For decades I have heard people talk about market failure, and use this as a means to advocate what governments should or shouldn’t do. I thought this way of thinking had waned, but it still seems to be very much alive.
First, a word of definitions. Many people use the phrase 'market failure' to describe situations where markets fail. But economists use the phrase in a very different way and its their approach that I focus on here.
The essential argument in economics is this: markets are the best and most natural way to organise the world. But they sometimes fail, for reasons such as tendencies to monopoly, the existence of externalities or underproduction of public goods. In these limited cases there may be a role for government to step in. Otherwise markets should be left to do their work.
Lots of clever people take this for granted. It’s part of the DNA of organisations like the IMF and World Bank, or Britain’s Treasury. Its logic is used by governments of all kinds and the ideas have been inculcated into thousands of minds as a world view so successfully that people never question it, and there is a certain intellectual pleasure in applying the theory to new fields. It feels tough, sharp and smart and often it is indeed healthy to ask whether a government really has to provide a service or act in the way that it does.
But when I hear people invoke market failure, I like to ask them to attempt a thought experiment. Try to think back to the world of three hundred years ago. Then it was widely believed that heredity was the natural way to organise societies. Power should be passed down through lines of descent. This was how families worked and how most businesses worked, with sons taking over the work of their fathers, whether fixing shoes or running banks. It was how states worked too, under the leadership of hereditary monarchs, and their rule seemed natural and logical.
Moreover the approach worked. All of the world’s most successful nations were run by monarchs. So the evidence for its efficacy was overwhelming. There had been occasional experiments with democracy or republics but these had nearly always failed.
It was recognised that there might be exceptions – ‘hereditary failure’ we could call it, by analogy with market failure. Very specialist knowledge might be needed in some cases – astronomy, engineering, medicine- that wasn’t best provided through hereditary institutions. The king might not have a male heir and occasionally the heir might be an idiot. So in a limited number of cases the hereditary principle could be suspended.
My question to the economists is: in logical form, how is your argument in any way different? Is your belief in the market not just a time-bound cultural construct, and a rather self-serving one? Does it have any scientific basis, and if so what? After all mainstream modern economics is founded on assumptions about human behaviour (rational, maximising etc), not empirical analysis of how humans actually behave.
It also doesn’t derive from any empirical analysis of how the most successful governments in the world actually work.
Indeed, there are good reasons why what governments do cannot be understood through the lens of market failure. Rather they provide justice, welfare and protection because this gives them legitimacy, and if they didn’t they would be thrown out, not because it accords with a theory. Sweden provides extensive care and welfare; Singapore provides housing and business investment; the US invests heavily in technology and aims to be ahead of any geopolitical competitor. In each case the reasons they do so have little to do with the deductive logic of market failure.
There are many things states could do but don’t do (at least usually). But again their rationales have little to do with the logic of market failure. Few intervene in detail in the daily life of families. Few try to run religions. Few organise food production and distribution (though the earliest states did, before the existence of anything resembling a market).
I’ve yet to have a really good justification for the market failure approach. I hope economists go away recognising that the ‘market failure’ frame may be useful as a thought experiment (and in general I favour ways of thinking that don't automatically assume that government is the solution to every problem).
But market failure shouldn’t be treated as a dogma, or a universal instrument or as an accurate guide to the world.
There is lots that I admire about economics – its clarity and rigour and its willingness to measure. There is also lots to admire in the detailed analytics around market failure – from information asymmetries to recent attempts to squeeze ecology and intergenerational fairness into the framework.
But too often when orthodox economics has gripped clever brains it makes them a bit stupid. They stop standing back and asking the right questions. Theory then becomes a trap, and not a tool.
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