When an industry in the private sector is not performing efficiently or effectively, there is said to be “market failure”. The recommendation by economists and others typically is then for government actions to combat such failure, such as taxes to help reduce pollution. The diagnosis of market failure may be accurate, but the call for government involvement may be naïve and inappropriate.
The reason is that actual governments do not necessarily do what economists and others want them to do because there is “government failure” as well as market failure. Before recommending government actions to correct market failures, one should consider whether actual government policies would worsen rather than improve private sector outcomes. Since many factors often make for considerable government failure, considering such failure is crucial and not just a theoretical fine point.
Those on the Left often call for government intervention in the private sector at the first sign of imperfections. Such imperfections are not limited to the more highly visible examples of millions of people without health insurance or severe environmental damage. I have friends who want the government to most actively regulate the cell phone industry because they think the services are better in Europe. That our phones have improved tremendously over the years – compare your Droid or iPhone to your first cell phone from 10 or 12 years ago, for instance – as have the coverage and plans, is insufficient. It is imperfect, thus can improve. The default measure is regulation. It will sometimes – no, often – make the situation worse, but that only means the regulation needs to be adjusted or the regulators replaced with more competent professionals. Imperfections in the regulation are worth tolerating because they done are in pursuit of improvements, not profits.
Government actions sometimes not only fail to overcome market failure but rather worsen the failure. Fannie Mae and Freddie Mac were formed as quasi-governmental institutions to help encourage mortgages in the residential housing market because of a belief that the private sector was not providing enough mortgages, especially to lower income families. Yet, as documented in detail in Reckless Endangerment by Gretchen Morgenson and Joshua Rosner, these two companies used their privileged positions to take excessive risks, and to insure large numbers of mortgage loans that should never have been made.
More damage was done by Fannie and Freddie, of whom the government has more control and information than it does of any private sector company – than all the reported private sector monopolies (Microsoft, Google, General Electric, Intel, etc.) combined. The problem wasn’t the regulation itself, of course, but rather the lack of it.
Hardly. The problem is often in the regulation itself. Regulators distort markets and create costs to be paid by others. They also create unintended consequences for which they are not responsible. The market is like a mobile, where movement on one side creates unpredictable and uncontrollable movement in the others. Market distortions are not easily contained, and we are foolish to think we can manipulate an industry as easily as we do computer code. The market, in its nature the cumulative result of millions of individual decisions, will almost always respond to a problem with more efficiency and information than the government can. Such understanding is what led economist Thomas Sowell from Marxism to capitalism.
Becker also offers his thoughts on how to decide if and when the government should intervene and regulate.
How does one approach policy once it is recognized that government failure is substantial, and often much worse than market failure? As a general rule I believe the presumption should be in favor of government actions only when market failures are quite large and persistent. So clearly governments should have the dominant role in the military and police areas, in the judiciary, in protecting against massive pollution, and in providing a safety net for its least fortunate members (private charities are important but do not do enough). On the other hand, when market failures are relatively small and likely to be temporary, as in monopoly situations or in exploiting consumer ignorance, government involvement should be minimal, as in minimalist anti-trust policies, and in allowing consumers generally to make their own decisions.
The intermediate cases are the most difficult: when market failures may be significant, and yet government alternatives are not attractive. This may be decided on a case-by-case basis, but I believe the usual rule should then be to let the market operate. This belief is based on the conclusion that, on the whole, government failure is far more pervasive, damaging, and less self-correcting, than is market failure. Others may reach different conclusions, but these are the problems that a relevant welfare analysis should focus on. Simply concluding that in particular instances markets are not working perfectly is a misleading and incorrect basis for supporting active and sizable government involvement.