Market Failure

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Libertarians, because they insist on "freedom", do not want to do anything about market failure. Their four major responses then are (1) denialism (a public relations style of lying) (2) insisting that market failure is optimal because all other possibilities are always worse (3) all market failures are caused by government or (4) the argument that government has failures too.

(1) is philosophical bullshit. That is a technical philosophical term, believe it or not. In short, the bullshitter does not care about the truth of what he is saying: he is concerned with other effects. In the case of denialism, the goal is FUD: fear, uncertainty and doubt.

(2) Long experience has shown that government intervention in market failures can greatly improve markets, both in micro and macro economic senses. Most obviously, the creation of stable law of property, defense and infrastructure such as roads which markets have never been able to do themselves.

(3) Most market failures are not caused by government: they are due to externalities, transaction costs, and a host of other non-government causes. This is another example of Manichean thinking: all good from the market, all evil from government.

(4) Yes, government and businesses have failures too. But they are not the same failures as markets have, and so we should expect to find some cases where markets do better and some where governments do better.
Real world economies are rife with market failure. This means choosing between second-best options such as imperfect markets, NGO's and government solutions. Ideology and economic theory cannot say which is best: you must resort to experimentation and history.


All Market Failures Come From Government Interference
A sly way of claiming that government responses to market failures cause market failures. Any economics text will tell you that externalities, transaction costs, and a host of other non-government causes are the source of most market failures.
An Introduction to market failures [More...]
"A market failure is something that is inherent to the market that causes the market equilibrium allocation to be inefficient."
Begging The Inequality Question [More...]
All too often, market advocates assume that markets work fine and fixing inequality might make them inefficient. But actually existing markets always depart from perfect models, and already have inefficiencies. Fixing the inequalities might make them more efficient.
Commons, Anticommons, Semicommons [More...]
A great overview of the basic concepts involved.
Economics in Two Lessons: Why Markets Work So Well, and Why They Can Fail So Badly (book, online) (1 link)
An excellent academic (but readable) rebuttal to the propaganda in Economics in One Lesson, the fallacies of Economics 101, some Chicago Economics and some Austrian Economics. Very simply, markets do not take into account ALL opportunity costs.
Economists used to be the priests of free markets -- now they’re just a bunch of engineers [More...]
Economics is being rescued from libertarianism. "[...] most economists favor government intervention in the economy in a wide range of areas, including income redistribution, minimum wage laws, environmental regulation, anti-discrimination laws, and others (and that was before the financial crisis!)"
Education (44 links)
Libertarians strongly oppose public education: they wish to eliminate tax-funding for education, regulation of education, and make education independent of government. Libertarians favor privatization and corporatization of schooling. This despite the obvious market failures in education and the international successes of state-run education.
EDUCATION as a source of market failure [More...]
A wiki page which explains the economics of education market failures because of externalities and imperfect information.
Eminent Domain (5 links)
Libertarians hate this limitation on property rights, ranting incessantly. And when used corruptly, it is detestable to all. But it does have an important role to play in overcoming a common market failure called the Tragedy Of The Anticommons. The key concept is that property ownership is not an unmitigated good, and, worse yet, it can lead to economic gridlock and underutilization of resources.
Externalities (3 links)
Few actions can be undertaken in a society without affecting other people. These effects are called externalities, and they can be beneficial or costly. Econ 101 covers how to deal with externalities, but this is conveniently forgotten for the sake of libertarian argument.
Fluoridation and Iodization (1 link)
Fluoridation is an amazingly cost-effective solution to the huge problem of dental caries. Libertarians who object to fluoridation ought not drink "guvment water" anyhow. Iodization is an important antidote not only to goiter, but to significant mental retardation.
Insurance Market Failures (1 link)
Many types of insurance cannot be offered privately (or voluntarily) because of a number of market failures or because they work poorly when they are offered. Unemployment insurance, old-age pensions, medical insurance, crop insurance, flood and other disaster insurance, etc. Then government should play a part. Some types of insurance need to be mandatory because otherwise compensation for injury or damage will frequently be unpaid.
Market Design (4 links)
Markets don't just spontaneously happen in their final (or current) form. They evolve or are designed by government and participants. Without such design or evolution, markets are rife with failures. Government must be involved to shape the laws and regulations that give order to the market.
Market Failure -- Introduction [More...]
The tutor2u introduction to the economic theory of market failures and government interventions. Concise and easy to understand. British examples.
Markets do it better and cheaper than government. Not. (1 link)
A common propaganda claim from Milton Friedman. Patently untrue for a number of market failures. An additional problem is that the products would be different, sometimes in undesirable ways, because markets have no incentive to create positive externalities
Markets: Guided by an Invisible Hand or Foot? [More...]
"Adam Smith and his disciples today see markets working as if they were guided by a beneficent, invisible hand, allocating scarce productive resources and distributing goods and services efficiently. Critics, on the other hand, see markets working as if they were guided by a malevolent, invisible foot, misrepresenting people's preferences and misallocating resources."
My Take on the Seven Things We Need to Focus on for Equitable Growth in America [More...]
Brad DeLong presents seven progressive ideas that promote growth and simultaneously reduce inequality.
Natural Monopolies (5 links)
Libertarians like to deny the existence of natural monopolies in roads, sewers, and many other services (like Google search) that have increasing returns to scale. Or they make crazy arguments that they should not be produced or regulated by government.
Notes for Debate with Jeff Miron on Marty Nemko’s Radio Show [More...]
"How much does each of us owe to all the rest for there being here to help us? How much do others owe each of us? How much larger are humanity’s collective resources because each of us is around?" Also, 8 kinds of market failure.
Optimal Solutions (3 links)
There are no optimal solutions for real-world economic problems. There are only second-best (or worse) solutions because the requirements for optimality (in markets or government) can never be met in the real world. Sometimes markets are second best and sometimes government is second best.
Private Sector Waste (5 links)
It is widely assumed that government is wasteful but the private sector is not. Every kind of market failure presents opportunities for private sector waste. Everybody who has worked in the private sector can tell stories of waste in their business. Competition may not be strong enough to eliminate very much waste.
Public Goods And Club Goods (17 links)
Libertarians often refuse to recognize public goods and club goods, or that governments have a role in their provision. The list of important goods with substantial public or club goods components is very long, and includes education, law, safety, health, transportation, research and much more. (Club goods are like public goods but excludable and only rivalrous with congestion.) Markets are unwilling to provide them in economically efficient quantities, since companies can't capture all of the returns from public goods.
The Cost of not Redistributing Money Part 1 [More...]
"... from a utilitarian point of view, the United States is ‘wasting’ (again, not factoring in the costs of redistribution), at least a third and a bit of its income through the distributive inefficiency of its income allocation."
The Elasticity of Demand With Respect to Product Failures; or Why the Market for Quack Medicines Flourished for More Than 150 Years [More...]
Markets did not punish the quack medicine industry due to unusually low elasticity of demand with respect to product failure and bounded rationality. The conclusion mentions that recent resaerch shows the FDA increased consumer welfare.
The Gridlock Economy: How Too Much Ownership Wrecks Markets, Stops Innovation, and Costs Lives (book, online) (1 link)
"Usually, private ownership creates wealth, but too much ownership has the opposite effect -- it creates gridlock. When too many people own pieces of one thing, whether a physical or intellectual resource, cooperation breaks down, wealth disappears, and everybody loses."
The Inefficiency of Inequality [More...]
"This problem, which economists call inefficient allocation, is present in the market for opportunities as well. [...] To a great degree, access to opportunity in the United States depends on wealth. Discrimination based on race, religion, gender, and sexual discrimination may be on the wane in many countries, but discrimination based on wealth is still a powerful force."
The Private Sector can solve that. (3 links)
Hand-waving arguments that because the private sector is already involved, there is no need for government. If you ignore market failures, game theory, historical evidence, psychology, transaction costs and more, why, it all makes sense!
Tragedy Of The Anticommons (7 links)
When resources cannot be efficiently used because their ownership is divided, we have an anticommons. Holdout problems are the classic example, but Global Warming is perhaps the most important example. Closely related to the Prisoner's Dilemma. See also the Tragedy Of The Commons. That is why many natural resources such as air are not private property.
Tragedy Of The Commons (9 links)
The tragedy of the commons is an economic theory of a situation within a shared-resource system where individual users acting independently and rationally according to their own self-interest behave contrary to the common good of all users by depleting that resource. In other words, due to capitalist greed. But there is only a tragedy of an UNREGULATED commons, as history has shown. Regulation is an obvious workable solution.
Types of market failure [More...]
Simple summaries of 10 categories of market failure with links to more extensive pages. An Economics Online page, part of their large index on market failures.
Uncertainty And The Welfare Economics Of Medical Care [More...]
Kenneth Arrow's classic 1963 article that details the differences between the medical care industry and competitive market models. This is why privatizing health care does not work well.
Varieties of Institutional Failure [More...]
James Acheson describes failures of resource management by markets, private property, government, and communal management. Libertarian emphasis on the first two only is inappropriate.
What Do Econ 101 Students Need To Remember Second Most From The Course? [More...]
Brad DeLong lists 7 assumptions necessary to "market efficiency", and describes the frequent failures of these assumptions. "A great government will have foresight and take care to structure political-economic institutions to make these seven arenas of myopia and market failure as small as possible."
What is wrong (and right) in economics? [More...]
"... anything that has turned into conventional wisdom is almost by definition wrong, or at least, overstated." Examples of dismissal of market failure, rejection of other social sciences, and benefits of globalization.
When is more competition bad? [More...]
Contrary to popular belief, standard economic theory does not provide a theoretical foundation for the notion that "competition is everywhere and always good." It turns out that legislation that promotes competition among producers may improve consumer welfare.
Where Private Investment Fails [More...]
Institutional economics. "[...] under rather common circumstances it is efficient (maximizing of profits, minimizing of long run average costs) for explicit rules, regulations, commands, organization charts, and social contracts to replace the invisible hand.
Why is the TI-84 calculator unstoppable? [More...]
"What TI has achieved is a holy grail in technology: a dominant design over which they full control. There is an entire ecosystem that hinges on that design and the switching costs are insurmountable."


People who think "free markets" work in healthcare or the Internet are just as functionally stupid about economics as the most hardline Communist who thinks that the government should exercise full control of the toothpaste market. Most of the world understands by now that the second guy is a dangerous fool. But we're at a weird point in history where the first guy undeservedly has more credibility. He shouldn't--and he won't for long.
David Atkins, "Americans: we love paying more for less"
[T]he information revolution in economics that Hayek kicked off well over a half century ago, ended up pointing to a larger public role both in rectifying market failures and in addressing the problem of unaccountable power exercised by employers over employees.
Sam Bowles, "How Hayek’s Evolutionary Theory Disproves His Politics"
Anybody stupid enough to think education works like consumer goods markets should have to explain why there isn’t a McHarvard franchise on their block.
Mike Huben
We are going to need a bigger and better government. The private unregulated market does not do well at health-care finance, at pensions, or at education finance. The private unregulated market does not do well at research and early-stage development. The private unregulated market does not do well with commodities that are non-rival, or non-excludible, or produced under conditions of greatly-increasing returns to scale. We are, in all likelihood, moving into a twenty-first century in which these sectors will all be larger slices of what we do. Thus in the twenty-first century a well-functioning economy will need a larger government share in the economy than was needed in the twentieth century.
Brad DeLong, "My Take on the Seven Things We Need to Focus on for Equitable Growth in America: Thursday Focus"
So how do you do useful economics? In general, what we really do is combine maximization-and-equilibrium as a first cut with a variety of ad hoc modifications reflecting what seem to be empirical regularities about how both individual behavior and markets depart from this idealized case. [...] But here’s the thing: economists have done their work this way for generations. So it’s really not a new paradigm. If anything, the true new paradigm was the attempt to justify everything with maximization and equilibrium -- but that’s the paradigm that failed.
Paul Krugman, "Paradigming Is Hard"
All that is spent during many years in opening the means of higher education to the masses would be well paid for if it called out one more Newton or Darwin, Shakespeare or Beethoven.
Alfred Marshall, Principles of Economics (1890), p. 216.
Large-scale government social-insurance programs are the best way we have found to achieve major and important public purposes. There has never been a private marketplace offering unemployment insurance. The unemployment insurance program works quite well: It gets money to people who have previously paid for it when they need it. Edward Filene’s welfare-capitalist notion that defined-benefit pensions offered by employers and more recent hopes that defined-contribution 401(k)s could provide old-age pensions more efficiently and effectively than Social Security have not covered themselves with glory over the past generation: Too many defined-benefit private pensions have not been paid out in full as promised, and too much wealth invested in 401(k)s has been skimmed off to enrich the princes of Wall Street. In health care, despite extraordinary administrative inefficiencies and little ability to improve quality and cost-effectiveness, the private insurance marketplace works—unless you are old, sick (and happen to be out of a job), or poor. Yet it is the old, the sick, and the poor who need health insurance most—hence, Medicare and Medicaid.
Brad DeLong, "Shrugging off Atlas"
It is really quite rare to find a buyer’s market for rented accommodation. Even if there is a slight oversupply of rental units for sale, time is almost always on the landlord’s side, because waiting is typically much more inconvenient for the party that has to wait without a house to do wait in. In general, when tenants and landlords are negotiating over the potential Pareto gain that could be made from renting the house, the landlord ends up capturing most or all of the surplus. The hot water and habitability laws are simply aimed at skewing things a bit in favour of the tenant and putting a floor on how bad a deal the tenant can end up accepting. It’s a standard game theory result that something which reduces your options can benefit you by reducing the number of bad options that you can end up agreeing to (most famously, the secret ballot has to be compulsory, because if you had the option to reveal your vote, you could be intimidated), and habitability laws are there for exactly this purpose.
Daniel Davies, "The correct way to argue with Milton Friedman"
In so far as I live in society, everything that I do inevitably affects, and is affected by, what others do. Even Mill's strenuous effort to mark the distinction between the spheres of private and social life breaks down under examination. Virtually all Mill's critics have pointed out that everything that I do may have results which will harm other human beings.
Isaiah Berlin, "Two Concepts of Liberty"
But in reality what we teach our students in the classroom – the advanced students if not the undergraduates –and what we talk about in the seminar room are typically much more about the myriad ways in which markets fail.
Dani Rodrik, "What is wrong (and right) in economics?"
A peculiar deformation of mainstream economics is the tendency to pooh-pooh the real-world relevance of all the theoretical reasons market fail and government intervention is desirable.
Dani Rodrik, "What is wrong (and right) in economics?"
Williamson borrowed from Coase the concept of "transactions costs" the idea that the market price in any transaction may fail to incorporate the full costs to the seller or buyer because of the very conditions of exchange. In particular, whenever there is uncertainty or the need for long-term relationships, the parties to a transaction are unlikely to be able to write contracts complete enough to cover all the contingencies or hidden costs. Furthermore, incomplete contracts encourage one or the other party to behave opportunistically, deliberately withholding information or broadcasting disinformation to get a better deal. In such cases, the transaction is likely to occur under a single roof, inside a "hierarchy" (that is, firm). This solution "internalizes" or reveals to the decision makers those otherwise hidden costs. Williamson showed that there are, even in pure theory, situations in which the inefficiencies of bureaucratic organization are offset by the greater predictability of the outcome. This is showing quite a lot, at least to academic economists. It says that under rather common circumstances it is efficient (maximizing of profits, minimizing of long run average costs) for explicit rules, regulations, commands, organization charts, and social contracts to replace the invisible hand.
Bennett Harrison, "Where Private Investment Fails"