Element 3.1: Protect Rights and Produce Limited Goods and Services

“A wise and frugal government, which shall restrain men from injuring one another, which shall leave them otherwise free to regulate their own pursuits of industry and improvements, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government.” ⁽⁷⁶⁾

Governments play a vitally important economic role. Governments can promote and enhance the welfare of the citizenry through the performance of two major functions: (1) the protective function, which provides people with protection for their lives, liberties, and properties; and (2) the productive function, which supplies some goods and services that have unusual characteristics that make them difficult to provide through markets.

The protective function refers to the government’s maintenance of a framework of security and order, including the enforcement of rules against theft, fraud, and violence including from other countries (national defense). Governments are granted a monopoly on the legitimate use of force to protect citizens from each other and from outsiders. Thus, the “protective state” seeks to prevent individuals or other actors from harming one another and maintains an infrastructure of rules that allows people to interact with one another cooperatively and harmoniously. A legal system that protects individuals and their property from aggressors, enforces contracts in an unbiased manner, and provides equal treatment under the law (see Part 2, Element 2.1) forms the core of this protective function of government.

The protective function is crucially important for the smooth operation of markets. When the government clearly defines and enforces property rights, market prices will reflect the opportunity cost of resources (discussed in Part 1, Element 1.2), and producers will be induced to produce the goods and services that are most highly valued by consumers compared to their production cost. Moreover, if contracts are enforced in a way that is efficient and without favoritism, transaction costs will be low and the volume of trade enlarged. When people and their property are protected, citizens can have confidence that they will not be cheated and that the wealth they create will not be taken from them—either by selfish intruders or by the government itself. This protection provides citizens with assurance that if they sow, they will be permitted to reap. When this protection is in place, people will sow and reap abundantly, and economic progress will result.

In contrast, when the protective function is performed poorly, problems abound. Opportunities to get ahead through deception, fraud, theft, and political favoritism rather than through production and trade will emerge. Earnings and wealth will not be secure, and market prices will fail to register the true cost of supplying goods and services. Incentives to develop resources will be weak, and economic growth will stagnate. Unfortunately, this is precisely the situation in many poor, less-developed countries.

The second primary function of government, the productive function, involves the provision of activities difficult to provide through markets. There is both an indirect and direct component of this productive function. The indirect component involves the creation of an environment for the efficient operation of markets through protection of property rights and stable money. As already noted, a legal structure that protects property rights and enforces contracts enhances gains from trade and market efficiency. Similarly, monetary arrangements that provide residents with access to money that has stable purchasing power across time reduces uncertainty and facilitates gains from exchange. The provision of a stable monetary and price environment is one of the most important productive functions of government. As discussed in Part 2, Element 2.5, when governments perform this function well, people will invest more, cooperate more fully through trade, and achieve higher income levels.

Sometimes the productive function of government is more direct. For some goods  markets are imperfect because establishing a one-to-one relationship between payment for and receipt of the good is difficult. Goods of this type are called public goods. Technically, for a good or service to be a public good it must possess two characteristics: (1) it must be “non-rival,” meaning that one person’s use does not reduce the amount available to another person; and (2) it must be “non-excludable,” meaning that if a person does not pay for the good there is no way they can be prevented from consuming it. Let’s start with a trivial example, a fireworks display. It’s both non-rival—one person watching it does not reduce the amount available to another person, and non-excludable—someone who does not pay for it cannot be prevented from watching it.

On a more serious level, national defense benefits all citizens and is jointly consumed by everyone. It would be virtually impossible to provide some citizens with protection against foreign aggressors without simultaneously providing it to all. If national defense were left to markets, they would likely produce too little defense to fully protect everyone. As a result, government provision of such goods may improve economic conditions. This issue is considered in more detail in Element 3-3, to come.

In other cases, it may be very costly to monitor usage and collect payments directly from users. When this is the case, it may be inefficient to provide such goods through markets. Roads, other than limited-access highways, have been used as an example. The cost of collecting fees and thereby charging users directly for their use would be exceedingly high. Thus, it has been typically more efficient to make most roads available to all and to finance them through taxation. With recent technological advances, however, the ability to automatically charge tolls for those entering certain areas, as is done by London and New York City mean that making users pay the costs of these roads is increasing feasible. Some might argue that parks provide an example, but clearly free admission to a park is a matter of choice as Disney World has easily established.

This is an important distinction. Some goods are “publicly provided goods” because society designates them as such because it is difficult to charge for them, while others are treated as such because of social preferences.

As we have stressed throughout, getting the most value from our resources requires that actions be undertaken only when the benefits exceed the costs. This principle applies to government as well as market activity. Unfortunately, when government action involves projects financed with taxes or through borrowing, both benefits and costs are difficult to measure. In the marketplace, the choices of buyers and sellers reveal information about benefits and costs. Consumers will not purchase goods unless they value them more than their price. Similarly, producers will not continue to supply goods unless they can cover their costs. But the information provided by the choices of consumers and producers is lost when the government undertakes an activity and finances it with taxes. There are no buyers spending their own money and thereby revealing information about their benefits. Moreover, the revenues paid to the suppliers were extracted through compulsory taxation, and therefore they provide no assurance that the project is valued more than its cost.

Government planners may try to estimate the costs and benefits, but their estimates to a large extent will be guesses, because they lack solid information based on the choices of buyers and sellers. Furthermore, in the real world, such cost-benefit calculations will often be influenced by political considerations.

As the quote from Thomas Jefferson introducing this element indicates, it is vitally important for government to restrain people from imposing harm on others (the government’s protective function). As John Maynard Keynes said:

“The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.”⁽⁷⁷⁾

Economics also indicates that there is a case for government provision of goods that are difficult to supply through markets (the government’s productive function). As the government moves beyond these activities, however, the case for still more government weakens. In order to better evaluate the economic role of both government and markets, it is important to develop a deeper understanding of the limitations of markets by applying the tools of economics to the political process.