MarketFailure

ThoughtStorms Wiki

Context : FabulousMonstersOfEconomicDebate

Here's something to get one's teeth into :

A short, Austrian blog post offering some answers to claims of market failure.

http://austrianeconomists.typepad.com/weblog/2006/05/respondingtoc.html

So the answers are these :

1) conceptual definitions of "problems" such as monopoly are flawed. For example, consider a wide enough definition of the market and there are no effective monopolies. Consider a narrow enough one, there are always monopolies.

2) there are institutional failures which fail the market rather than failures of the market. For example not everything is property. Externalities are essentially the failure of things to be property.

3) best of a bad bunch. Markets may be failures, but non-markets (eg. governments) are worse.

4) ongoing process. Sure markets have failures but they also have processes which are focused on solving those failures.

OK. Well, here we go :

1) Sure, definitional / philosophical / conceptual arguments are always a tricky matter of steering between simply defining your concepts so that you win vs. losing. If I can define markets broadly enough, probably monopoly goes away. But have I just imagined a market which is infinite? Or composed of continuous prices and products, rather than one broken up into the discreet quanta of goods and moneys which we actually have? I may draw my market broad but it must still be a recognisable model of the real human instititution if my reasoning about it is allowed to refer to our situation.

: Personally, I think the idea of monopoly as a binary all-or-nothing factor probably is naive. It's better to think of it as a kind of "viscosity" or "friction" which prevents buyers shifting from one seller to another. It is graded (FractalMonopoly) : larger markets with more suppliers have a lower degree of monopoly while more restricted markets with fewer suppliers have a higher one. That doesn't, though, seem to be an argument that monopoly either doesn't exist, or isn't a problem severe enough to require a solution.

It's hard to tell from the blog post whether the conceptual analysis arguments also cover the idea of dependencies between different products or suppliers. Or the idea of network externalities which make some products more attractive because everyone else is using them etc. Perhaps these can be folded into the idea of the costs of switching between suppliers and a general viscosity notion of monopoly; even transaction costs can be folded in. On the other hand, these may simply not be considered "failures". You might say : "Sure everyone uses Windows because everyone else does. But that still means everyone prefers Windows". It's not a "failure" of the market to detect this preferability of Windows.

2) Nevertheless, there is another kind of externality (such as unloading your pollution on others) which needs to be addressed. The "institutional" answer to "failed markets" is that this is a problem of failed laws or the failure of society to package stuff like clean air up as property in the first place..

: There should be several responses to this. Firstly, if I sell you a car, which turns out not to run because it lacks an engine, then it's not valid to say "it is working, it's just that you've forgotten to put the engine in." Function is a property of the whole system. Half systems that don't work, don't work. Period! And if you try to sell me a market that doesn't function as advertised, I don't see that "well, it would work if only you added the missing components (ie. the rest of nature wrapped up as the right kind of property)" gets you off the hook. The market, as is, is not functioning. And appeal to a hypothetical market, as could be, means little.

: Secondly. There are serious practical problems with wrapping everything up as property. Economists love to think of property as some kind of Platonic ideal. A conceptual tool. And in this view, markets are wonderful abstract information processing machines. But property needs to be implemented by political power. Societies decide what things count as property and what their rules are, and to an extent, property can only exist if it is recognised and policed. New types of property require new types of policing and power applied to protect them. Property which is hard to police and protect will soon cease to be property at all. (OnProperty)

: So, what if the kinds of property required to solve externalities aren't practical to implement? For example, it looks like the propertarian answer to pollution is to bundle up the whole of nature's pollution absorbtion capacity and trade it in a market. But, in practice, we're an unimaginably long way from being able to monitor and enforce such exclusionary rights. OK, so these practical problems dog almost any attempt to deal with pollution. But that doesn't alter the facts; if the answer to "market failure" is that "were an entirely unfeasable kind of property to exist, markets wouldn't fail", I don't think the defence is in good shape. To go back to my car example, this is like selling a "working" starship without a warp drive. Not only is it missing an essential part, but no-one even knows how to build the missing piece.

: There's a third issue, which might not be a question of market failure but is of equal importance. The question of justice as we invent new kinds of property. As HernandoDeSoto points out, the real mystery of capital is that we've forgotted how property comes into being. And the answer is that it's pretty messy. Propertarians don't tend to worry too much about the justice of the original allocation. They gloss this over with Lockean homesteading myths while condoning land-grabs by the aristocracy, slaughtering indigenous peoples, and handing off nationalized industries to arbitrary ex-civil servants. Nothing matters except that previous non-market-tradable stuff becomes market-tradable.

You can't justify the creation of property on propertarian ground - that's just circular. So you end up reverting to an appeal to utility. The "institutional" solution to market-failure almost certainly demands the creation of many new types of property (to eliminate all those negative externalities). Who will decide how they're allocated? And will the allocation be fair? (See also : PollutionRightBackedCurrency)

3) The third response. Markets aren't perfect but better than anything else.

: What's the quantifier here? All market allocations are better than all government allocations? One counter-example would sink such a strong claim. And I doubt many would like to be hostage to anything so brittle. So we're left with the usual arguments : on average, most market allocations are better than most government ones ... if you squint a bit, and take a general overview from 40,000 feet. But what can we infer from this about the next government allocation vs. the next market allocation? Not much. Attempts to assert that, say, 80% of the time, the market is more likely to get the allocation right than the government, flounder without some kind of objective, market-independent metric of what the right allocation actually is. Ultimately, extreme Austrians will bite this bullet : define the "right" allocation, tautologically, as whatever the market actually produces. But it's an example of defining your concepts so you win, on the grand-scale. Sure, if "success" is defined as what the market does, then markets can't fail by definition. But the claim is tautological and content-free. If "markets don't fail" is to have some empirical value, then it must be potentially falsifiable within the conceptual framework. It must be an open question. And for that to be the case, there must be an independent measure of appropriate allocation. Let's see one.

4) As the blogpost suggests, the "we're not failure free, but have the best mechanisms to cope with it" is probably the best response. This way you can define markets cybernetically : they're feedback driven machines seeking certain kinds of balances. But such a view doesn't preclude the idea that such systems may have failures. It doesn't even preclude the idea that such systems have systematic failures. Compare the well known HuntingProblem, that most HomeostaticSystems have, with the "cyclic" (or generally a lot more chaotic than cyclic) behaviour of markets.

Well, if anyone wants to buy me this :-) : http://www.independent.org/books/briefmarketfailure.html

(http://www.amazon.com/gp/registry/registry.html/ref=cmwltopnav_wishlist/002-1095431-0055269?%5Fencoding=UTF8&type=wishlist))