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Beyond market failure and government failure

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Abstract

Criticisms of market outcomes often rest upon a notion of ‘market failure,’ meaning that the market has failed to align incentives and knowledge to produce an optimal outcome. Rejoinders to classic market failure arguments have taken several forms: that there are institutional or contracting solutions to various forms of market failures, that optimality is not a reasonable goal for real world economic activity, or that government may fail as well. Similarly, Wittman (The myth of democratic failure, University of Chicago Press, Chicago, 1995) and others have argued that concepts of government failure are equally problematic as the ordinary forces of political competition may render politicians sufficiently accountable to achieve realistically defined standards of efficiency. Even thinkers like Buchanan imagine that constitutional design may allow politics to fend off its tendency to become a zero-sum game. Both concepts are problematic in a world of entangled political economy in which market and government activity are interconnected. We argue that it is time to abandon both ‘market failure’ and ‘government failure,’ and instead focus on problems of institutional mismatch, when the rules governing interaction are ill-suited to the problems that agents confront.

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Notes

  1. Arrow (1951) and Downs (1957) published their work before Bator (1958) and Samuelson (1954), while Black (1958), and ultimately Buchanan and Tullock (1962) as well as Olson (1965) appeared shortly afterwards. See also Medema (2009, Chaptert 4) on the Italian Tradition of Public Finance in economics.

  2. Hall et al. (2018) find that most (upper level) undergraduate public economics textbooks cover rent-seeking in varying degrees of detail. On the other hand, rent-seeking receives zero coverage in graduate-level public economics textbooks. Receives zero coverage in graduate level public economics textbooks. Llyalk actually matters, arguing that standard models assu.

  3. A simpler and ubiquitous method of property delineation is the practice of fencing. To see a discussion of land enclosure via fencing in the American west with the introduction of low-cost barbed wire fencing, see Anderson and Hill (1975).

  4. Van Zandt (1993) and Bertrand (2006) push back against claims made by Coase.

  5. Examples include childcare (Mocan 2001), labor (Gibbons and Katz 1991), credit (Ausubel 1991), insurance (Puelz and Snow 1994; Chiappori and Salanie 2000), capital (Booth and Smith 1986), and automobiles (Bond 1982; Genesove 1993).

  6. For an empirical examination of market-provided warranties in used car markets, see Mann and Holdych (1996). For similar studies using laboratory experiments, see Holt and Sherman (1990).

  7. This is the main reason we have not explicitly addressed monopoly as a form of market failure. Antitrust policy and regulation of natural monopolies are obviously institutional solutions to purported problems. It is worth noting, however, that monopoly has probably become less of a concern in the academic literature on market failure, owing to insights about contestability (Demsetz 1982), and that it is unclear whether anti-trust policy is a an effective solution to concentrations of market power that do exist (Shughart and McChesney 2010; Young and Shughart 2010). Moreover, whether monopoly generates inefficiency also depends on controversial behavioral assumptions, such as whether monopolists act as Cournot or Bertrand competitors.

  8. Pasour (1987, p. 123) argues against the claim that rent-seeking is a government failure, pointing to the fact “that rent-seeking waste can only be identified by substituting the observer's own standard of value.”

  9. Similarly, Salter and Young (2017) compare governance institutions in England and France. Their research highlights the importance of assembly representation in the development of the rule of law in the former as well as differences in their effect on economic institutions in both countries.

  10. See, for example, Brennan and Buchanan (1980, 1985) and Buchanan and Congleton (2003).

  11. Spreadsheet available here (link).

  12. Despite the advantages we enumerate in the proceeding section, then, mismatch talk does not allow us to evade the problem of the second best (Lipsey and Lancaster 1956). Rather, it transfers that problem from the domain of interacting policies to the domain of interacting institutions.

  13. Governance likewise may be about more than determining rules, so that the two concepts would be overlapping rather than proper subsets. Governance failure could include the misallocation of resources within an institutional framework and not only the inept design of an institutional framework.

  14. A popular example is that of controls on fluid milk. See, for example, Ippolito and Masson (1978), Helmberger and Helmberger (1994) and Johnson (1985).

  15. This is also an advantage for an “efficiency always” perspective. Leeson (2018) “bites the bullet”, arguing that since institutions are the result of maximizing behavior, they must be efficient. Our argument is orthogonal to his. Even he allows a role for economists to “improve the world” by shifting relative prices through costly action and lowering others’ search costs for better institutions. In his approach, such actions change what is efficient rather than closing the gap between what is efficient and what simply is. He also distinguishes sharply between efficiency and wealth generation. Though we have used the language of inefficiency throughout because it is standard, mismatch talk works both for analyzing the non-efficiency properties of institutions (such as how much wealth they generate), or as a talk strategy for Leeson’s “inside the model” economists who shift was is efficient.

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    Glenn Furton & Adam Martin

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Furton, G., Martin, A. Beyond market failure and government failure. Public Choice 178, 197–216 (2019). https://doi.org/10.1007/s11127-018-0623-4

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