The Market Failure Myth

Transcription

1 George Mason University From the SelectedWorks of Daniel Rothschild Fall December, 2014 The Market Failure Myth Daniel Rothschild, San Jose State University Available at:

2 The Market Failure Myth By: Daniel Rothschild The common justification for government intrusion is market failure. Market failure is when there is a demand for a good that is not being provided even though the demand for the good would cover the cost of supplying that good. Market failure also exists when there is a systemic excessive (a very suspect and subjective word) provision of goods greater than the quantity for which an informed demand would cover the social (another suspect word) costs. In other words, market failure exists if there s a systemic excess of demand but no way to cover the costs. Markets are considered to fail when they produce either positive or negative externalities. Government intervention is justified in order to correct for market failure. There are a few problems with the market failure doctrine. One is what constitutes negative or positive externalities? Isn t what is good or bad dependent on the subjective preferences of people? For example, national defense is not necessarily a positive externality. To the pacifist, national defense is a negative externality, while to the neoconservative warmonger, a lack of an interventionist military generates a negative externality. Likewise, the same good itself can generate either a positive or negative externalities depending on the circumstances. For example, deodorant, fire protection and roses can be considered a positive externality. I paid the full cost of

3 my deodorant and yet other people benefit from such a scent. If this is the case, does that mean deodorant is a public good? As Hans-Herman Hoppe points out, What if the production of so-called public goods did not have positive but negative consequences for other people, or if the consequences were positive for some and negative for others? What if the neighbor whose house was saved from burning by my fire brigade had wished (perhaps because he was overinsured) that it had burned down; or my neighbors hate roses, or my fellow passengers find the scent of my deodorant disgusting? (Hoppe 1989: 29). According to the economics literature, market failure results when there are externalities, free-riders, asymmetric information, or the good itself is a public good. A public good is a good that is nonexcludable (the good can t be provided to an individual without being provided to others) and non-rivalrous (one person s consumption of a good doesn t prevent another person from consuming a good). Paul Samuelson calls these non-rival goods, collective consumption goods which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good (Samuelson 1954: 387).

4 If market failure (as it s commonly defined) exists because of public goods then the market currently provides many public goods. A movie theater is not rivalrous in the sense than another person entering the movie theater doesn t diminish other patrons enjoyment of the movie, yet movie theaters are currently provided by the market. Likewise, schools are excludable, yet government supplies them. As Randall G. Holcombe points out, If a good is Samuelsonian public, the marginal cost of adding an additional consumer is zero, and this can be tested with data on the cost of public goods. Empirical studies on many goods confirm that government output empirically is a private good, not a public good. Legislation-the cost of passing laws-would seem to be about as public as any governmentally-produced good, because laws passed for one person can costlessly cover others, yet when subjected to an empirical test of Samuelsonian publicness, even legislation turns out to be primarily a Samuelsonian private good. One might debate about what one means by the term public good, but if one takes the precise Samuelsonian definition, empirical evidence shows that the government produces private goods, not public goods. (1997: 11-12). Holcombe also mentions that one of the justifications for providing public schools is because education is a positive externality and therefore would be underproduced in the free market. If this is the case, all the government needs to do to increase the amount of education available is to subsidize schools instead of having to run and create them (1997: 19). Holcombe mentions that government fails to limit itself to

5 producing public goods (as they are defined economically nonexcludable or nonrivalrous) and so government expenditures doesn t limit itself to only providing public goods, but goods that are in the states self-interest to provide. According to Samuelson, Here is a later example of government service: lighthouses. These save lives and cargoes; but lighthouse keepers cannot reach out to collect fees from skippers. So, says the advanced treatise, we have a divergence between private advantage and money cost... and true social advantage and cost. Philosophers and statesmen have always recognized the necessary role of government in such cases of external-economy divergence between private and social advantage. (1964: 45). Yet as Richard O. Zerbe Jr. and Howard E. McCurdy mention, lighthouses were mainly privately produced in Britain during the 17 th century. Zerbe and McCurdy mention that the examples the defenders of market failure provide are not based on historical evidence since history shows how these goods were provided by the market and were profitable to do so. According to J.E. Meade, taxes and subsidies are needed in the cases of beekeepers and apple farmers since this is an example of a positive externality. Apple farmers provide valuable services to beekeepers, since bees feed on the blossoms of fruit trees, while at the same time the bees provide valuable pollination services to apple growers (Zerbe and McCurdy 1999: 569). Yet this is purely theoretical and not based on reality. S.N. Cheung actually studied the relationship between apple farmers and beekeepers, and that there was no externality; rather there were

6 contractual arrangements between the apple growers and beekeepers to allow the bees to eat the fruit and provide pollination to the apple growers. Since both apple growers and beekeepers benefit there was no market failure to prevent such an exchange. The reality is that these existed based on the free choices of beekeepers and apple farmers without the coercive powers of the state needed to ensure this positive externality takes place. Holcombe mentions that radio waves are considered nonexcludable and yet in countries that have government provided radio broadcasting there is a black market for private radio broadcasts (Holcombe 1997: 8). If radio waves were truly public goods then how can there be a black market in them? Perhaps the reality is that nonexcludability is not a sufficient condition for market failure. Jeffrey Hummel points out that if free-riding is an example of market failure (since people won t produce the good since it s not profitable to do so because of freeriders), government is not the solution to this problem. Government itself has freeriders. Hummel mentions that government has concentrated benefits and dispersed costs. People spend a lot of money lobbying for government favors. The goal of this lobbying is to be able to free-ride. If the lobbyists are successful then government provides them a subsidy or a service that others are forced to pay the cost of. According to Hummel, The State makes it much easier to enact policies that funnel great benefits to small groups than to enact policies that shower small benefits on large groups. Because of this free-rider induced political failure, the State has the

7 same problem in providing non-excludable goods and services as the market.moreover, the group that campaigned for the State-provided public good will not in all likelihood bear very much of the coerced cost of the good. Otherwise they would have no incentive to go through the State, because doing so then costs more in total than simply providing themselves the good voluntarily. Instead, the costs will be widely distributed among the poorly organized large group, who may not benefit at all from the public good. (Hummel 1990: 102). Hummel also points out that voting itself is a form of free-riding since no one win or loses by one vote, people would free-ride off of the voting of others, and yet people still (irrationally) vote. If free-riding was enough to justify market failure there would be few improvements in the world. Another example of free-riding that occurs in the political realm is repealing bad policies. For example, repealing a tax benefits (almost) everyone both those who lobby to repeal the tax and those who don t yet once the tax is repealed those who didn t spend their efforts trying to repeal the tax free-rided off of the efforts of others. I hope I ve made it clear that free-riding isn t absent in the political sphere. If freeriding is a market failure, then how come there is free-riding in the political realm as well? Another type of supposed market failure are negative externalities. The typical example is pollution. A person buys a product, the maker of the product generates

8 pollution which harms a third party, therefore the price of the good fails to reflect the full price since the costs of pollution isn t included in the price of a good. There are a few responses to this. One is that does government have any negative externalities of its own? Are negative externalities exclusive to the market? If not, then negative externalities can t be considered a market failure. I would venture that the government is replete with negative externalities. War is an example of negative externalities. The collateral damage that results from war is a negative externality. The deadweight loss of taxation, as well as subsidies and tariffs generate negative externalities. Voting could be considered a negative externality since the candidates who don t vote suffer the negative externalities brought on by those who achieve political power. Government subsidized education is a negative externality, not only by making private schools more expensive, but also having a person go to a public school, become propagandized in the necessity of the state generates negative externalities to any anarchist. Likewise, if the tax for pollution is too high then there would be an underproduction of useful goods and services (and this generates a political failure and negative externality). Also if the tax for pollution is too low the polluters would still be partially subsidized, thus not solving the negative externality caused by pollution.

9 Is pollution a market failure? Currently, government monopolizes the court system. Any negative externalities that exist are due to not a market failure, but a government failure to not properly punish those who cause harm to others. A free market doesn t mean free as in beer but free as in freedom. If the government fails to deter people who violate the property rights of others that s not a market failure (since courts and legislation is currently monopolized by the state), but is a government failure. In conclusion, the market failure doctrine is vague and confused. The failure that supposedly exists isn t unique to the market and therefore can t be defined as market failure. Likewise, the examples typically given that justify government public goods doesn t reflect the reality since many public goods are currently being supplied by the market, as well as government supplying many private goods. Freeriding doesn t occur under a system of contractual arrangements, but is prevalent in politics. Government is all about free-riding and wealth redistribution. Likewise, the market currently provides things which generate positive externalities (such as soap) and the failure of governments to punish property violators is a negative externality of government, not the market. In short, market failure can t exist since a free-market is based on respecting private property rights and voluntary interactions. Only coercion can make people worse off and coercion is not a product of the market but a product of the state.

10 Works Cited 1) Holcombe, Randall G. "A theory of the theory of public goods." The Review of Austrian Economics 10.1 (1997): ) Hoppe, Hans-Hermann. "Fallacies of the public goods theory and the production of security." Journal of Libertarian Studies 9.1 (1989): ) Hummel, Jeffrey Rogers. "National goods versus public goods: defense, disarmament, and free riders." The Review of Austrian Economics 4.1 (1990): ) Samuelson, Paul A. "The pure theory of public expenditure." The review of economics and statistics (1954): ) Samuelson, P.A. (1964). Economics: An introductory analysis (6th ed.). New York: McGraw Hill. 6) Zerbe Jr, Richard O. and Howard E. McCurdy. "The failure of market failure." Journal of Policy Analysis and Management 18.4 (1999):