitive markets; instead of a value-free economy, we must embrace a normative economy that explicitly directs competitive markets towards the issues most pressing to European citizens.

1. Laissez-Concurrencer

The European Union has expanded civil liberties and increasingly integrated its member’s market economies for decades. Despite great increases in the prosperity and quality of life of its citizens, enthusiasm for the project has waned. Populists are on the rise, running on programs that reject both advances of the civil and the market society. Their success is often blamed on the inability of market economies to solve the pressing problems of our times: the distribution of the abundant wealth generated by capitalism; the outsized political influence of wealthy individuals and groups on political decision-making; the inefficiency of multilateral coordination in problem-solving regarding e.g. immigration, tax evasion, and climate change. It is this failure of markets to adapt to modern problems, critics propose, that creates fertile ground for populism and authoritarianism to grow.

Indeed, the free-market doctrine is unsatisfactory. Why is it popular among liberals? Markets are a powerful, decentralized problem-solving tool that aggregates information among its participants into profit-maximizing solutions that can rarely be imitated by central planners. Consider the production of a smartphone: it requires many resources from multiple continents, it requires the coding of software, it requires design, manufacture, and distribution. For each of these, many choices are possible. What is better? A sturdier but pricier phone or a more fragile but cheaper phone? A phone running on android or apple software? A phone with great computing power or a phone with a longer-lasting battery? No single government, capitalists believe, should make this call. Consumers should. By their consumption behavior, consumers signal which suppliers made the right choices,1 relative to the preferences of smartphone-buyers. By their purchases, they further select which companies do a good-enough job at satisfying consumer demand to stay profitable. Companies that offer low-quality products at too-high prices will not find buyers, and go bankrupt. If many companies compete for the most successful smartphone and consumers can freely choose, based on accurate information, the product most desirable to them, then consumers will end up with a desirable product at a desirable price. This sounds good in theory.

Thee ideal result of the free market competition would be optimal, if achievable. But the free market will not by itself remain competitive. Often the unregulated market will produce winners that amass market power and capital. They can use this power to bar competitors from entering the market, and often attempt to use their economic influence to gain political capital. Such economic power must be limited if markets are to remain competitive, and aside from the state, it is unclear who else could limit such concentrations of power. In essence, then, one does not want a free market. One wants a competitive market.

What should states do? States should foster competitive markets, not unregulated markets: unless the state actively encourages competition between market participants, there is no guarantee markets will approach their theoretical potential instead of succumbing to market failure. To foster competition would be to allow state intervention, but limit its scope signicantly. First and foremost, it would forbid the state from playing favorites by rewarding individual actors. Subsidies or preferential treatment for individual market actors skew the competitiveness of the market. We should therefore not only reject subsidies because they are unfair, but also because they limit the potential a market can unfold by limiting its competitiveness. Yet this hands-off doctrine towards individual market actors should not be confused with a classical liberal passive attitude of the state towards the market. State intervention is very much necessary in the real world, where manifold ways of market failure can occur. Markets can end up deadlocked in monopolistic or oligopolistic dominance such as can be observed in many modern digital markets, for example regarding search engines or social networks. Markets can end up maximizing narrow productivity while producing significant costs for society at large, as becomes apparent when considering the problems of climate change and  (formerly problematic) ozone layer depletion. Markets can act short-sighted and game political actors by using 2 their importance for the economy as ”insurance” against bankruptcy, as seen in the state bailouts of the global financial crisis. State intervention is necessary to rectify such market failures. But state intervention should take the form of an intervention into the conditions under which market processes take place, not into the market itself.

This section sketched an economic reorientation from the classic liberal laissez-faire (”let-do”) doctrine towards what could be called a laissez-concurrencer (”let-compete”) doctrine1. Such a doctrine does not believe the competitive market is of intrinsic value but understands it as a problem-solving tool. Problems can be manifold. Popular examples may be ”how to produce bread at the lowest possible price”, ”how to coordinate a global supply chain to create a pencil” or ”how to fairly distribute wealth”. The latter of these is different from the former two, in that there is no clear way how a market would achieve this outcome. To answer this challenge, proponents of competitive markets must direct markets towards a solution of a problem, deciding which problems can and should be addressed. In this sense, the state does not only intervene to create an economic order that keeps markets competitive, as outlined above. It further prioritizes problems that are not to be ignored by the market order and thereby places normative constraints and demands on markets. The aim then must be to foster competitive markets as a tool for an explicitly normative economy.

Why should we believe that a normative, competitive-market economy can help us prepare Europe for the 21st century? I will briefly illustrate its potential by considering two central problems the European Union in particular, and modern democratic states more broadly, face. The principles outlined so far suggest solutions that seem promising and may increase the faith of Europeans in the problem-solving capacity of their market economies. The problems I consider are climate change and economic inequality.

2. Application

2.1 Climate Change

Competitive markets can solve complex problems well. Can they solve climate change? The problem of climate change is often considered the most central challenge humanity faces in the 21st century. Critics argue that climate change is driven by the indifference of capitalism towards ecological values. They hold the orientation of the market economy towards profit and economic growth to be irreconcilable with a sustainable economy that leaves our planet intact. To halt climate change, these critics believe, we must radically reconceptualize our economy: we must embrace de-growth, i.e. a non-profit oriented economy.

While largely ignored by political decision-makers, these criticism gain plausibility by the repeated failures of conventional political measures to meaningfully slow down global warming. Neither the laissez-faire doctrine nor state interventionism have proposed viable solutions for a sustainable economy. Free markets by themselves do not  tackle the problem of climate change since there is no profit to be made from protecting the environment. The climate is a public good, available to and shared by all humans. Depleting it by emitting e.g. carbon dioxide damages this public good, worsening the situation for everyone. But while the damage to the climate is minuscule for any individual action, the comparative economic gain that may arise from not having to invest in carbon-dioxide reducing measures is great.

Hence, market participants, be they corporations or consumers, have no economic incentive to produce or purchase sustainable products. This is problematic since the repeated depletion of the public good does have very dramatic effects on the public good’s availability. As we repeatedly emit e.g. carbon dioxide, the climate situation becomes worse and worse. Yet this harm is not reflected in the price and profitability of the market transaction. The market fails to reflect the damage its participants are causing to the planet. If free markets fail, they must be corrected. Hence, many believe the state must intervene to save our climate by promoting a sustainable economy.

But state intervention in favor of a sustainable economy has not been very successful either. The clearest example may be Germany, Europe’s strongest economy and therefore a country that has the economic resources for drastic state-interventionist measures. Their course towards a more sustainable economy (”Energiewende”) has focused on the energy sector, with the transport and heating sector running behind. Long-running subsidies into solar energy were used as a catalyst to get a renewable energy sector off the ground. Individual energy sectors were shut down by decree: the nuclear sector is set to phase out by 2022, the coal sector is set to phase out by 2038. These interventions were focused on market outcomes, favoring certain methods of energy generation over others, directly subsidizing or eliminating market actors. These reforms have not been very successful, however. The subsidies for solar energy have not been able to create a competitive solar industry sector, and as they run out, the German solar energy industry is being outcompeted by other countries’ industries, especially China. The phase-out of the relatively climate-friendly nuclear industry before the coal industry (and instead of oil and gas) has increased reliance on climate-harming oil and gas. Roughly a third of German energy is still generated from oil. The negligence of the transport and heating sector, partly because of the strong influence of special interest groups in Germany, has crippled Germany’s ability to reach its short-term climate goals. Compared to 2005 levels, Germany has increased its energy consumption in transport. Neither the free market nor state intervention have offered satisfying solutions to the problem of climate change. What is needed is a competitive market solution that is guided, but not mandated, by the state: a carbon dioxide tax, as has been demanded by economists for a long time.

Maybe surprisingly, there is much less controversy among economists regarding regulatory climate change policy than one may expect. Climate Change is a problem that markets fail to solve unless regulated. A lesson found in every introductory economics textbook is that public goods that can be depleted yet are not assigned a price will suffer from what is known as a tragedy of the commons: a shared-resource being depleted by individuals that act contrary to what would be in their common interest if individuals were to coordinate. Such a depletion of a public good by market participants can be considered a market failure. Nor is it unclear how a market-based solution to this problem would look like: put a price on the depletion of the public resource! Most economists argue that in putting a price on carbon dioxide emissions, one can utilize the market to find solutions to energy-efficient production of goods. Instead of following Germany in planning which energy sectors are to be pursued further, one should utilize markets to find a solution. Instead of following Germany in designating which sectors are to be part of a solution to climate change, a carbon tax includes all participants in a market by pricing in the cost to public goods that are caused by the emission of carbon dioxide. If it becomes unprofitable to emit carbon dioxide, it becomes profitable to find ways to reduce its production.

A carbon tax rectifies a market failure through competitive markets without granting special privileges to groups or industries. This would mean an end of subvention or bans for individual energy industries, irrespective of whether they are sustainable (e.g. solar subsidies) or unsustainable (e.g. coal industries). A competitive energy market emerges only when all actors compete under the same conditions, and outdated or unpromising technologies are discarded by the market, not state, forces. This would further mean strict pricing on CO2 emitted during production in form of a CO2 tax, rewarding sustainable behavior of both consumers and industry in form of lower relative prices and costs for sustainable products.2

Without a doubt, such a tax would be more harmful to some industries than others. Both production and usage of a car are more expensive than the production and usage of a bike. The production of beef is more energy-intensive than the production of vegetables. But legislating to protect these industries, such as by granting them exceptions from CO2-taxation, is functionally equivalent to subsidizing them relative to their competitors, who would incur fewer  losses due to CO2-taxation, relatively speaking. Competition does not square with preferential treatment. Industries should compete under real-life conditions. In the real world, CO2-emitting industries harm the climate. The relatively high cost they face when their depletion of the public good is priced in is proportional to the harm they create in using their current production technologies. That some industries will face much more hardship than others, at least until they can adapt towards and compete for more sustainable production practices, is a feature, not a bug, of market-based climate change solutions. These industries are harmed because they are harmful. The current organization of the market is indifferent towards their harmful behavior because it leaves the usage of a public good unpunished when it should reflect the cost of the depletion of a public good to avert market failure.

In summary, a competitive market based solution to climate change is preferable both to a laissez-faire solution that ignores the problem and to a state-interventionist solution that threatens to be inefficient or even harmful, as the case of Germany illustrates. Among market-based solutions, one without preferential treatment of individual industries is preferable, since one risks to undercut the competition for sustainable production practices if one grants privileges to selected industries and sectors.

2.2 Inequality

The traditional question faced by proponents of the market economy is the so-called social question. Gains in productivity and prosperity may materialize in a market economy, but if they only benefit those that are already wealthy, it is hard to see why any non-wealthy citizen should support Liberalism. But social systems that redistribute wealth are often seen as contrary or harmful to market competition. Critics argue that redistribution programs curb the incentive to work and engage in the labor market. This ignores that there are economic grounds that speak in favor of granting the worst-off signicant incomes even when not currently employed in the labor market. Those that have no capital at hand have a harder time entering the labor market, have a harder time turning down unfair or disadvantageous contracts, and can spend less time searching for a suitable job. Entering a market is a process that requires time to search and match market opportunities to individual preferences. If individuals are not granted sufficient income for their basic cost of living, they have no time to inform themselves on the market. This skews the labor market competition in favor of employers, who can dictate the conditions under which desperate workers enter into contracts. A free market may thus fail to enable a fair and competitive labor market, skewing competition towards employers. A fair market competition requires an adequate living standard for all that enables workers to act, rather than react, on the labor market. At the same time, it should do so without privileging individual groups.

An efficient way that does not undercut the incentive to competitively engage with the labor market may be the adoption of a negative income tax for EU citizens. In such a system, all citizens are given a negative “tax credit” when filing their income taxes. As income taxes are deducted, citizens with no or low income will end up with a negative number as their effective tax, meaning that they receive a certain amount of money as their taxes are processed. The beauty of the proposal is that it guarantees a minimal standard of living for each individual while retaining the incentive to work since every Euro earned will remain profitable post-tax. An example, to better illustrate the concept:

Imagine three citizens of a country that has a 50% tax rate on income and a negative tax credit of -1000€. A citizen without any further income will have a taxable income of 0€ -1000€ reduced by the 50% tax rate for a total of -500€, leading to a 500€ ”tax return” by the government. A citizen that earns 1000€ will have a taxable income of 1000€ – 1000€ = 0€, and thereby keep his total income of 1000€ without further payment. A citizen that earns 2000€ will have a taxable income of 2000€ – 1000€ = 1000€ reduced by the 50% tax rate for a total of 500€ payable tax, so this citizen will retain 1500€.

On this model, each citizen is guaranteed a minimum income by the state in form of the negative tax credit * tax rate. But as the income of a citizen increases, so does the income that the citizen has after taxes.

While research on forms of universal basic income, of which the negative income tax is one, has increased, no country-wide attempt to establish it has been undertaken yet. As such, a negative income tax would be, to some degree, experimental, and would have to be accompanied by research into the effects it has both for the citizens and the labor market they participate in. If envisioned as a European, and not a regional, proposal, its implementation may need to be sensitive to the local price level, the local income tax level and other economic variables. A negative income tax would certainly be a transformative policy, with high stakes on its success or failure. A high level of prudence would be needed to ensure its success, which is far from guaranteed. While a negative income tax can be financed directly under certain circumstances (as in the example considered), realistic applications will likely either have to raise tax rates on middle- and high-income earners or reduce the negative tax credit to a pittance.

A third alternative, in spirit of the proposal of a carbon dioxide tax considered above, would be to use the earnings of a carbon dioxide tax to fund the introduction of a negative income tax. Such a climate dividend in the form of a negative income tax would fulfill multiple purposes. It would raise acceptance for the economic changes that would be associated with the pricing of carbon dioxide; it would ease the re-entry into the labor market by those employed in industries that are no longer viable once their carbon emissions are priced into their products; lastly, it may serve as a clear sign of the EU towards its citizens that it can provide for the worse-off while enabling a new, sustainable market.

3. Conclusion

This essay considered the problems of climate change and income inequality and proposed a market-wide carbon dioxide tax and a market-wide negative income tax as proposals in the spirit of a competitive market in a normative economy. Both proposals could be combined in the form of a climate dividend. In doing so, it rejected both free-market and state-interventionist solutions in favor of solutions that shape market competition, instead of intervening in outcomes of market processes or remaining a passive bystander to them. Besides the two exemplary problems and proposed solutions, the message this essay hopes to convey is more broad. The state cannot by itself solve the complex problems that markets address. At the same time, merely ”freeing” the market from regulation leads to market failures and processes that are orthogonal to the issues that society has to resolve. A normative economy must direct markets towards these issues. We must not free the markets – we must let them compete: Laissez-Concurrencer.

Further Reading

  • Dold, M. F. and Krieger, T. (2019). The ‘new’ crisis of the liberal order: Populism, socioeconomic imbalances, and the response of contemporary Ordoliberalism. Journal of Contextual Economics.
  • Goldschmidt, N. and Wohlgemuth, M. (2008). Grundtexte zur Freiburger Tradition der Ordnungsökonomik.
    Mohr Siebeck, Tübingen.
  • Howard, P. H. and Sylvan, D. (2015). ‘The economic climate: Establishing expert consensus on the economics of climate change. Institute for Policy Integrity, pages 438–441.
  • IEA (2020). German energy policy review. International Energy Agency: Paris, France.
  • Köhler, E. A. and Kolev, S. (2013). The conjoint quest for a liberal positive program: “Old Chicago,” Freiburg, and Hayek. In: FA Hayek and the Modern Economy, pages 211–228. Springer.
  • Ostrom, V., Ostrom, E., and Savas, E. (1977). Public goods and public choices. Alternatives for Delivering Public Services.
  • Tondani, D. (2009). Universal basic income and negative income tax: Two different ways of thinking redistribution. The Journal of Socio-Economics, 38(2):246–255.
  • Zweynert, J., Kolev, S., and Goldschmidt, N. (2016). Neue Ordnungsökonomik. Mohr Siebeck, Tübingen.
  1. A historically-interested reader may recognize this proposal as in the spirit of the ordoliberal ideas proposed by the German post-war economists such as Rüstow, Röppke, and Eucken. Indeed, the hope is that the Social Market Economy they engineered in post-war Germany can be partly recreated and updated for the 21st century. See the further reading section, especially on ‘Ordnungsökonomik’.
  2. Note that such a proposal would require levying the tax on imported goods (via tariffs), unless the European producers were to suffer a competitive disadvantage in the market competition with non-European producers