Understanding the topic

Neoclassical economics is underpinned by a number of core concepts that have an impact on how we analyse the economy and create public policy. General equilibrium theory and market failure theory are central to understanding the neoclassical paradigm and its consequences on public policy-making.

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Understanding the essay question

Focusing on the green job economy and the policies that have been influenced by the UK's net-zero ambitions, this essay will connect economic theory to real-life policy scenarios to clearly describe, synthesise, and then contrast government interventions that are supported by the neoclassical paradigm of market-fixing and those that are supported by a new economic thinking theory of market-shaping.

This essay will explore how the market-failure theory of neoclassical economics negatively casts the role of the state as market fixer, intervenor, enforcer or redistributor (Sekera, 2020) through government interventions in the form of public goods, regulations, and market-based incentives to correct externalities and achieve an ever romanticised 'equilibrium'. This essay will then contrast the neoclassical paradigm of market-fixing to a new economic theory of market-shaping – an approach to policy-making that emphasises the role of the state as one that co-produces value, collaborates across public and private sectors, and facilitates the direction of markets over the long-term.

By identifying, describing, and contrasting real-life policy scenarios that reflect either a market-fixing or market-shaping rationale, this essay will argue how each is supported by the appropriate rationale and demonstrate the wide-reaching impacts each has on policy-making within the green job economy.

Understanding the topic

Neoclassical economics can be characterised by its romanticised obsession with markets. It has an unwavering emphasis on the rationality of individuals and their maximisation of utility, and outright neglects any kind of historical or social context (Dequech, 2007; Johnson, 2017). At its core, it is a theory of economics that depicts the economy as a market (Chang, 2002), focusing on the exchange of value within it, the efficient allocation of resources, and the need for government intervention to correct positive or negative externalities.

Neoclassical economics is built on the premise that the ideal market is equated with perfectly competitive markets that drive efficient outcomes. The General Equilibrium (GE) theory, popularised by economists Leon Walras and Vilfredo Pareto and later developed by economists Kenneth Arrow and Gérard Debreu, uses mathematics to understand the conditions in which an economy reaches a state of equilibrium. Equilibrium in neoclassical economics is essential. It represents the optimal allocation of resources and goods, and in Pareto-efficient markets, no change can be made without making someone worse off. Its the picture of a perfectly balanced market with efficient outcomes. The First Fundamental Theorem (FFT) of welfare economics (Arrow, 1951) defines the conditions that are required for Pareto-efficient markets and acts as a starting point for market failure theory (Mazzucato, Ryan-Collins 2022). Put simply, if any of the three conditions set out by the FFT for 'perfect markets' is not met - prices are incorrect, individual actors fail to behave rationally, or equilibrium is not achieved - then the market is deemed as not achieving allocative efficiency and is in a state of failure. Under these conditions, the influence of Arrow's GE theory reinforces the role of the state as an institution that supports the market. It suggests that government intervention is only required to fix situations in which markets fail to efficiently allocate resources (Arrow, 1951).

The role of the state as one that facilitates change, rather than directly creating it, is symptomatic of the market failure approach to policy-making (Lundvall, 1992) and inherently restricts the types of government interventions that can be deployed. Marianna Mazzucato and Joshua Ryan-Collins argue that because policymakers have interpreted and utilised the concept of market failure as a justification for public policy intervention, it limits the role of the state to one that is seen as merely "administering," "fixing," "regulating," or at best "facilitating" and "de-risking" (2016, 2022). This concept of economics, argues June Sekera, associates public action with a host of discouraging problems in government interventions (2020). For positive externalities created by "public goods" that are both non-rivalrous and non-excludable, the state is left as a lone actor because the private sector has no incentive to create value in which the public would "free-ride" – otherwise known as "the tragedy of the commons". For negative externalities, such as pollution, the state is responsible for fixing the market through regulations and market mechanisms to internalise external costs (Mazzucato, Ryan-Collins 2022). The central problem with these types of interventions is that, while they aim to create optimal market conditions, they often lead to suboptimal outcomes from a societal perspective (Lundvall, 1992) because of the lack of consideration towards social context and broader outcomes. Fundamentally, the neoclassical paradigm of economics forces the state into a role that prevents it from shaping or leading change.

Market-shaping, on the other hand, is an alternative approach to policy-making that begins with notion of public value as being collectively generated. It’s an approach that is built on Karl Polanyi’s (1957) perspective that markets should be considered as outcomes of the interactions of individuals, firms and the state. This new economic approach depicts government interventions, not as simple corrections to market failures but as objectives in and of themselves (Mazzucato, Ryan-Collins 2022) and can lead to more sustainable and equitable policy-making. The characteristics of a market-shaping approach can best be articulated through Mariana Mazzucato's 'R-O-A-R framework', as outlined in her practical approach to implementing mission-oriented innovation policies (2016, 2017). These characteristics can be defined as: (1) policies that actively set directions of change, fostering more dynamic, bottom-up exploration, discovery, and learning; (2) policies that encourage public organisations to learn by doing and build absorptive capacity; (3) policies that transform static metrics into dynamic ones that go beyond the static ideas embodied in cost/benefit analysis; and (4) policies that build symbiotic private-public partnerships that form new deals, sharing the risks and rewards of investments.