The Limits of the Market: The Pendulum between Government and Market.

• Author: Hemphill, Thomas A.
• Position: Book review

The Limits of the Market: The Pendulum between Government and Market

Paul De Grauwe

New York: Oxford University Press, 2017, 165 pp.

In the preface to The Limits of the Market, Paul De Grauwe, an economics professor at the London School of Economics, begins with two basic premises: first, that a centrally planned economy does not work; second, that pure market systems do not exist anywhere. According to De Grauwe, "The only relevant question, then, is how precisely that mixture should look"--that is, the correct mix of market freedom and public policy oversight.

He writes of a "Great Economic Pendulum"--that swings between greater and lesser government intervention--"cyclical movements" in economic history. To illustrate this, he describes a general decline in government involvement in the world economy during the first part of the 20th century. Then the Great Depression ushered in greater government involvement that continued through the middle decades of the century. That gave way to renewed market liberalization in the 1980s, which ended with the Great Recession. With this brief overview of modern economic history as his departure point, he begins to explain what he sees as the limits of capitalism.

"The limits of a market system relate to the fact that the connection between individual and collective rationality can be severed," De Grauwe writes. He identifies two types of situations in which large numbers of people do not believe that their own interests are being met satisfactorily by markets. The first type, which he labels "external limits," and others commonly call "externalities," involves individual decisions that have a positive or negative effect on others. The second category, "internal limits," involves the conflict between individuals' "System I" decisionmaking--relying on intuition and emotion--and "System II" decisionmaking--relying on reason. These two systems are connected and require a satisfying balance between emotional and rational demands in order for the market system to work effectively. Often, however, this balance of individual and collective rationality is not maintained.

DeGrauwe argues that individuals do not take into account the external effects of their individual decisions. He offers three examples of this: climate change and global warming ("carbon dioxide as a harmful gas generating external costs across geographic borders"); financial markets ("a banking crisis where the system reaches its limits before collapsing and requiring a government bail-out"); and public goods and the free-rider problem ("the market system has no mechanism for creating public goods").

He discusses how the expansion of the market system brings it to its "internal limits." He identifies three mechanisms that lead to the discrepancy between individual and collective well-being.

The first mechanism has to do with markets and distribution, whereby the price system leads to an inequality of income and wealth, a sense of injustice, and a desire for individual charity on the part of those able to purchase a good ("sharing with those not able to pay for a product"), as well as a possible revolt by those individuals in the lowest income groups ("protests and violent revolutions").

The second mechanism has to do with intrinsic and extrinsic motivation. Intrinsic motivation means "that people are...