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The Market Failure Myth / Artikel mises.org
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<font face="Verdana" size="1" color="#002864">http://www.mises.org/fullstory.asp?control=1035</font>
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<font face="Arial" size="2"><font face="Verdana" color="#002864" size="5"><strong>The Market Failure Myth</strong></font>
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<p align="left"><st2:PersonName>
<st1:GivenName>
<font size="4">by D.W.</font></st1:GivenName>
<st1:Sn>
<font size="4">MacKenzie</font></st1:Sn>
</st2:PersonName>
<font size="2">[Posted August 29, 2002]</font>
<font size="2">[img][/img] The
term"market failure" came into frequent use by economists during
the 20<sup>th</sup> century. During the 1930s, economists like <st2:PersonName>
<st1:GivenName>
Joan</st1:GivenName>
<st1:Sn>
Robinson</st1:Sn>
</st2:PersonName>
and Abba Lerner succeeded in focusing the attention of their colleagues on
imperfections in market prices.</font><a title href="http://www.mises.org/fullstory.asp?control=1035#_edn1" name="_ednref1"><font size="2"></font></a><font size="2">
Deviations from optimal prices in markets were responsible for failures to
direct resources to their most highly valued uses. Thus, markets supposedly
fail on efficiency grounds.</font>
<font size="2">By focusing on efficiency in the use of scarce resources and
failures in markets to do so, interventionist-minded economists try to show
that their concerns are utilitarian and scientific. There is nothing
inherently wrong with having such concerns. <st2:PersonName>
<st1:GivenName>
Ludwig</st1:GivenName>
<st1:Sn>
von Mises</st1:Sn>
</st2:PersonName>
demonstrated the importance of distinguishing between value-free economic
analysis of how to attain ends in and normative discussion of what ends we
should attain. It is, however, important to also distinguish between those
with genuine concerns of this kind and those who instead only appear to have
them.</font>
<font size="2">The debate over market failure is vast, but a few exchanges
stand out as important. Economists <st2:PersonName>
<st1:GivenName>
Kenneth</st1:GivenName>
<st1:Sn>
Arrow</st1:Sn>
</st2:PersonName>
and <st2:PersonName>
<st1:GivenName>
Harold</st1:GivenName>
<st1:Sn>
Demsetz</st1:Sn>
</st2:PersonName>
had an exchange several years ago that deserves some attention. <st1:Sn>
Arrow</st1:Sn>
contended</font><a title href="http://www.mises.org/fullstory.asp?control=1035#_edn2" name="_ednref2"><font size="2">[ii]</font></a><font size="2">
that free-enterprise economies underinvest in research and invention because
of risk. <st1:Sn>
Arrow</st1:Sn>
also asserted that an"ideal socialist economy" would supply such
information free of charge, thus separating the use of and the reward for
producing such information.</font>
<font size="2">In the late '60s, <st2:PersonName>
<st1:Sn>
Demsetz</st1:Sn>
</st2:PersonName>
penned a devastating critique of Arrow's arguments on information, and of the
"market failure" literature in general.</font><a title href="http://www.mises.org/fullstory.asp?control=1035#_edn3" name="_ednref3"><font size="2">[iii]</font></a><font size="2"> To
Demsetz, markets fall short of perfection, but so does government. To point to
market imperfections as proof of the need for government intervention, he said,
is to indulge in the"Nirvana Fallacy," whereby we compare allegedly
imperfect real markets to imaginary governmental institutions that lack even
the smallest imperfection.</font>
<font size="2">Now, a vast literature exists on the imperfections of
government in allocating resources. Yet, many economists still recommend
government intervention to correct market failures, often without also
considering the possibility of government failure. Why is this so? We can
better understand this reluctance to make reasonable comparisons between
markets and government if we examine what a leading economist has to say about
these matters.</font>
<font size="2"><st2:PersonName>
<st1:GivenName>
Joseph</st1:GivenName>
<st1:Sn>
Stiglitz</st1:Sn>
</st2:PersonName>
is among the most prominent proponents of government intervention. In
particular, Stiglitz has written many papers on informational problems in
markets. While Stiglitz has a reputation for favoring intervention, he has
seemed not altogether unreasonable about these matters in the past. Stiglitz
once claimed (with Sanford Grossman)</font><a title href="http://www.mises.org/fullstory.asp?control=1035#_edn4" name="_ednref4"><font size="2">[iv]</font></a><font size="2">
that markets are not perfect aggregators of information. From this, he and
Grossman concluded that we need a greater understanding of how central
authorities use information before we can tell if they use information
better than in markets. </font>
<font size="2">Stiglitz arrived at the conclusion that government can
improve upon welfare even when it faces serious informational constraints,
because its incentives and other constraints are better than in markets. At
the time that Stiglitz made this claim, we could easily have afforded him some
reasonable doubts concerning his knowledge of how government works. Academics
often lack real-world experience, and this was largely true in Stiglitz's case.
However, Stiglitz did make a foray into the public sector.</font>
<font size="2">Stiglitz notes</font><a title href="http://www.mises.org/fullstory.asp?control=1035#_edn5" name="_ednref5"><font size="2">[v]</font></a><font size="2">
that, upon embarking on his venture into the public sector, some friends of
his suggested that he might return from <st1:Sn>
<st2:State>
<st2:place>
Washington</st2:place>
</st2:State>
</st1:Sn>
"a bit more jaundiced about the role of government." This came to
pass. During his stint in the <st1:Sn>
<st2:City>
<st2:place>
Clinton</st2:place>
</st2:City>
</st1:Sn>
administration, Stiglitz identified four problems in government:
commitment problems, bargaining problems, imperfect competition, and
asymmetric information. Stiglitz now believes that these problems prevent the
government from implementing efficient policies. He also contends that
incentives for secrecy in government are central to these problems.</font>
<font size="2">Stiglitz now admits that government does suffer from
imperfections. Thus, he now has the knowledge of how governments use
information--knowledge that he lacked years ago. How does Stiglitz
interpret the lessons he learned from his <st1:Sn>
<st2:State>
<st2:place>
Washington</st2:place>
</st2:State>
</st1:Sn>
experience?</font>
<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">
<font size="2">"Making government processes more open, transparent,
democratic and more participation and effort at consensus building is likely
to result not only in a process that is fairer, but one with outcomes that
are more likely to be in accord with the general interests. Perhaps we can
bring [efficiency] to government" ("Distinguished Lecture on
Economics in Government: The Private Uses of Public Interests: Incentives
and Institutions," <em>Journal of Economic Perspective</em> 12,
no. 2. [Spring 1998]: 3-22).</font>
<font size="2">So he hopes that we can make government more efficient. But
why should we make this effort? If government has serious failings that
prevent its efficient operation, should we not at least consider free-market
capitalism as an alternative? Or are we for some reason obligated to bend over
backward to make government work efficiently?</font>
<font size="2">One might expect that, after seeing government failure first
hand, <st2:PersonName>
<st1:title>
Professor</st1:title>
<st1:Sn>
Stiglitz</st1:Sn>
</st2:PersonName>
would at least consider the possibility that we can get better results from
free markets. Considering that he has in the past claimed not to know which is
more efficient, markets or government, one might expect such an objective
scholar to comment favorably on privatization after witnessing government
failure.</font>
<font size="2">After all, objective scholars, concerned only with economic
efficiency, should simply accept the facts as they are. Instead, however,
Stiglitz holds out hope that we can improve upon the efficiency of government.
The fact that he never held out such hopes about free markets further
illustrates his bias. Objective scholars arrive at conclusions based on sound
reasoning and valid evidence rather than on wishful thinking.</font>
<font size="2">Given that Professor Stiglitz is apparently immune to all
arguments and evidence for markets and against government, we must conclude
that he is not at all concerned with value-free economic analysis aimed toward
finding the most efficient means toward given ends. Instead, he sees the
expansion of government as the end that we should pursue.</font>
<font size="2">Stiglitz is by no means alone in his passion for government.
Indeed, he owes his prominence in the profession to the admiration of his work
by many of his peers. It is therefore reasonable to suspect like-minded
economists of ideological bias as well.</font>
<font size="2">Such persons hide their biases behind a veil of technical
jargon as they pursue their ideologically driven goals. The failings of big
government during the 20<sup>th</sup> century matter not to their goals because
the expansion of government is their goal. They are not concerned with
what system works best, but with how best to promote the system that they want
to see work.</font>
<font size="2">There is nothing inherently wrong with attempts to establish
ends for us to aim at in economic matters. Those who desire more government
simply for its own sake, however, should at least be honest about their
intentions. Instead of pretending to be concerned with efficiency, <st2:PersonName>
<st1:title>
Professor</st1:title>
<st1:Sn>
Stiglitz</st1:Sn>
</st2:PersonName>
and others like him should admit that are advocates of particular ends rather
than analysts of different means.</font>
<font size="2">If their ideological convictions for government have
merit, then they should be anxious to explain them. If their beliefs lack
merit, then they should accept this graciously. In either case, it is clear
that all too many economists are not interested in an open and honest debate
over these issues. Instead, they use deceptive rhetoric about market failure
to hide their true agenda: the expansion and empowerment of the state.
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D.W. MacKenzie is a Ph.D. candidate and a Walter Williams fellow at George
Mason University. Send him EMAIL and
see his Mises.org Articles
Archive.
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<div id="edn1">
<a title href="http://www.mises.org/fullstory.asp?control=1035#_ednref1" name="_edn1"><font size="2"></font></a><font size="2">
For example, see"The Concept Monopoly and the Measurement of
Monopoly Power," <em>Review of Economic Studies</em> (<st1:GivenName>
June</st1:GivenName>
1934): 157-175.</font>
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<div id="edn2">
<a title href="http://www.mises.org/fullstory.asp?control=1035#_ednref2" name="_edn2"><font size="2">[ii]</font></a><font size="2">
Kenneth Arrow [i]Economic Welfare and the Allocation of Resources for
Invention in The Rate and Direction of Investment Activity p 609-625
(1962)</font>
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<div id="edn3">
<a title href="http://www.mises.org/fullstory.asp?control=1035#_ednref3" name="_edn3"><font size="2">[iii]</font></a><font size="2">
See Information and Efficiency, Another Viewpoint in The Journal of
Law and Economics p 1-21 (1969)</font>
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<div id="edn4">
<a title href="http://www.mises.org/fullstory.asp?control=1035#_ednref4" name="_edn4"><font size="2">[iv]</font></a><font size="2">
See <st1:Sn>
<st2:City>
<st2:place>
Sanford</st2:place>
</st2:City>
</st1:Sn>
Grossman and <st2:PersonName>
<st1:GivenName>
Joseph</st1:GivenName>
<st1:Sn>
Stiglitz-</st1:Sn>
</st2:PersonName>
Information and Competitive Price Systems in The American Economic
Review May 1976</font>
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<div id="edn5">
<a title href="http://www.mises.org/fullstory.asp?control=1035#_ednref5" name="_edn5"><font size="2">[v]</font></a><font size="2"> Stiglitz, <st1:GivenName>
Joseph</st1:GivenName>
: Distinguished Lecture on Economics in Government: The Private Uses of
Public Interests: Incentives and Institutions The Journal of
Economic Perspectives, Vol. 12, No. 2. (Spring, 1998), pp. 3-22.
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