Good government makes a market economy possible, period. And bad government ruins the positives of capitalism, which is one of the many reasons why people around the world are in poverty.
Firstly, countries without functioning governments aren’t a utopia of free market prosperity. The government makes the rules. Around the world, there are places where it is near impossible to conduct the simplest business due to the lack of a functioning government.
A first example being Nigeria, which hosts one of the worlds’s largest oil reserves, yet businesses face the problem of BYOI- bring your own infrastructure. This means that it is very difficult to do business even though there is wealth of raw materials at hand. But this isn’t an example of how the free market has failed; it’s an example of how the government has failed to develop the infrastructure needed to support a market economy. Without good governance, the effect of trickle-down economic development will be minimal.
The harsh reality is that no one really like the umpire, but the umpire is essential, regardless. Firstly, the government defines and protects property rights. You own things, and, to an extent, you can do what you want with them. You can sell it, rent it, whatever. And most importantly, you can invest in your property with full confidence whatever return you get, will also belong to you. No one else is going to claim your property as their own.
The same idea works with ownerships of art, ideas and inventions. Take the example of a book, from the stage of writing it, and then publishing it, and then selling it; only private parties are involved, and logically any government intervention would only be an inconvenience. You might even think the government is hindering the business by taxing the income of the author. But, the whole process is made possible by copyright law, which is a crucial form of property rights. No one can steal the contents of the book and publish it without playing royalties.
Similarly the government enforces rights such as patents to the company that invented Viagra, for example. The ingredients inside a Viagra pill cost pennies to make, but because Pfizer has a patent on Viagra giving it a monopoly on the right to sell the pill for a number of years, charging $7 for a pill. This huge mark up, which also happens with new HIV/AIDS drugs and other essential products, is referred to as social injustice by many.
If everyone else was allowed to make Viagra, the price of the pill would fall drastically due to the availability of immediate substitutes. The reason that Pfizer is still overpricing its customers is because if Viagra didn’t get patent production, then Pfizer would have never invested the massive amount of money and resources necessary to invent the pill initially.
The real cost of breakthrough drugs is the research and development that goes into them, rather than the production of each individual pill. The average cost of bringing a new drug into the market is somewhere in the ballpark of $600 million. The government could buy out the patent when a new drug is invented, in an effort to supply low cost drugs to the people and keep the incentive for firms to innovate. But this could cause problems in the fact that is very expensive and who gets to decide what drug remains patented and what doesn’t. Regardless of that, this idea lays in line with the basic economic reality that individuals and firms will only invest if they are guaranteed a return.
Effective regulation makes markets more credible. Because of the government, you can buy shares in the FTSE 100 with confidence that neither the company nor the traders are participating in fraud. The government is responsible for the law. The institution that is the government allows us to undertake complex transactions with people we don’t know.
We give our hard-earned money to a person at the bank, who we have never met before; and we do this because we know that there is infrastructure in place to that means the person won’t pocket the money for themselves.