From the inception of economics as a discipline, it has developed an unquestionable relation with the issues of state and governance. This is very evident from one of the earlier texts in political economy – Kautilya’s Arthasastra. It elaborates on almost all aspects of the economy and guidelines to refine the governance system in a way to build a strong and stable economy.

All classical economists – such as Adam Smith, Ricardo, and JS Mill, among others – have emphasised on the role of the state in building up and regulating the economy. Only in the later period of neo-classical economics do we witness the growth and strengthening of the laissez-faire concept, which states that market can function smoothly by itself and hence the government shouldn’t intervene in its activities and obstruct its equilibrium. But this was not the end of the story; in due course the world witnessed the great fall of market forces in keeping the economy in equilibrium and lost belief in the magic of the invisible hand.

Keynes restored the scope of government intervention in correcting market failures. This has unravelled the myth that the market can’t fail.

But the economic history opened new eras of crisis and the corrective mechanisms was to again go back to the so-called self-correcting market arguments. The world has passed through several crises in the 1970s and the 1990s and we have recently witnessed the 2008 financial crisis.

In all these decades, economists and governments were oscillating between the two major schools of thoughts that primarily differ in the role of the state in driving the economy. The major ideological debates in the world have, in fact, always revolved around this question since the origin of economics as a discipline. But it’s still misty what the universally acceptable take on good governance is for an economist amid all these heterogenetic opinions on the role of a state.

In the history of economics there is a diversion from linear progression of this discipline to a parallel stream developed by a group of economists, especially on the question of possession and regulation of the means of production, which is the base for all economic activities. This group is called Marxist economists because they are identified with the pioneer of this school of thought: Karl Marx. Many a time they were portrayed and misunderstood as a group that talks about exploitation, surplus value, class conflicts and revolution. But a study that goes deep into the roots of Marxist economics essentially is a different approach to the same question facing all lines of thought in economics — what should the interface between the state and the market be? Redistribution of resources is at the core of the Marxist argument on good governance.

According to Marxist economists, the state is a device to initiate and accelerate the process of redistribution by using its sovereign power, causing the society to be more equitable. At the same time, they critique the state by pointing out its role in capitalistic accumulation. In such a process, the Marxist economists hold, the state often becomes the facilitator. Arguments like nationalisation of resources and establishment of a socialist mode of production is the Marxist way of redefining the role of the state in the economy.  

With this background, it is easy to bring out economists’ notions of good governance. The strategy for good governance should be to understand the differences between their thoughts. This will give us a complete idea of the various components of good governance such as accountability, transparency, participation and equity. As a preliminary observation, neo-classical economics can only address the questions of accountability and transparency, which are important indicators in the efficiency argument. It is from here that Keynesian and Marxists economists take separate routes, arguing for equity as an indicator of good governance and good economic policy, where they see the state as a disciplinarian of the market, correcting the latter’s failures.

Can state address market's failures?

• This brings us to a new set of questions.
• What are the failures of the market?
• How can these be addressed by the state (as good governance)?

These are questions economists ask of themselves and the polity at large. The origin of sub-disciplines of economic studies and practice like new institutional economics, law and economics, welfare economics, developmental economics, etc. have an inseparable connection with these questions originally raised during debates on efficiency and equity.  

Allocation of scarce resources was a major focus of economics till one point of time. One of the questions asked of free-market economies is whether they have been able to allocate resources efficiently in all cases. A close analysis reveals that markets are not able to achieve and maintain efficiency in allocation, which is the most important cause of their failure. Competition in free-market economy is no panacea for efficiency. In the face of such market failures, the government's role as a corrector is well-recognised by economists.

Intervention by the government in the economy is very necessary to enable individuals to move beyond the Pareto frontier and reach a higher state of welfare, thereby making a Pareto improvement. (Pareto efficiency, or Pareto optimality, is a state of allocation of resources in which it is impossible to make any one individual better off without making at least one individual worse off. Pareto improvement, in neo-classical economics, is an action done in an economy that harms no one and helps at least one person.)

Markets are usually considered to be efficient due to certain features – such as better information, better adaptability, greater flexibility and decentralisation of power. Prices reflect all information in the market. All actors in a market are able to avail information and able to act accordingly. At the same time, market provides greater flexibility to individuals and their personal adaptations. The capability of market to adapt to the changing conditions and then reflect it through prices gives it scope for greater adaptability in the system. The market system has a complete decentralised structure.

If the free-market economy is ‘the best’ resource allocation mechanism, how do the failures appear? No market economy can achieve perfect allocation because some imperfections are innate to the system. This gives rise to questions like what alternative methods are there or how can these imperfections be corrected. Government intervention in the markets is the most widely-accepted way to address this issue. Even though there some differing voices on this issue which say the government interventions are a generate disturbances in the smooth functioning markets, most economists do see some merit in involving the government in the economy. With the Keynesian revolution, this became the order of the day.

Marxist economists also emphasise on the point that state ownership of resources are the best way to tackle the issues of efficient allocation and equity. Well-known economists Lipsey and Chrystal identifies 7 major cases of market failures — inefficient exclusion, common property resources, public goods, externalities, asymmetric information, missing markets and monopoly. In this context, it is very important for a responsible government to make policy interventions to tackle these.

But it is very clear that these government actions come with their own set of pros and cons. Economists view good governance from this point of view and they try and estimate how effective government policies are in correcting for market failures from a paradigm of minimising the cons. However, these attempts can only moderate the effects of market imperfections; they can’t be a real panacea for the pathology of markets.

Apart from all the above questions on efficiency there is also a serious question on equity which is under the consideration of economists. Despite a slowdown, the world economy is on a path or growth. What is worrying is that inequality is also on the rise. Markets are not capable of altering the existing distributional pattern but they can efficiently manage to continue the allocation through signals of the price mechanism. So, markets are not capable of efficiently allocating resources to achieve the wider objectives such as equitable income distribution and other social goals of welfare. Government intervention, again, is the most widely-accepted remedy to these problems of wealth and income inequality in the society. But “often the goal of a more equitable distribution conflicts with the goal of a more efficient economy”. This point throws some light on the unending debate between the neoclassical and Marxist economists. On this point, up to a certain level, Keynesians also agree with the equity argument and they highlight the role of government in addressing the widening income inequality and how it will reduce the vulnerability of an effective demand crisis in the economy.

In this context, good governance will be the best way to protect the basic rights of the population and their right to have an equitable society. Governments will be the pioneering agents to decide and instrumentalise the policies on education, health, food, housing, etc. of their subjects. This will be also a better grievance-redress system on the sharing of resources. According to Marx, governments should own the resources and should ensure that their respective populations are able to derive equal amount of benefit from these in a conflict-free manner. The protective legislations and policies and all are part of this mission. Direct and indirect taxes, subsidies, public expenditure, inclusive growth policies, redistributive measures and other welfare measures are the tools with which governments devise their good governance measures.

Governance incurs costs which should be kept at the minimum. New institutional economics specifically address the questions of transaction cost. Government policies should aim at maximum benefit to the larger population with minimum spending. Economists always tend to analyse the government policies in a cost-benefit framework; other considerations are secondary to them. Usage of science and technology to modernise governance is a major point which economists tend to support as a method to minimise the cost and increase transparency and accountability.

In a nutshell, economists’ perception of good governance is very divergent and based on the efficiency and equity arguments. These two principles may play out contradictorily in many cases. These concepts can only be analysed historically. Early-period economists emphasised on the interventionist and growth promoting activities of the state. National wealth and revenue became the central themes. But later, the neo-classical economists emphasised on the original and self-regulating power of the market to keep economy in perfect equilibrium. Good governance is, thus, restricted to the efficiency in the police functions of the state. But with the coming up of Keynesian economics, it has to be spread across various economic activities as a regulator and an agent of welfare. Since the 1970s, economists started paying greater attention to this concept. The key words became inclusive growth and governance. What economists view as good governance is a part and parcel of an evolutionary history of economic thought which can be a guideline to address the issues coming up.