Our Friend the Market

Liberals need to understand: The rules that structure the market are at least as important as government programs.

By Dean Baker

Tagged EconomicsFree MarketsInequalityMonopoly

The standard liberal approach to economic policy is to support government programs that counteract the inequities gen- erated by the market. Unfortunately, this narrow focus on government programs has effectively given the right free rein to restructure the market to redistribute an ever-larger share of income to the rich and very rich. While tax and transfer policies are important, if liberals had not ignored, or in many cases supported, the ways in which the right was restructuring the market, the existing levels of poverty and inequality that the government needs to address would be far lower.

In other words, liberals need to spend at least as much time on the rules that structure the market as they do on government programs that redress the problems it creates. This is because the idea that the extremes of wealth and poverty we see are inherent outcomes of the market is wrong. These extremes are the result of the way in which the market has been structured by the government.

Let’s start off with, perhaps, the most explicit example of this structuring: patent and copyright monopolies, which are entirely a government invention. There is nothing “free market” about Bill Gates’s enormous fortune. It’s because the government will arrest anyone who mass produces computers with Microsoft software without first paying the company licensing fees.

The Microsoft story is not unique. Huge sectors of our economy exist in their current form because of government-granted patent or copyright monopolies, including the pharmaceutical industry, the medical equipment industry, and the entertainment industry. These monopolies are not just long-fixed rules of the game. Government policy has made them both longer and stronger over the last almost four decades.

This government hand is seen clearly in the prescription drug industry, which has caused renewed outrage among the public in recent years. Spending on prescription drugs hovered near 0.4 percent of GDP, with no discernible trend from 1960 to 1980, when the Bayh-Dole Act was passed into law. It passed the Senate by a huge, bipartisan 91-4 margin and was signed into law by President Carter.

Bayh-Dole allowed private companies to obtain patent rights on research sponsored by the government. Prior to Bayh-Dole, the government retained control over research that it funded. The change was especially important for the pharmaceutical industry, because the government funds a large amount of bio-medical research through the National Institutes of Health (NIH) and other agencies. Since Bayh-Dole became law, spending on prescription drugs has skyrocketed to more than $440 billion in 2018 (2.2 percent of GDP); more than five times the share of GDP it took up in 1980.

We have benefitted from increased private spending on research as a result of Bayh-Dole, but granting these monopolies was only one of many possible mechanisms to provide incentives for new innovations. This is simply not the free market; it is deliberate government policy.

The implications of this point are enormous. Another important example: We continually hear the refrain that workers need more education and skills to succeed in the modern economy, but the extent to which the economy rewards education and skills is also a matter of government policy, not the endogenous course of technology. If we envision a world with no patent and copyright protection, we would not have a slew of Silicon Valley millionaires and billionaires nor NIH alumni becoming biotech tycoons.

Of course, it is important that we have incentives for innovation and creative work, but the point is that government policy can make those incentives greater or smaller. If we want more equality, and arguably a more efficient economy, we could make patents and copyrights shorter and weaker and have more direct funding to put research and creative work in the public domain immediately after it is produced. The Human Genome Project is one model, where results are posted nightly. If we did this with research into drug development, new drugs could be sold as generics, costing a tiny fraction of the price of patent-protected medicine.

Patents and copyrights are only one area where progressives have wrongly viewed the results of government policy as natural market outcomes. “Free trade” is another great example.

The conventional view is that the United States lost a large number of high-paying manufacturing jobs because tens of millions of hard-working people in the developing world are prepared to do this work at a fraction of the pay received by U.S. workers. This is true, but there are also millions of very bright and ambitious people in the developing world who would be prepared to train to work in the United States as doctors and other highly paid professionals in the United States. Yet those industries aren’t suffering.

The real reason that U.S. manufacturing workers face competition from the developing world but doctors don’t is that government policy structured U.S. trade deals to subject manufacturing workers to international competition, while largely protecting doctors and other highly paid professionals. Trade deals like NAFTA were structured to make it as easy as possible for U.S. manufacturers to set up operations that take advantage of low-wage labor overseas and ship their output back to the United States.

By contrast, government policy left in place, or even increased, the barriers to foreign-trained doctors practicing in the United States. As a result, U.S. doctors earn on average close to $300,000 a year. As of 2011, this was roughly twice the average for other wealthy countries, and puts about a quarter of physicians in the top 1 percent. If government policy had gone the route of opening trade in physicians’ services, and U.S. doctors earned something close to what their counterparts in other wealthy nations earned, it would have a huge impact on pay scales at the top end of the U.S. labor market. Subjecting doctors and other highly paid professionals to the full brunt of international competition would mean the top 5 percent of the wage distribution would be much closer to the bottom 95 percent, closing the huge gap that has opened over the last four decades.

Finance is another area where government policy structured the market to support a bloated industry, one that creates large fortunes for a small number of people. The most dramatic incident in this respect was the massive bailout for the industry after the financial crisis. The magic of the market would have sent Goldman Sachs, Citigroup, and other financial behemoths into bankruptcy.

Instead, Congress and the Federal Reserve Board raced to supply the necessary loans and guarantees to keep the major banks afloat. (No, we did not risk a second Great Depression without the bailout. The Federal Deposit Insurance Corporation could have kept the normal flow of payments going. And we learned the secret to escaping a severe depression almost 80 years ago with the start of World War II. It’s called “spending money.”)

Beyond the bailout, government policy has structured finance to support an incredibly inefficient industry that unnecessarily makes some people very rich. Government policy literally rewrote the rules on bankruptcy to support mortgage-backed securities and derivative trading. Also worth noting is the fact that the financial industry would be dramatically downsized if financial transactions were not exempted from the sort of sales tax imposed on most other items in the economy. Again, it is clearly the rules that government puts in place that give so much money to the big winners in finance, not anything intrinsic to the market.

The list of ways in which the market has been structured to ensure income flows upward is extensive, but the point here is that there is nothing inherent to the market that causes it to generate at once both poverty and extreme wealth. Government can and should, instead, look to structure the market to make sure the benefits of growth are more broadly shared.

This is both an economic and political necessity for progressives. If the right continues to set the rules of the market in ways that redistribute an ever-larger share of income to those at the top, progressives are not going to be able to offset the upward redistribution with tax and transfer policy. Though the right exaggerates the negative effects of tax and transfer policy, it does have economic costs, and the more progressives rely upon only tax and transfer policy to ensure that everyone can maintain decent living standards, the larger these costs will be. High tax rates do lead to economic distortions as people jump through lots of hoops to avoid or evade them. The main growth sector in a progressive administration should not be the tax shelter industry.

However, the political obstacles to very large-scale tax and transfer policy are probably even greater. There is a deep suspicion of government among large sectors of the electorate. To some extent, this is tied in with racism and classist ideas of the lazy poor reveling in government largesse. But the origins do not really matter: It is politically very difficult to obtain public support for large-scale tax and transfer programs.

The market is infinitely malleable. It can be structured to produce broadly shared gains or extreme inequality. The right, at least implicitly, understands this fact. Until we realize that the market is a tool that can be structured to produce progressive outcomes, we will be enormously handicapped in our battles.

Read more about EconomicsFree MarketsInequalityMonopoly

Dean Baker is a senior economist at the Center for Economic and Policy Research. His most recent book is Rigged: How Globalization and the Rules of the Modern Economy Have Been Structured to Make the Rich Richer.

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