The Myth of Market Failures

[jaws]

http://www.lewrockwell.com/rozeff/rozeff79.html

An excellent essay on the topic of market failures, and the reason why it's a completely spurious argument against the free market. Here's a particularly juicy bit:

Government officials are even less constrained than economists by the unenforced customs or canons of a value-free science. One encounters all sorts of government studies and policies, often written by economists, that build upon the foundation of market failure. For example, the following justification for government is extracted from a report to the European Commission: "A higher, all-enveloping level – such as the State – should carry out activities that cannot be performed efficiently by the market, or that should not be performed by it because of the nature of these activities. In other words public authorities are to take action when market failures arise. Markets fail to achieve an efficient outcome when competition is imperfect, when information is incomplete, when there are public goods to be produced, when production induces externalities, or when the markets face uncertainty. Equity considerations can also call for government intervention."

In other words government intervention is legitimate whenever anyone ever does anything, without explaining how the government is supposed to determine how to correct the failure or how it is even known there is a failure.

Like divine right and democracy, market failure is nothing more than an attempt to legitimize the rule of an elite over the population.

[hilldweller]

This stuff is bananas. Governments build roads, provide infrastructure and public goods not to hoard power over private individuals but rather because private individuals have no desire to do any of these things left to their own devices. Say what you want about market failure but the status quo is perpetuated by the free market because it is much preferable to it than absorbing the tremendous cost of building a city. Instead, governments bankrupt themselves at the expense of private developers, who happily burden taxpayers with the cost of their developments. Funny thing is, for all your clamoring for private cities that there is little actual interest in the idea on the part of developers.

[wahday]

I agree with hilldweller. My take on the quote (within the quote) you provided is that it is referring to things like public works, as well as "natural monopolies" in which the government steps in and says that given the scale of a particular enterprise (like power delivery or telecommunications), it is impractical for there to be an unlimited number of providers (and that there are barriers to entering the market to begin with).

Imagine if every few miles, the roadways were built and maintained by a different private company, each of which billed you for use.

The "state" may also intervene in the market if the service delivery is considered part of the health, safety and welfare of the populace, like water delivery and sewage. Even if these things are contracted to private companies, they don't compete for individual customers and the infrastructure is built by the government.

Once infrastructure is put into place, or with advances in technologies, these natural monopolies may be deregulated or other structures may come in to play to allow more competition in the marketplace (such as with telecom). But the possibility that a private company could build and operate a subway system, for example, without government intervention in the market, is unrealistic.

[jaws]

I agree with hilldweller. My take on the quote (within the quote) you provided is that it is referring to things like public works, as well as "natural monopolies" in which the government steps in and says that given the scale of a particular enterprise (like power delivery or telecommunications), it is impractical for there to be an unlimited number of providers (and that there are barriers to entering the market to begin with).

It is impractical for there be an unlimited number of bakeries in a small town, and yet even a single bakery is still a competitive bakery, even though it is a natural monopoly within a certain range.

Every single business is an exclusive provider within a certain range. That doesn't mean it is a monopoly. A monopoly implies being able to deny other competitors access to a market, and that is only possible with the use of government force. Monopolies are therefore not market failures, but government failures.

Imagine if every few miles, the roadways were built and maintained by a different private company, each of which billed you for use.
[...]
Once infrastructure is put into place, or with advances in technologies, these natural monopolies may be deregulated or other structures may come in to play to allow more competition in the marketplace (such as with telecom). But the possibility that a private company could build and operate a subway system, for example, without government intervention in the market, is unrealistic.

You need to read my essay on the subject. It's perfectly feasible and highly preferable.

The "state" may also intervene in the market if the service delivery is considered part of the health, safety and welfare of the populace, like water delivery and sewage.

Housing and clothing are certainly necessary for the health, safety and welfare of the populace, why isn't there a market failure in those industries?

In fact, the opposite standard must be applied. The last place where the government should interfere is in life-critical industries because that is where its negative impact will be the worst.

Instead, governments bankrupt themselves at the expense of private developers, who happily burden taxpayers with the cost of their developments. Funny thing is, for all your clamoring for private cities that there is little actual interest in the idea on the part of developers.

Why would there be? The most successful developers today are by defition those that have most profited from the current system. They are certainly not going to want to change the system unless it is even more to their advantage. That is not the free market however, it is just one more of countless examples of private interests securing monopolies from the government, thus an example of government failure.

[Wannaplan?]

I would like to see what would happen if we turned the courts over to the private sector. Just think, we could have a private judicial entity take action when an alleged market failure arises. Who needs justice when we have the free market to adjudicate disputes? Who needs laws when we have the free market to tell us what's right from wrong?

[wahday]

It is impractical for there be an unlimited number of bakeries in a small town, and yet even a single bakery is still a competitive bakery, even though it is a natural monopoly within a certain range.

Every single business is an exclusive provider within a certain range. That doesn't mean it is a monopoly. A monopoly implies being able to deny other competitors access to a market, and that is only possible with the use of government force. Monopolies are therefore not market failures, but government failures.

The bakery is not a "natural monopoly" in the sense it is often used in ecoomics. That is to say, the cost of running another bakery in the same town does not make it extremely difficult for others to enter the market.

My understanding of what you quoted at the beginning of this thread was that natural monopolies are examples in which the "free market" (if there is such a thing) "fails" to provide open competition because of obstacles such as the cost of creating a massive infrastructure.

From wikipedia:
Natural monopolies tend to arise in industries where capital costs predominate, creating economies of scale which are large in relation to the size of the market, and hence high barriers to entry; examples include water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines), therefore it is unlikely that potential competitor would be willing to make the capital investment needed to even enter the monopolists market.

I don't see that this applies to the bakery example.

You need to read my essay on the subject. It's perfectly feasible and highly preferable.

I have read your essay and offered my comments, all of which you dismissed out of hand.

Housing and clothing are certainly necessary for the health, safety and welfare of the populace, why isn't there a market failure in those industries?

Because the costs of providing these services does not provide an obstacle to others entering the market and generating competition.

As I mentioned in my earlier posts, these things are not stagnant. What may have at one time required government assistance or regulation to ensure delivery was manageable and affordable may later be deregulated and divided vertically and horizontally, as with telecommunications. This is a dance between government and the market. The music is constantly changing.

The last place where the government should interfere is in life-critical industries because that is where its negative impact will be the worst.

In places like Bolivia and South Africa, the World Bank insisted that public water delivery be privatized, but only a single international provider was able to even dream of making such a bid to develop the infrastructe and deliver potable water. The result was a 200% plus rise in costs. Failure to pay in South Africa resulted in water being shut off, residents forced to collect water from stagnant pools, and an outbreak of cholera took the lives of many.

http://www.publicintegrity.org/water/report.aspx?aid=49
http://www.tradewatch.org/cmep/Water...rica/index.cfm
http://www.cbc.ca/news/features/water/bolivia.html

How would your model have addressed these situations differently?

[jaws]

I would like to see what would happen if we turned the courts over to the private sector. Just think, we could have a private judicial entity take action when an alleged market failure arises. Who needs justice when we have the free market to adjudicate disputes? Who needs laws when we have the free market to tell us what's right from wrong?

Laws were once provided on the free market. This is how the common law emerged.

The bakery is not a "natural monopoly" in the sense it is often used in ecoomics. That is to say, the cost of running another bakery in the same town does not make it extremely difficult for others to enter the market.

My understanding of what you quoted at the beginning of this thread was that natural monopolies are examples in which the "free market" (if there is such a thing) "fails" to provide open competition because of obstacles such as the cost of creating a massive infrastructure.

There are costs to enter any market. If it is unprofitable to enter a market against the current provider, then that means that the current provider is highly competitive. It is not being monopolistic because it offers a better, cheaper product than anyone else who could enter the market against it. Everyone else is a submarginal producer. If the government were to interfere in this company's activities, it could only drive up the prices.

A monopoly on the other hand occurs when there is a provider that could enter a market and turn a profit, but it is legally forbidden from doing so. For example, italian taxicabs.

I have read your essay and offered my comments, all of which you dismissed out of hand.

I don't see your name anywhere there. Are you using two usernames?

As I mentioned in my earlier posts, these things are not stagnant. What may have at one time required government assistance or regulation to ensure delivery was manageable and affordable may later be deregulated and divided vertically and horizontally, as with telecommunications. This is a dance between government and the market. The music is constantly changing.

Then what's the standard by which the government interferes into the market? How do you determine when interference is necessary?

So far the only answer to this question has been "when politicians say so". That means market failures are nothing more than a justification for political action against the market.

In places like Bolivia and South Africa, the World Bank insisted that public water delivery be privatized,

The World Bank is a government agency.

[wahday]

I don't see your name anywhere there. Are you using two usernames?

My comments were to the draft version you circulated before posting the latest.

Then what's the standard by which the government interferes into the market? How do you determine when interference is necessary?

Firstly, I think that you are confusing my comments regarding a NATURAL monopoly with a MARKET monopoly (see below). They are not the same thing. Bakeries do not fall under the natural monopoly umbrella because the capital costs required to undertake the enterprise are not astronomical.

Besides, there are many different types of monopolies, not all of which have to do with government interference: efficiency monopolies, legal monopolies, local monopolies, coercive monpolies, monopolistic competition, etc.

Here is a simplified version of how governments make such determinations and which I learned in my econ 101 class:

"A Natural monopoly should not be confused with "market monopoly.” A natural monopoly may exist if per-unit costs in the industry diminish as the number of customers increase over time and where no combination of two or more firms could produce the product or service for less cost. If an industry is a natural monopoly then economists refer to the industry's costs as being "subadditive.”

An industry may also change from being a natural monopoly to a competitive industry as a result of technology innovation and other factors. For example the cable and telephone industries were at one time considered natural monopolies, but now subadditive costs analysis has largely demonstrated them not to be natural monopolies.

Economists have also recognized that a natural monopoly may exist in an industrial infrastructure, but not in the sale of the actual service or product. Hence, in the electrical and gas markets the move by regulators to separate the delivery of power or gas (a competitive market) from the distribution system (a natural monopoly)."

by Bill St. Arnaud

So far the only answer to this question has been "when politicians say so". That means market failures are nothing more than a justification for political action against the market.

Wow, this is a vast oversimplification. Are you suggesting that economists do not play a role in determining these decisions? If so, I think that is incredibly uninformed.

The World Bank is a government agency.

Which government are they an agency of?

The WB (no, not Warner Brothers...) is actually made up of two development institutions owned by 184 member countries - the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA).

Besides, my point was less about the WB than about the realities of providing water delivery in Bolivia and South Africa. In both cases, the decision was made to have the service offered privately rather than through the government or through regulation. The result was that only one company was in the position to undertake the task. The governments in these cases agreed NOT to regulate the industry and as a consequence, the health, safety and welfare of the public (ie. their right to clean and safe drinking water, which is a public health issue) was comprimised. As it was not tied to the municipality, the community had no mechanism for recourse.

[jaws]

Firstly, I think that you are confusing my comments regarding a NATURAL monopoly with a MARKET monopoly (see below). They are not the same thing. Bakeries do not fall under the natural monopoly umbrella because the capital costs required to undertake the enterprise are not astronomical.

So how much capital do you need to invest before you're a natural monopoly? Is there a number out or is it as arbitrary as the rest of the theory?

Wow, this is a vast oversimplification. Are you suggesting that economists do not play a role in determining these decisions? If so, I think that is incredibly uninformed.

"Economists" under the employment of governments will say anything for the money. Communist countries employed more "economists" than anyone else to plan their industries. It was of course a complete disaster.

For hundreds of economists paid by someone powerful to say what they're saying, there will be no more necessary than one with the integrity to refute them based on principles of economics. Of course the proponents of market failures will hire economists to justify their actions, the purpose of it, as I stated in my initial comment, is to legitimize the use of political power. What's more legitimate than an economist telling you it's all perfectly safe and good for you?

Which government are they an agency of?

The WB (no, not Warner Brothers...) is actually made up of two development institutions owned by 184 member countries - the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA).

There you go.

[wahday]

So how much capital do you need to invest before you're a natural monopoly? Is there a number out or is it as arbitrary as the rest of the theory?

I'm not so sure the rest of the theory is "arbitrary" - have you read it? You don't seem to be making any distinctions among different kinds of monopolies, for example, which I think if your economic theory is expected to carry weight, you need to do.

Once again:
A natural monopoly may exist if per-unit costs in the industry diminish as the number of customers increase over time and where no combination of two or more firms could produce the product or service for less cost. If an industry is a natural monopoly then economists refer to the industry's costs as being "subadditive.”

This is the simple answer/general principle since I can't really reproduce demand curves, etc. here. Really, though, this is in any intro econ text.

"Economists" under the employment of governments will say anything for the money.

But "the government" is not a single voice with a single agenda - it consists of many points of view, opinions and interests. How do these apparently corrupt economists decide which idea to back with their "fabricated knowledge?"

That Alan Greenspan, man, just telling us what "the government" wants us to hear....

What's more legitimate than an economist telling you it's all perfectly safe and good for you?

Is it as legitimate as you telling me how it should be?

The criticism I have of your essay is that I don't feel you clearly explain many of the bases on which your assumptions lie. I also think you need to examine in more detail the relationship between theory and praxis - what you are proposing is in the theory end of things, but it behooves you (if you are taking this seriously) to consider a range of possible outcomes, abuses of the system, and ways in which things might NOT going according to your plan. This lends some legitimacy to your argument, recognizing that nothing is really that simple

People have given you lots of feedback which I think a good researcher would incorporate into their thoughts. You tend to just defend your points without acknowledging that the way you have explained some of your ideas may be unclear (which was the gist of my draft comments). Maybe everyone else is stupid. but if you want to win them over to your side, you need to engage in a dialogue and not simply a defense.

IMHO...

[jaws]

I'm not so sure the rest of the theory is "arbitrary" - have you read it? You don't seem to be making any distinctions among different kinds of monopolies, for example, which I think if your economic theory is expected to carry weight, you need to do.

I recognize your distinctions, it's simply not true that market-dominant suppliers are monopolies. If you draw a supply curve you will have, at the lowest price, one provider, then at a somewhat higher price, two providers, and so on until an infinite number of providers ("perfect competition"). The first provider is the most efficient and every other provider is submarginal, meaning less competitive. If demand is so low that only one provider can operate profitably, the most efficient provider, then that single firm cannot be, by any definition, a monopoly.

Even if someone claims that this business is a natural monopoly, there is absolutely nothing that can be done to improve the situation. By definition this is the most efficient producer, meaning it has the best available capital and knowledge in the field. If a politician starts commanding this business to work against its own choices in order to allow the closest submarginal competitor to enter the market, this can only make the business less efficient and raise prices for consumers. This becomes a clear case of government failure.

Once again:
A natural monopoly may exist if per-unit costs in the industry diminish as the number of customers increase over time and where no combination of two or more firms could produce the product or service for less cost. If an industry is a natural monopoly then economists refer to the industry's costs as being "subadditive.”

This is the simple answer/general principle since I can't really reproduce demand curves, etc. here. Really, though, this is in any intro econ text.

There is no such thing as an industry with strictly diminishing average costs. Every industry has its own optimal size, and even though some industry's optimum size is really huge (petroleum for example) there comes a point where the business is impossible to manage and size becomes a cost instead of a benefit.

Regardless neoclassical monopoly theory has nothing to do with the size of a business, it is based on the idea that a monopoly can charge a price above marginal cost for its product (thus it is "inefficient"). Since in a market with less than an infinite number of participants every business faces a downward-sloping demand, then every business is guilty of being a monopolist, or none at all. Neoclassical monopoly theory is nonsense. Everybody is a monopoly of some type.

Even worse for the theory, the slope of the demand curve determines how much in excess of marginal costs (or how inefficient) the monopolist's prices will be. Since we have absolutely no way to know what a firm's demand curve is, it is quite possible that large-scale business is more efficient (in the neoclassical sense) than small-scale business. The large business could be producing at a point in the demand curve that is much flatter.

But "the government" is not a single voice with a single agenda - it consists of many points of view, opinions and interests. How do these apparently corrupt economists decide which idea to back with their "fabricated knowledge?"

Whoever will pay their salary. Principled economists can only really write books for a living, unless they beat the odds and get tenured. That means they have to get real jobs to pay the bills. Unprincipled economists can advance their careers by justifying the agendas of whoever is employing them. Since most of them work in government, or in government schools, they have the incentive to justify the government's actions.

That Alan Greenspan, man, just telling us what "the government" wants us to hear....

Alan Greenspan was once an acolyte of Ayn Rand and a hardline defender of the gold standard. Then he had to get a job. Some years later Alan Greenspan claims that central bankers act "as if" a gold standard was still in place, which if you know anything about central banking is just plain hilarious. Of course Alan Greenspan went through great lengths to ensure his language was incomprehensible so you wouldn't know how funny he was.

The criticism I have of your essay is that I don't feel you clearly explain many of the bases on which your assumptions lie. I also think you need to examine in more detail the relationship between theory and praxis - what you are proposing is in the theory end of things, but it behooves you (if you are taking this seriously) to consider a range of possible outcomes, abuses of the system, and ways in which things might NOT going according to your plan. This lends some legitimacy to your argument, recognizing that nothing is really that simple

People have given you lots of feedback which I think a good researcher would incorporate into their thoughts. You tend to just defend your points without acknowledging that the way you have explained some of your ideas may be unclear (which was the gist of my draft comments). Maybe everyone else is stupid. but if you want to win them over to your side, you need to engage in a dialogue and not simply a defense.

IMHO...

I did add some things to the full text. You should give it a read.

[Luca]

Jawsy, tell me you're NOT a gold-standard fan?

BTW, when Greenspan was a Rand follower...he was young...he needed the money... (South Park character explaining his mom's picture on the over of "crack whore monthly")

[jaws]

Jawsy, tell me you're NOT a gold-standard fan?

BTW, when Greenspan was a Rand follower...he was young...he needed the money... (South Park character explaining his mom's picture on the over of "crack whore monthly")

The market can provide money just like anything else. There doesn't need to be a gold standard any more sophisticated than defining a common weight and measure.