Exaggerating Market Failure, Forgetting State Failure

History shows that nations that forget their own limitations often fail in much more expensive ways. In Indonesia today, almost every economic issue seems to lead to the same conclusion: the state must play a larger role. The state is entering various economic spheres through downstreaming, strengthening the role of State-Owned Enterprises (SOEs), the formation of Danantara, the Free Nutritious Meal (MBG) programme, village cooperatives, and the discourse on forming a national export agency. Almost all these policies stem from a similar diagnosis: the market is deemed to have failed to produce the desired economic outcomes.

This logic is not without merit. Various economic literatures prove that market failure does indeed occur. Joseph Stiglitz (1989) stated that markets cannot function effectively and fairly when there is asymmetric information, externalities, monopolies, or coordination problems. In present-day Indonesia, various economic issues, such as inequality, weak industrialisation, oligopolistic dominance, and low added value of natural resources, are indeed often viewed as manifestations of market failure.

Therefore, the state indeed has an important role in performing corrections when the market fails to work optimally. However, the problem arises when the existence of market failure is immediately assumed to be an automatic justification for the expansion of state intervention. It is as if every economic problem requires more state intervention. In reality, modern political economy has long warned that the state itself can also fail. When market failures are exaggerated while state failures are ignored, interventions originally intended as solutions have the potential to create new distortions.

In Indonesia, warnings regarding the risks of state failure are not new. Soemitro Djojohadikusumo (1977), one of the architects of Indonesia’s developmentalist thought, believed that the state must play a central role in economic development. However, Soemitro never assumed that the state was automatically effective. He emphasised that state intervention can only succeed if supported by several heavy prerequisites: political leadership with deep social responsibility, the ability to understand development dilemmas and strategic choices, adequate technocratic capacity, and a power framework that allows for effective public participation.

In other words, an active state does not automatically mean an effective state. Failing to meet these prerequisites can lead to state failure in the form of bureaucratic inefficiency, policy distortion, economic rent-seeking, and corruption. The problem is that the expansion of state intervention today appears to be developing much faster than the development of its own institutional capacity.

Ironically, state failure is much less discussed than market failure. When food prices rise, the public immediately sees market failure. When the Rupiah weakens, the market mechanism and global sentiment are blamed. When investment slows, the business world is scrutinised. When domestic industry loses competitiveness, the market becomes the primary defendant. Conversely, when state intervention creates regulatory uncertainty, inefficient bureaucracy, opportunities for rent-seeking, or corrupt practices, the impact often emerges slowly and widely, making it not always immediately visible.

The issue is that the state is not a perfect institution. Friedrich Hayek (1945) once warned that economic information signals are dispersed across various elements of society. Various signals, such as consumer preferences, business risks, production conditions, and technological changes, are always shifting and cannot always be fully and accurately captured by the government. Thus, there is an implicit assumption that the bureaucracy can process economic information better than market mechanisms when the state takes on too many roles in the economy.

In practice, this assumption tends to be overly optimistic. Public choice literature, pioneered by James Buchanan and Gordon Tullock (1962), shows that political actors and bureaucrats are not entirely neutral institutions. They also possess political incentives, organisational interests, and the drive to maintain power and resources. Therefore, the larger the space for state intervention, the greater the opportunity for rent-seeking, patronage, and corruption. The greatest problem for an overconfident state is that it begins to see almost every issue as a reason to expand itself.

The state should not be a primary player in the market, but rather an institution that creates a conducive business and investment climate, provides legal certainty, and ensures effective rule enforcement. The state should act as a referee, not as a player. Meanwhile, the function as a market participant should be largely left to the business world and the community. The presence of the state as a market player can only be justified in sectors where the private sector is truly unable or finds it unattractive to provide goods and services adequately.

However, current policy trends indicate the opposite direction. Danantara, for example, has the potential to position the state as a dominant player in various strategic sectors that have long been spaces for investment by national or foreign private companies. The MBG programme on a large scale also has the potential to displace school canteen businesses and local food providers who previously lived from the consumption ecosystem within educational environments. Meanwhile, village cooperatives formed top-down could create direct competition with small grocery stores and small distribution networks that have grown organically at the village level.