If we want to have access to the best cars, or the best possible cars that can be made in proportion to the demand for them (in comparison to the demand for other products, given limited resources), we let the market drive the production of cars. Specifically we give the producers incentives to make cars that people want (profits), and then let them compete with each other. Although it might be possible to construct other systems that also result in the best cars being produced, markets are easy to setup and well understood. Logically then if we want to live in the best possible government it would seem wise to make the system of government itself subject to market forces.
In some ways governments are already subject to market forces. A government’s wealth and power is determined to a large extent by the number of people living under it and what they can contribute to the government. And people can leave one government for another if they find some other government to be more to their liking. However, the market for governments that currently exists is far from free. There are significant barriers to choosing a new government, many more so than there are when choosing a new car (you don’t have to move to learn a new language to change your model of car). And there isn’t much variety in modern governments, you have a choice between living under some kind of representative democracy, a theocracy, or a tyranny. This would be like only having three models of cars to choose from, again not a situation that is conductive to markets doing their work.
So, if we wanted to generate a situation in which governments were affected by market pressures, what would need to change? To begin with we would need to create an incentive for the people behind the government to make it the best it can be. And to do that is simple, give the head of that government unlimited power over the people under their rule and their possessions (limited of course by whatever self-imposed rules the government is established with). Thus if you attract more people to live under your government, or make the people living under your government wealthier, you would have more power and wealth, an incentive that seems to motivate people well enough normally. Secondly, governments would have to be forbidden from placing any limitations on who may leave their government, for any reason (although a government is not required to let people become part of it). Thirdly, governments would have to be given a maximum size, to ensure that in any area there would be a number of governments to choose from, making changing the government you live under no harder than moving across town. Finally, we might want to impose some minimum standards for human rights, such as forbidding governments from killing their citizens, or treating their citizens cruelly and unusually, and from developing weapons and armies that could be used against other governments.
Obviously any regulation of these micro-governments would require an over-government with an army, both to enforce the rules, and to defend the micro-governments from outside aggression. And so there would need to be officials to run the over-government and its army, and to regulate the creation of micro-governments, even though the over-government would have no citizens of its own. Somehow the over-government would have to be kept under control, which could be done in any number of ways, but my favorite is that it could be regulated by a pool of randomly selected citizens (from the micro-governments), sort of like jury duty.
If such a system were ever to be implemented I would expect that we would end up with a bunch of micro-monarchs, each striving to be the best ruler, but few of them giving up their absolute power (who would?). But I also expect that for the most part these micro-monarchs would be more pleasant to live under than our own representative democracy. Each of them must do their best to balance popular opinion against what is objectively the best choice. If the monarch bows too much to popular opinion then they may be led to make bad choices, which will result in their subjects leaving for other rulers. On the other hand, if they never listen to popular opinion then their subjects might feel ignored, and thus leave for other rulers. Thus the market will decide what is the best balance of independent judgment and listening to popular opinion, which is something that can never happen in a democracy.
However, despite how attractive such a system might seem, it is probably impossible to make the transition to it from our current system of government. Even if the people who were currently the most powerful were willing to make the change (or if the people threw them out of power in order to make the change) it would be difficult to get the system up in running because not all regions are equal; it is better to rule over part of a city than part of a countryside, because not everyone can be a micro-monarch, and because when starting such a system there is no guarantee that there will be even one good ruler in your region that you could live under. Oh well.