Indeed, all the economic models I'm aware of are explicitly theoretical, including ones that cover how governments and markets work. They often contain assumptions that are obviously not present in the real world: like perfect information or zero transaction costs. Of course, that doesn't mean they're not occasionally testable to some extent, but I'm strongly skeptical of anyone claiming to have a "proof" of any nontrivial claim regarding these ideas. That said, I do personally find the arguments that markets will outperform governments more convincing than the inverse.
On the topic of market transactions with externalities, you might find the Coase theorem interesting, and the related folk theorems in game theory. I see it as a compelling rebuttal to the Pigovian model of using a centralized organization (generally government) to internalize social costs.
> On the topic of market transactions with externalities, you might find the Coase theorem interesting, and the related folk theorems in game theory. I see it as a compelling rebuttal to the Pigovian model of using a centralized organization (generally government) to internalize social costs.
One can envision idealized democratic government as a mechanism for realizing the required precondition for the Coase theorem, to wit, the democratic process of policy making in such a system is the venue in which externalities are traded. (That such exchanges occur in the policy making process in any government of human beings is widely observed, the "ideal democratic" part is that that all citizens have equal power in the policy making process, such that the trade is generalized.)
This, of course, unifies the Coase theorem with the Pigovian model (the separation between the two comes from treating "government" as something distinct from the participants in the economy, rather than a venue in which those participants interact.)
On the topic of market transactions with externalities, you might find the Coase theorem interesting, and the related folk theorems in game theory. I see it as a compelling rebuttal to the Pigovian model of using a centralized organization (generally government) to internalize social costs.
http://en.wikipedia.org/wiki/Coase_theorem
http://en.wikipedia.org/wiki/Folk_theorem_(game_theory)
http://en.wikipedia.org/wiki/Pigovian_tax