Two spectres stalk our world the - market and the state, and one or the other is blamed for all its ills. Some feel a visceral aversion to or mistrust of 'the market': they observe its invasion of ever widening areas of our lives and they see it as corrupting what is human, just and decent in them. Others feel similarly about 'the state': they rail against state planning and state 'intervention' which they see as incipiently totalitarian, stifling individual freedom, dignity and initiative. Whether it is health or education, the railways or the media, some see privatisation as the sole way to avoid the rigidities and inefficiencies of state planning; others think that only states can be trusted to run vital services as public responsibilities. But if we are to understand how best to organise our societies fairly to benefit all, we need to question the bipolar disorder that leads us to think in this 'either-or' way about market and state. While ideologues would have us believe that the dysfunctions of one can only be cured by the other, the truth is they each require, and correct, the other. For a start we need to clear away some of the more exaggerated claims made from either side, and assess the most compelling cases for and against each.

First consider 'the market', whose original advocates were French and Scottish Enlightenment thinkers. They saw in the market the possibility of a levelling democracy free of the distorting influences of rank, privilege and deference.

French thinkers deemed commerce to be socially beneficent, writing of le doux commerce. According to Montesquieu, "wherever manners are gentle there is commerce; and wherever there is commerce, manners are gentle." Voltaire praised the London Stock Exchange as a place where "the Jew, the Mahometan, and the Christian deal with one another as if they were of the same religion, and reserve the name of infidel for those who go bankrupt." As for the Scots, Adam Smith praised David Hume for showing in his History of England "how commerce and manufacture gradually introduced order and good government, and with them, the liberty and security of individuals." And it was, of course, Smith who developed the classical economic defence of the market as maximising efficiency and enabling self-sustained growth and development.

Contemporary market evangelicals continue to draw on this two-fold argument. They argue that markets co-ordinate economic activity by communicating, through prices, information unavailable by any other mechanism and provide incentives for people to train themselves and to innovate. Markets secure liberty and encourage individual choice and they promote equality, enabling unforeseen relations between strangers and dissolving hierarchies.

What are the anti-market arguments? Their roots lie in the 19th century and the legacy of German romanticism, which detested the instrumental character of commerce. Deploring "the brutish God-forgetting profit-and-loss philosophy," Carlyle protested that "cash-payment is not the sole nexus of man with man." Marx and Engels took up the phrase in The Communist Manifesto, writing that as the "constantly expanding market" spreads over the surface of the globe, leaving "no other nexus between man and man than their naked self-interest, than callous 'cash payment'," men are drowned in the "icy waters of egotistical calculation".

Neo-Marxists developed this theme but critics of the market were not exclusively on to the left. Policy-oriented social democrats speak of the market driving out altruism and reciprocity, communitarians of 'the morality of the bazaar' and republicans of the erosion of public institutions and the corrosion of civic virtues. Feminists see the market as degrading to women. Tradition-minded right wingers resent the way in which markets disrupt hierarchies and anti-immigration movements oppose open labour markets. Greens favour protecting the environment over the satisfaction of human desire.

Beneath the ideological diversity are some common thoughts. One is that markets lead to commodification. Certain goods and services are said to be debased or corrupted by being treated as mere things. So, for example, in his book Everything for Sale, economic journalist Robert Kuttner writes that "advertiser dominance debases journalism into entertainment," that holidays have been "debased into three-day shopping weekends" and that making "free libraries more market-like would destroy their essence". Richard Titmuss claimed that selling blood crowds out altruism, diminishing the scope for giving the worthwhile things that benefit society. As he famously put it, private market systems "deprive men of their freedom to choose to give or not to give," the commercialisation of blood has the effect of "discouraging and downgrading the voluntary principle. Both the sense of community and the expression of altruism are being silenced."

Economist William Baumol argues that there are services "in which the human touch is crucial," they resist standardisation because "treatment must be tailored to the individual case" and "quality is, or is at least believed to be, inescapably correlated with the amount of human labour devoted to their production." The danger is that the dehumanising commodifying processes of the market squeeze out the human touch. Michael Sandel discusses the way that commodifying reproduction - the market for surrogacy, babies and sperm - can distort the way we view these crucial human processes, and Elizabeth Anderson suggests that market allocation is only suitable for "pure economic goods" not for those that are "higher, personal or shared".

But it is not always clear exactly what these writers are objecting to. Do they not exhibit a certain tang of paternalist nostalgia? Would human relations be totally pure if it were not for the inhuman hand of the market? Is it really true that thinking sometimes in objective or instrumental ways is incompatible with altruism, reciprocity and the realisation of higher values? Are markets only and always about exploitation?

Anthropologist Mary Douglas has persuasively argued that goods are "adjuncts" to a "ritual activity" which uses things to make "firm and visible a particular set of judgments in the fluid process of classifying persons and events." This implies both a more benign function for the market and the impossibility (and undesirability) of a world without some form of exchange and quantification. Is it plausible to think that its replacement by gift giving without the possibility of gain would be an improvement?

Is it even obvious that treating people as objects and as a means to some end is always a bad idea? (Kant's famous categorical imperative enjoins us to treat persons never simply as a means). Surely it must depend on the end and on who is doing what in pursuing it. Beethoven, who according to his biographer was "filled with a deep conviction as to the significance of his work and his art", referred in his journal to two of his friends as "merely instruments on which to play when I feel inclinedÂ… I value them merely for what they do for me." Not entirely noble perhaps, but in this case and others, perhaps a justified selfishness.

And why assume that we cannot both know the price of something and that it is priceless? We do this all the time. We adhere to the Christian and Kantian idea that the individual is sacred, while we also know that insurance and planning decisions, made on our behalf, will result in a given number of statistically certain deaths, which, once they are costed out, are deemed to be acceptable. We all participate in systems that put a cash value on human life, at the same time as believing that life itself means more than can be calculated.

A second anti-market argument is that markets reproduce and aggravate inequalities. Certainly markets can graphically illustrate human desperation, and exploit global inequality. Markets can lead to desperate exchanges. In the transnational market for organs kidneys sell for $10,000 to $15,000 in Egypt, a cornea fetches $4,000 in India; and in the baby market black babies cost less than white babies. How many people would choose to sell their kidneys or their babies if the world were more equal? Markets in this case tend to exhibit and amplify pre-existing forms of inequality.

But the most telling objections to the operations of the market lie in the accusation that the market erodes the basis of citizenship. According to TH Marshall, citizens' rights developed over time from civic through political to social rights, which culminated in the various European welfare regimes after the World War II. These established the universal provision of education and health care, financial support in case of unemployment, injury, illness and old age, and, in some fortunate places, housing, legal aid, citizens' advice, access to public spaces, public libraries and media. These can be seen as providing the preconditions for core citizenship by enabling citizens to acquire and maintain the capacities needed for its equal exercise. This era was the triumph of the public service ethos of state provision, over that of the market. But in the 1970s the mid-century citizenship package started to unravel. With the worldwide spread of neo-liberal ideology, abetted by governments of the centre left in pursuit of economic efficiency, health services, education, public utilities, transport and broadcasting have been opened up to marketisation and privatisation.

This had the effect of severing the link between political representative (national or local) and citizen (who has become instead, a consumer). Marketisation and public-private partnerships enable politicians to divest themselves of responsibility and, crucially, of accountability for the provision of public services. Citizens can no longer hold their representatives accountable for service delivery, which is rendered faceless, consigned to the anonymous forces of the market.

Marketisation similarly threatens the preconditions of good citizenship - namely, the services that generate and sustain people's capacity to function as good citizens. In particular, when markets invade the spheres of education and public broadcasting, some of the capacities - notably the cognitive capacity to process information and achieve a rational understanding of one's world - are, to say the least, not encouraged. The market has no (financial) incentive to do so. As US experience abundantly shows, where public broadcasting is only marginally present in a predominantly commercial environment, there are no countervailing mechanisms to resist the descent into trivialisation and fragmentation. In general, market dominance means subservience to corporate media power, which cares little for non-redeemable values like truth.

So much for the pros and cons of the market: what about the state? Following Max Weber I take 'the state' to mean "the human community that successfully claims the monopoly of the legitimate use of physical force within a given territory", and add the need for a legitimating constitution (formal or informal) and a minimum range of legitimated and functioning institutions. States are both a framework for public action, and actors in their own right. States do things. The question is when they do things what kind of harm can they cause? The best-known answer to this constitutes one of the pillars of neo-liberal ideology and is of Austrian provenance: 'Beware the state as an agency of central planning, above all when in pursuit of social justice!'

This argument was made most forcibly by economist Friedrich Hayek in the late 1930s. Hayek argued that a state engaged in central planning and redistribution was necessarily the enemy of freedom and justice. State planning was, in the title of his most famous book, The Road to Serfdom. Hayek's best argument was about the kind of knowledge any state planning body would have access to: "[n]either the 'available' resources nor the 'existing' needs are objective facts" he argued, "they can never be known in all relevant detail to a single planning body." The state planners reliance on similarly dubious 'statistical aggregates' would always mean that "the peculiar circumstances of time and place" would be disregarded, individuality flattened out. For Hayek the solution was to access the diverse knowledge dispersed across the population, to which one central body could never have access. This could only be done through "some mechanism which will delegate the particular decisions to those who possess [the knowledge], and for that purpose supply them with such information about the general situation as will enable them to make the best use of the particular circumstances of which only they know." In other words, the market.

From this argument Hayek drew wildly extravagant conclusions: start central planning and redistributing income in pursuit of 'the mirage' of social justice and you destroy your citizens' liberty. Hayek assumed that the 'competitive market' is the 'natural spontaneous order' of human society. He has nothing to say about the realities of monopolistic markets and of concentrated corporate power. Yet Hayek was right about the indispensability of market signals for the relaying of inherently dispersed and local knowledge and he was also right about the limits that this knowledge, embodied in local practices, sets to projects of state-led social engineering.

James Scott's book, Seeing Like a State, explores the ways in which modern state-led projects of social engineering extinguish local, dispersed practical knowledge. Scott's inspiration is anarchist, not market-liberal, but his conclusions are similar. He focuses on three compelling case studies of state-initiated social engineering that are human disasters: the construction of the 'city of the future' Brasilia, Soviet collectivisation and compulsory villagisation in Tanzania. His claim is that they exemplify "high modernist faith", found among "those who wanted to use state power to bring about huge utopian changes in people's work habits, living patterns, moral conduct and worldview" - a faith typical of "the avant-garde technocrat" with no sense of the human scale.

Scott's cases show ways in which the utopian, top-down, authoritarianism that is typical of state planning is incapable of realising its dream of remaking the social order. A society is built on a wide array of practical skills and acquired intelligence that responds to a constantly changing natural and human environment, the kind of knowledge which state planners may ignore or suppress. Scott argues that states will tend to make catastrophic errors, create bureaucratic rigidity and, echoing Hayek, systematically distort people's lives by imposing technocratic dreams upon them, irrespective of their own dreams and values. The inevitable result of such vaunting ambition is, as in the Brasilia case, a city without life.

But Scott exaggerates and focuses on extreme, worst-case scenarios of state planning (yes, Brasilia, but what about Saint Petersburg and Haussmann's Paris? What about Roosevelt's New Deal, Scandinavian social democracy, the US interstate highway system, public health successes such as the eradication of cholera and polio?). Yet his critique is a powerful indictment of the harm that overweening state ambition and the sidelining of diverse, flexible human skills, can inflict.

So state planning can be clumsy and insufficiently attuned to local forms of practical knowledge. And market mechanisms can debase valued services and things, aggravate inequalities and undermine the bases of citizenship. Each needs the other to counter its worst excesses.

There is no pure market or pure state system: the two interlock, and, moreover, each is increasingly acting like the other. Huge companies like Wal-Mart act more and more like states, presiding over their own ecosystems, suppressing local knowledge, developing bureaucratic procedures and neo-imperial ambitions. Meanwhile states act more and more like market corporations. Think of how state education in Britain has taken on the language and practice of the market - an obsession with quantitative measurement like league tables, a culture of productivity with financial incentives. The question is: what mechanisms should be in place to govern the interaction between state and market in, say, health care, education and broadcasting? We must overcome the idealist belief in either state or market, and approach each sphere realistically, ready to make creative decisions which preserve the principles of both efficiency and accountability.

Steven Lukes is Professor of sociology, New York University