What are free markets not good for?

In a comment to this post by Yazad, I said something to the effect that free markets probably do not have much of a role in areas such as national defence, internal security (aka police), education, social security, healthcare, etc. [I don't have access to the full post, so I am paraphrasing what I wrote]. Gaurav asked me in a follow-up comment what criteria one may use for deciding where free markets do not work well.

Now, I am not an economist to worry about such deep questions, nor am I a philosopher to ponder them for a living. This is my excuse for not being able to give a coherent answer to Gaurav's question. So, what can I do? Outsource the answer, that's what!

For a serious analysis, I will just refer you to two recent columns by Paul Krugman on healthcare, where he compares the largely private insurance based system in the US with the universal, publicly funded -- and less expensive and more effective -- systems in some West European countries. Universal access may be the reason why education and social security could fall in the same category as healthcare, so Krugman's arguments probably apply to them too.

As for internal security, I remember this debate in Reason in which the participants agonized over its place in an ideal libertarian society. You've got to read it to believe the kind of hand wringing that is required for reconciling libertarianism with the need for an internal security force (State Coercion!). In fact, it is so surreal and other-worldly, that it almost begged to be whacked. And, whacked, it certainly was, in this Belle Waring post, declared by Brad DeLong as "the best weblog post ever". Let us look at the key portions of this post (with emphasis added by me):

Reason recently published a debate held at its 35th anniversary banquet. The flavor of this discussion is indescribable. In its total estrangement from our political and social life today, its wilfull disregard of all known facts about human nature, it resembles nothing so much as a debate over some fine procedural point of end-stage communism, after the state has withered away.
...
Allow me to summarize.

Richard A. Epstein: even in the libertarian utopia, some forms of state coercion will be required. If we must assemble 100 plots of land to build a railway which will benefit all, and only 99 owners will sell, then we may need to force a lone holdout to accept a fair price for his land. Similarly, the public enforcement of private rights and the creation of infrastructure will require money, so there will have to be some taxes. [Note to self: no shit, Sherlock.]

Randy Barnett: Not so fast! Let's cross that bridge when we come to it rather than restricting liberty in advance. We'll know a lot more about human liberty in the libertarian utopia, and private entrepreneurs will solve these problems somehow without our needing to grant to governments the dangerous ability to confiscate our property in the name of some nebulous "public good." And as for rights enforcement -- look it's Halley's Comet!

David Friedman: Epstein places too much confidence in his proposed restrictions on government power. Rights could be enforced privately, and imperfect but workable solutions to the holdouts in the railway case could also be found. "To justify taxation we need the additional assumption that rights enforcement cannot be done by the state at a profit, despite historical examples of societies where the right to enforce the law and collect the resulting fines was a marketable asset."

Now, everyone close your eyes and try to imagine a private, profit-making rights-enforcement organization which does not resemble the mafia, a street gang, those pesky fire-fighters/arsonists/looters who used to provide such "services" in old New York and Tokyo, medieval tax-farmers, or a Lendu militia. (In general, if thoughts of the Eastern Congo intrude, I suggest waving them away with the invisible hand and repeating "that's anarcho-capitalism" several times.) Nothing's happening but a buzzing noise, right?

Now try it the wishful thinking way. Just wish that we might all live in a state of perfect liberty, free of taxation and intrusive government, and that we should all be wealthier as well as freer. Now wish that people should, despite that lack of any restraint on their actions such as might be formed by policemen, functioning law courts, the SEC, and so on, not spend all their time screwing each other in predictable ways ranging from ordinary rape, through the selling of fraudulent stocks in non-existent ventures, up to the wholesale dumping of mercury in the public water supplies. (I mean, the general stock of water from which people privately draw.) Awesome huh? ...

I am sure there are other online sources that present cogent arguments against free markets in some segments of the economy. As and when I find them, I will update this post. In the meantime, if you know of any, please feel free to add them in the comments. Thanks.