To this point we have espoused a rather ambitious view concerning the objectives of government planning. We sought “first-best” solutions and placed no a priori restrictions on the scope of government activity. Unfortunately, we were forced to conclude in Chapter 5 that there was little hope of finding incentive-compatible mechanisms that were both workable and comprehensive in coverage. Therefore, we will limit our objectives in most of the sequel.

The nature of our limitations involves leaving a large segment of the economy in an uncontrolled market sector and using a variety of indirect methods to allocate remaining goods in a public sector. This view of the scope of public activity is most easily justified on positive grounds: The U.S. economy has evolved into one having this mixed structure, so we want to know how well it can be expected to work. However, there is some reason to believe that the mixed economy can be given a normative justification as well. That is, such a division of responsibility in allocation may be the second-best optimal organizational form when all informational and incentive costs are accounted for correctly.

Although we cannot prove the second-best optimality of a mixed-economy structure, we can draw on material from earlier chapters to give an informal argument. We saw in Chapter 3 that market decentralization involves a considerable saving in information collection and transmission as compared to other potential allocation methods; further, such decentralization achieves a first-best allocation for the class of private goods if agents can be made to behave competitively.