From the time Lehman Brothers filed for bankruptcy last September, most politicians and public servants have been busy trying to contain the damage of the global economic crisis, without paying much attention to the economic order that may emerge in the recovery phase.

Some believe that in time governments will have served their role, having absorbed bad debts and handed back the de-toxified financial institutions to their rightful owners, who can get on with the business of financial speculation.

And some believe that the crisis is the end of capitalism as we know it.

Between these extremes are more considered views, such as that put forward by Kevin Rudd in his recent essay on ‘The Global Financial Crisis’ in The Monthly.

Rudd acknowledged that the crisis marks a turning point from one epoch to another, but he also warned us ‘not to throw out the baby with the bathwater’ and to resist the pressure to retreat to ‘some model of an all-providing state and to abandon altogether the cause of open, competitive markets both at home and abroad’.

We have witnessed a stark demonstration of market failure –– the greatest such failure in eighty years. It demonstrates the paucity of the economic philosophy of neoliberalism, which took hold in the 1980s. This philosophy has been described by John Halligan of the University of Canberra as ‘private sector primacy’ –– essentially a mirror image of the old Soviet model, which put primacy on central planning and public ownership. It essentially denied the existence of market failure; and even if there was evidence of market failure, the counter argument was that government failure is much worse.

Contrary to some perceptions, this was not a retreat to ‘small government’. As neoliberalism inflicted pain on vulnerable groups, and opened up widening economic disparities, governments found they had to boost social security transfers, such as family allowances in Australia, to compensate for the incapacity of weakened economies to provide well-paying jobs. Public spending came to be seen simply as a fiscal tap to be turned on or off as macroeconomic or political conditions required, with scant regard to its benefits. A tourist railroad in Beaudesert, a ‘road to recovery’ to Marree, a grant to the ethanol industry all fell into the broad category of ‘public spending’ –– something governments did but not subject to the rigours of benefit–cost analysis or the tests of market failure.

The fiscal taps are now flowing freely, but the process is still haphazard. Why, for example, is the Queensland Government spending $60 million on a football stadium on the Gold Coast? Why is the Commonwealth Government spending another $3.4 billion on assistance to the car manufacturing industry? What market failures justify these outlays? If people want to watch football on the Gold Coast, why can they not pay for it? If we need more fuel-efficient cars, why will the private market not provide them?

At the same time, governments are still neglecting economic needs where the private sector cannot provide at all, particularly in areas such as environmental protection, education and public health. And they're trying to use the private sector to provide some public goods at very high cost, such as toll roads, and other expensive public–private partnerships.

Governments should be guided by a clear understanding of when private markets do and do not work. Not some sloppy ‘third way’ with a little socialism here, a little capitalism there, but a firm idea of government’s legitimate economic role as a contributor to our common wealth.