Markets vs. Government: Who Should Provide What?

The role of government in society often sparks political debate. But economists have thought about this question from a more objective angle, developing a thorough understanding of what markets do well and when they fall short. The conclusion is simple: If something is valuable but markets don’t provide it efficiently, there’s a case for the government to step in.

Why might markets fall short? Markets work best when buyers and sellers voluntarily trade, each benefiting from the exchange. But that process breaks down when the costs or benefits of a good spill over to people outside the transaction. Economists call these spillovers externalities.

When a product creates positive externalities-that is, benefits beyond just the buyer and seller-markets tend to underprovide it. After all, businesses can’t easily charge people who aren’t paying customers.

A classic example of a positive externality is knowledge and innovation. That’s why we have patents and why governments fund research. But knowledge isn’t the only case. Here are five other key areas where private markets usually fall short.

The first one is national defense. Defense is the textbook example of what economists call a public good-something that benefits everyone and where one person’s use doesn’t reduce anyone else’s. No private company could profitably sell “national security,” because once it’s provided, you can’t exclude people from enjoying its protection. That’s why this job pretty much always falls to the government.

The second is public infrastructure. Think about highways, water systems, public transit, dams, and the electrical grid. These are essential for the economy to function, but they’re very difficult for the private market to provide. This is because infrastructure projects require long-term planning, coordination across different cities and regions, and often face huge upfront costs. That kind of scale and coordination is hard for private firms to manage profitably, especially when the benefits are spread across so many people and places.

The third example is public health and disease control. Vaccinations, pandemic preparedness, and clean water all benefit individuals, but also help society as a whole by preventing the spread of illness. Private healthcare markets don’t always invest enough in prevention or emergency readiness, because they can’t always profit from keeping the public healthy. That’s where public health agencies come in.

The fourth example is environmental protection. Things like air and water pollution impose real costs-on our health, on agriculture, on the climate. But if polluters aren’t forced to pay those costs, they have little reason to reduce their emissions. Environmental damage is a classic example of a negative externality — a cost passed onto others. To fix it, governments use tools like pollution limits, technology requirements, taxes, or subsidies for clean energy.

The fifth example is education. Like knowledge creation, education generates wide-reaching benefits-more informed citizens, higher productivity, and maybe even better health outcomes. While private markets of course provide some educational services, the socially optimal level of education is higher than what markets would provide on their own. That’s why most countries, including the U.S., invest heavily in public K-12 education and provide subsidies for higher education.

These are just some examples of where private markets fail to deliver what society needs. Markets are powerful and efficient-but they’re not perfect. When firms or individuals can’t capture the full value of what they produce-or ignore the full costs of what they do-markets tend to get the final outcome wrong.

That’s where the government has a role to step in and correct the market failure, either by regulating the market with subsidies, taxes, or other policies or by providing some goods and services itself.

And of course, government policies aren’t perfect either. Bad incentives, waste, and unintended consequences of poorly designed policies are all real risks. But rather than assuming that government intervention is always good or always bad, we should evaluate each policy on its own merits-looking at the specific problem, the proposed solution, and the evidence on whether it’s likely to do more good than harm.

Originally published at https://mytwocentsandcounting.substack.com.