Market failure

Market failure is a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers. This is a direct result of a lack of certain economically ideal factors, which prevents equilibrium. Public goods are one of the examples of a market failure.

Market failure and public goods

Main article: Public goods

When Paul Samuelson first formalized public-goods theory, it was at a time when many economists subscribed to what Harold Demsetz has called the nirvana approach to public theory. Demonstrating some "market failure" with respect to an abstract optimum was considered sufficient to justify State action. Economists assumed that the costless, all-knowing, and benevolent State could simply and easily correct any failure.

Since then, economists have become far more realistic. Demonstrating "market failure" is no longer sufficient. To justify State action, one must show that the State has the capacity and the incentive to do a better job than the market can do.

Economists within the field of public choice have come to the realization that the free-rider incentive does not only arise for market enterprises. The free-rider incentive can arise for any group, especially political groups wanting to influence State policy.

Assume that a fairly large group of people wishes to change some State policy — for instance, repeal a tax. If enough people contribute money, time, or other resources to bringing about the tax's repeal, they will succeed and all be better off. The money saved in taxes will more than reimburse them for the effort. Unfortunately, once the tax is repealed, even those who did not join our campaign will no longer have to pay it. They will be free riders on this political efforts.

Just as in the case of a non-excludable good in the market, every potential beneficiary of the tax repeal has an incentive, from the perspective of economic self-interest, to try to be a free rider. If enough of them act according to this incentive, the tax will never be repealed. This result can be called a "political failure," completely analogous to the "market failure" caused by non-excludability.

The democratic 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 same problem in providing non-excludable goods and services as the market—with one crucial difference. When a group successfully provides itself a public good through the market, the resources it expends pay directly for the good. In contrast, when a group successfully provides itself a public good through the State, the resources it expends only pay the overhead cost of influencing State policy. The State then finances the public good through taxation or some coercive substitute.

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 had 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.

This makes it possible for organized groups to get the State to provide bogus public goods, goods and services which in fact cost much more than the beneficiaries would be willing to pay even if exclusion were possible and they could not free ride. In this manner, the State generates negative externalities. Rather than overcoming the free-rider problem, the State benefits free loaders, who receive bogus public goods at the expense of the taxpayers.

Links

• "The Market Failure Myth" by D.W. MacKenzie, August 2002
• "Joseph Stiglitz's Market-Failure Myth" by Christopher Westley, January 2012
• "Are "Sticky Wages" a Market Failure?" by Robert P. Murphy, January 2011
• "Response to the "Market Failure" Drones" by Thomas E. Woods, Jr., June 2009
• IP: It’s a market failure argument by Jeffrey Tucker, February 2009
• " The Myth of Market Failure" by Christopher Westley, June 2002
• "Is Emergency Care a Failed Market?" by Eric M. Staib, September 2009
• Airport Congestion: A Case of Market Failure? by Murray Rothbard (Chapter 52 from Making Economic Sense)
• Why Externalities Are Not a Case of Market Failure (pdf) by Brian P. Simpson, March 2003
• "What Are You Calling Failure?" by Gil Guillory, May 2005
• "Response to Davi on Coordination Failures" by Lucas Engelhardt, June 2009
• Market failure at Wikipedia