Economists have difficulty reconciling free markets and the role of government. The ultra-iberals want everything to be free markets and private enterprise-the leftists want all to be run by a socialist government. I write this post to explain clearly which domains should best fall in government, and which ones should fall under free markets and private enterprise.
The rule-Government should dedicate itself to pain-relief type roles in society. The other activities, which are to increase citizens' pleasure, should be left to private enterprise.
A military (to protect citizens of country from other hostile countries) is best handled by an organized government. Mercenaries don't make good soldiers-when the country starts to lose they will run away. National glory and public esteem exist for soldiers-that's why they lay their lives for protecting their countrymen. Absent these-no sane man would fight for their country. A private enterprise military probably looks good in peace times, but any threat of a serious war, and these guys will disintegrate. Put another way, a private military will charge an exorbitant amount of money to provide security to a country, when really needed.
Police force (internal to the country-to protect citizens hurting each other) is another example where the government is best at doing the job. If private cops were hired for security, they would charge exorbitant amounts of money to give security. When you have an intruder outside and are begging for help on the 911 line, they will charge you $5000 to send a cop. Not good, is it?
Firefighters must also be a State run enterprise. It is a glorious, respectable job. The death of a firefighter in action gets the same respect as the death of a soldier or policeman in action. If firefighting became a private, monetary gain enterprise, costs of getting someone to put out a fire would be astronomical. There were private fire fighter companies when the United States was formed a few hundred years ago-there were many problems and they were all nationalized. See more details here in Tina Dupuy's article.
All countries of the world have these departments- military, police and firefighers under the government, as you might expect.
Notice that these are pain-relieving in nature-citizens need to pay these institutions of military and police to keep away the pain of being attacked by a foreign nation or by a violent individual in their country.
Now consider extraction of aluminum, a home builder, a cell phone provider, or a furniture maker. Products of these companies bring pleasure to society (most of their production, not all) and these are best left to private enterprise. However, a Government must ensure enough competition, at least 5 actors in each industry, to make this work. If there are 3 actors or less, they will collude to raise prices, and you will give them a monopoly against their own citizens. Any country which has less than or equal to 3 cell phone providers has cell phone companies charging exorbitant amounts of money for something which is very useful, but very cheap to make (cell networks). Most of the capital of cell phone providers is spend in useless activities like marketing, image-protection, and even thwarting entry of new competitors. They do not go to improve the network or reduce cost of calls. Countries where you have more than 3 cell phone providers have some of the lowest cost of cell phone calls in the world (e.g. UK, India).
Pleasure providing activities do not need a government to run them-and the capital for these must be left in the hands of private citizens and corporations.
Health care is an activity, because it is by it's very nature pain-relieving, is best left in the hands of the government. I am all for social medicine. All countries where public health care is low-e.g. USA, Chile, Canada, you have rich doctors, who become nothing more than merchants (that's their incentive). I don't like doctors who are very rich, just as I wouldn't like military people or policemen who are rich. I respect their profession, and large monetary compensation for them necessarily reduces my respect for them. Even a politician is like that-a rich politician deserves no respect from me, but one who lives reasonably but is more interested in doing good to society at a LOW PRICE is more likely to excite my respect. Doctors who are rich have already charged a HIGH PRICE for their service to me-I can't screw myself more by respecting them! I have given them my money, that's enough.
Instead of pain relieving, you can think of basic necessities. It is good if government dedicates itself to providing basic necessities of society-and the others are best taken care of by a free market (always with enough competitors). electric utilities are an example of an industry which is best kept in the hands of the government, or needs to be heavily regulated if there are less than 3 competitors.
The most important thing I want to take you from this post is that Free Markets DO NOT WORK for pain relieving activities, even if there is free competition. You can have any many doctors and private hospitals as you want, but that will not be a good system. The doctors and hospitals have a huge incentive to lie, to make up stuff to charge their patients more...and that's why these activities are not handled well by private enterprises. Someone lying about their car or coffee is one thing-but when doctors start to lie, it is a sad society. This has happened in The USA, Canada and Chile, where you have loads of these doctors and clinics who do completely unnecessary procedures to people. The goal is mercenary. A public health system would be much better for healthcare. Even poor India and relatively poor Argentina have vastly better healthcare, with good moralistic doctors, than Chile, Canada or USA. The incentives for the profession have not been set right-a doctor should strive to be prestigious, a life saver-and not to make more money! Just as a policeman or a military guy-I don't want any of these guys to be rich. A society where they are rich is not a fun society for me. France is a great example of a country to emulate in health care-it is almost all public, there is absence of large private hospitals, and there are no rich doctors. I don't know much about Germany's Health Care, but probably is similar to France-have never met a rich German doctor.
In France, a person who is more sick pays less; the very sick and old people pay nothing. The co-pay goes down with the degree of illness. It is only humane that someone who is already very sick with a bad illness, e.g. Cancer, be charged LESS than someone who comes about with a minor problem, that the State or Society as a whole bear a larger fraction of the cost for the former. Terminally ill patients do not pay anything in France for health-care. Capitalism in medicine has it backwards-if you are really sick, you pay more. You can see the problem now-the system is illogical, the really sick and the dying are given a double whammy of paying more.
Or consider this example...how can you feel good charging thousands of dollars per day for a baby born premature, or for giving someone a fast palliative surgery? The doctors who are doing this all are a "part of the system"..and you are left footing the bill. All morality in providing for your brethren when they need you is lost when healthcare and drugs are privatized; you need a strong public system to administer this vital part of society. I have found substantial difficulty paying in countries where healthcare is private not because of the money, but because of the morality of paying someone to relieve me of my bad state. On the other hand, I have no problem if someone wants to charge $100K for a Tesla or a few million dollars for an apartment in Manhattan; those are pleasure providing objects, and the seller should try to charge the maximum they can in such dealings. However, for pain-relieving activities, the seller should charge the minimum-it is morally the only way you can feel good if you are a seller of pain-relieving activities like doctors, pharmacies, firefighters, police, etc.
Something similar happens in the US in another field-you get medical insurance if you have a job. If you don't have a job, you don't have medical insurance. It is exactly the ones who do not have a job who need more help-but the rules are designed instead to punish them even more. The rationale for this policy is that bums should not be supported by society, etc. Completely ignored is that fact that getting a job is not easy, and most people out of a job are not bums, are just temporarily out. The medical insurance tied to having a job is a really bizarre practice in that sense.
In some ways what I am saying is an extension of what Smith realized-that people dont want to pay anything for things they need, but will pay happily for things they want. He gave the example of water-everyone needs water, but no one wants to pay for it exorbitantly. The same goes with basic necessities-they should be as cheap as possible, if not free-because in the end the NET PRODUCTIVE OUTPUT of society, as measured by the consumable goods it produces, will go up. A society full of doctors and funeral services people is clearly a very poor and miserable society.
Same goes for Insurance providers. We don't want them to be rich-we want them to have their low profits and let them provide a service to society at the lowest cost possible (division and spreading out of risk is their main job).
Productive labor is the labor which produces stuff (consumable goods) in society. The other part of society, military men, lawyers, doctors, police, etc. are non-productive, even though they are very useful. They help the productive part of society produce better, more efficiently, or produce more.
Pharmaceutical companies are a case in point. You would think that when you buy stock in Pfizer or Merck you are buying scientists and innovation-but a large part of these companies are people working in distribution, marketing, and sales people. The common capitalistic argument that paying high price for your drugs (medicines) puts more money into the pockets of these companies and therefore encourages innovation is false-because most money is gone to increase sales forces, management teams, etc. Plus even if it would go 100% to scientists, it would encourage fraud and fudging of data. No one said that you get a better police force or military if you pay for it directly. Why are we saying it for doctors and big pharma?
The argument that you need to pay them to advance innovation and cutting edge science is false. NASA and the US Military come up with loads of innovative technologies-and are Government owned. Innovation and Science is a great thing in itself-there is no need for exorbitant monetary gain to get with it. True Doctors who really want to help people should not want to become stinking rich. More on this here.
Therefore, the original rule I said-that things which are pain relieving in society should come as cheap as possible, becomes even more plausible. Encouraging this automatically increases the overall production of society-the cheapness of pain relieving activities or necessities of life encourages the production of other (wanted but not needed) consumable goods. Let those be governed by the free markets, etc. but essential goods and services a society should try to produce at the lowest cost, and if that means they rest with the Government (like the police and military), so be it.
I want to stress that I don't want to see doctors who are poor-just like I don't want to see police, fire-fighters or military men who are poor. I want them to live well, earn their decent, stable earnings; but none of these categories of people I want to see being very rich. If money is their compensation, they are prone to lie to and abuse the other members of their society or country.