Aktuelle Volkswirtschaftslehre: In your view, what are the principal strengths of a market economy, particularly when it comes to coordinating economic activity?
Jürg Müller: A market economy has two fundamental strengths. The first is economic in nature: a market-based system is an extraordinarily effective mechanism for coordination. It brings together knowledge, skills and preferences that are dispersed across individuals, firms and countries, combining them into a functioning whole. Prices play the central role in this process. They make it possible to reflect these decentralized pieces of information and coordinate them efficiently. Added to this is competition, which drives innovation and ensures that companies compete with one another. Inferior or overpriced products and services are gradually pushed out of the market.
The second strength is closely related to the first. Because this coordination takes place without centralized control, it both requires and reinforces individual freedom. People can make their own choices, start businesses, experiment with new ideas and take responsibility for their actions. It is no coincidence that Adam Smith was first and foremost a moral philosopher. He recognized that the “market economy” as a form of organization not only generates prosperity; it is also a framework that promotes individual freedom.
Under what conditions does a market economy reach its limits, and when do economists speak of market failure?
A market economy faces two broad limitations. First, it is essentially “blind” to questions of distribution. While it can determine whether an outcome is efficient, it cannot tell us whether that outcome is morally desirable; such questions must be resolved through public discourse.
Second, there are situations in which markets fail to produce efficient outcomes. In such cases, we speak of market failure. One example involves externalities, where economic actions affect third parties without the associated costs or benefits being fully reflected in market prices. Noise pollution or environmental damage are classic examples. A second case concerns public goods, which markets tend to underprovide. National defense is the textbook example. Third, information asymmetries among market participants can lead to market collapse, as can occur in insurance markets. Fourth, there is market power. In the case of natural monopolies, a single provider may produce more efficiently than multiple providers (e.g., railway infrastructure), and that provider then gains market power. Market power can also arise from collusive arrangements (e.g., cartels).
Many forms of market failure involve environmental issues, shared resources or externalities. What role should prices and competition play in addressing these problems?
They should play a central role. Economists have long developed tools for internalizing external costs, including carbon taxes and tradable emissions permits. Such instruments deliberately harness the pricing mechanism: those who impose costs on the environment should bear those costs. Competition then encourages firms to develop the most efficient and environmentally friendly solutions. In practice, however, policymakers often resort to bans or subsidies, which usually distort incentives for innovation and competition.
When markets fail, calls for intervention often follow. What role should the state play, and where are the limits of intervention?
The state can improve outcomes when market failures exist. Wherever possible, however, it should seek to harness competitive forces rather than replace them. At the same time, it is important to recognize that state action can make matters worse. Not only markets fail – the state can fail too.
This can happen in two ways. First, the state may postulate and address a market failure where none exists. This often occurs when the behavior of responsible adults is to be steered in a politically desired direction. Second, the state may respond incorrectly to a genuine market failure. Such cases often lead to regulatory spirals, as attempts are made to mitigate the counterproductive effects of original rules with new ones – which, in turn, can cause new unintended consequences.
From an economic perspective, how should one decide whether a problem is best addressed by markets, regulation or other institutions?
From an economic perspective, one should first diagnose the problem precisely. Is there a market failure? If not, the matter can generally be left to private actors. If so, a second question arises: Which instrument addresses the problem most directly and with the fewest unintended side effects – that is, which solution is both effective and efficient.
In some cases, civil-society solutions may be the best answer. In others, clear rules by the state may be necessary. The key is a clear-headed assessment of the advantages and disadvantages of all available options.
This interview appeared in the latest edition of “Aktuelle Volkswirtschaftslehre 2026/2027”, edited by Jan-Egbert Sturm and Peter Eisenhut and published by Somedia Book Publishing.
