Private-Market Misfires and Misconceptions

When government lets the market fix policy problems, it often fails.
by | February 2016

Donald F. Kettl

Donald is a Governing columnist, former dean of the School of Public Policy at the University of Maryland, a nonresident senior fellow at the Volcker Alliance and a nonresident senior fellow at the Brookings Institution.

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It’s no secret that Americans like private markets better than they like government. In a 2014 Pew Research Center poll, 70 percent of Americans said they believed they were better off in a free market system. Only in South Korea and Germany do citizens like markets more.

From environmental policy to health care, this basic finding has framed the critical decisions of government in recent years. If we want to take on a new policy challenge, citizens and policy experts seem to agree, it’s better to trust the states than Washington. And the states should do as much as possible through private markets.

The strategy has launched some remarkable policy innovations. But most of the time, it hasn’t worked out so well in practice.

Take the movement to reduce carbon emissions. In the 2000s, many states embarked on a revolutionary cap-and-trade strategy. They would set a cap on acceptable greenhouse gas levels, businesses would pay for the right to emit the gases and the hidden hand of the market would reduce pollution by the largest amount at the lowest cost. By 2008, according to a count by the University of Michigan’s Barry Rabe in the journal Governance, 23 states had joined the effort. It seemed a perfect solution. New markets developed, and regional consortia planned to reduce greenhouse gases by 10 percent or more within a few years.

But that perfect solution didn’t last long. Rabe found that, within five years, more than half the states had walked away from their cap-and-trade commitment. The market-based alternative to command-and-control regulations evaporated as a state-based policy tool.

Then there’s the marketplace system at the core of the Affordable Care Act. It’s easy to forget that the Obama administration originally was trying to avoid using a Washington-driven hammer. Instead, the plan aimed to provide health insurance to everyone by encouraging the states to do the job -- and having the states work through market-based insurance exchanges to make the policies available.

Relying on state-based markets seemed a logical step, both ideologically and pragmatically. It stood to minimize complaints about big government by pushing policy implementation into the private sector, and it echoed the Pew poll results. After all, there’s scarcely a more popular refrain than the one that proclaims government should be run more like a private business. But as in the cap-and-trade example, this market-based strategy just didn’t work well. State implementation proved wildly uneven. Federal policymakers found themselves without the results they sought. And everyone came away more convinced than ever that government couldn’t solve problems like this, even though many of the problems were rooted in private market failures.

By the end of 2015, 38 states had declined to set up health-care exchanges, leaving the federal government to step in and create them. Three states -- Hawaii, Nevada and Oregon -- tried the exchange approach and backed out when enrollment was lower and costs were higher than expected. Some states, like Maryland and Washington, enthusiastically embraced the exchanges but fumbled the launch. Pressed by angry Republicans, who criticized the states’ lack of accountability for federal funds, the Obama administration took back $200 million in grants it had made to states that had struggled to launch their exchanges.

Why did these efforts fail?

Part of the answer has to do with the partisan makeup of the statehouses. Republicans hold 31 of the 50 governorships, and many of the Republican governors came to office touting free markets and smaller government. In most states, the champions of aggressive policy innovation are on the run. Fewer citizens in these conservative states believe that climate change is manmade, and that reduces the incentives for state-level action. The fumbled launch of the Affordable Care Act website eroded public support for health-care reform. The appetite for strong state policy initiatives has gradually evaporated.

Moreover, as Rabe points out, managing the pollution market mechanisms turned out to be hard, and financially strapped states had a shrinking capacity to do the job well. That was even truer for the health exchanges, where some of the most ambitious states stumbled despite their aggressive efforts.

The fundamental flaw lies in two assumptions: that markets always work better than governments and that markets will run themselves if government gets out of the way. The first assumption is the stuff of fierce ideological debate, but the second is really a settled question. Markets just don’t run themselves in delivering public goods, because most of the time they are being asked to do things they aren’t used to doing. And because policymakers tend to assume that the markets will take care of themselves, they often don’t build governmental capacity to steer the process. The reformers then end up running after problems as they develop down the line.

It’s tempting to dance around the big battles over the size of government by assuming private markets can step in and fix everything. Too often, we end up abandoning the markets, disappointing the customers and undermining everyone’s confidence in leadership. There’s no sidestepping the fact that government requires governing.

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