Monthly Archives: May 2014

Market failure? More like economists’ failure.

In economics, we are often taught that market failures justify government intervention, though this is a strange way of looking at things. A market failure is, broadly speaking, any situation in which a market has failed to “efficiently” allocate resources; what “efficiency” means is all too often left unsaid. Some might see climate change as a market failure – the social cost of pollution is not properly represented by the private cost of it. If one person doubles their polluting, the impact is spread over everyone, so they are only negligibly worse off. If everyone were to do the same, however, that would obviously be bad.

Why should situations in which a market is unable to properly operate be called a “market failure”? Why not blame those who insist blindly that markets should solve everything? It seems ludicrous to blame the market for being applied to areas it simply doesn’t belong to. Nobody would call the collapse of a wooden skyscraper a “timber failure”. We would blame the architects and engineers who told us it would work to begin with, we would ask why they blindly insisted that timber was the best option and we would hold them accountable for the harm they did to others when they approved the construction of that wooden skyscraper.

We, as economists, need to stop using the term “market failure”. It is not the fault of the market for not allocating things perfectly efficiently all the time, it is the fault of economists for insisting it would. Here I am being slightly unfair – of course economists do not insist that everything is best solved by the market. However, we still take this as our starting point with worrying regularity. In order to prove to economists that a market isn’t applicable to a situation, it sometimes has to fail first. We should have seen the harm that structural adjustment programs would cause, yet we did not. We should see the harm that healthcare privatisation will cause in the UK, yet market fundamentalism has blinded us to it.

This is not to say that the market isn’t efficient some of the time – perhaps even for most of its current uses. However, those who promote its use everywhere need to take a step back. Firstly, the use of Pareto efficiency is extremely problematic. While Pareto efficiency is a politically neutral concept, the choice of it as something to pursue is not. Something is Pareto efficient if nobody can be made any better off without making someone else worse off. This is a good starting point for talking about efficiency, that much is clear. However, it really is something of a bare minimum.

Aiming for Pareto efficiency alone is extremely conservative. When our discussion about efficient use of resources stops as soon as we talk about transferring them from one person to another, we need to accept that this is a discussion in which change of the status quo is not even considered. The distribution is irrelevant – if only one person becomes even a little worse off, no matter if many people become much better off because of it, then it is less efficient. This is a perverse definition of efficiency, and should be avoided.

Suppose a desert island has 5,000kcal of food per day on it, and that a person needs 1,500kcal/day to scrape by, 2,000kcal/day to live fairly well, and is fully fed with 2,500kcal/day; beyond that, they enjoy eating the extra food, but gain little nourishment from it. If there are two people on this desert island, one with 3,500kcal/day and one just fending off starvation on 1,500kcal, this is Pareto efficient. All the food is used up – the person near starvation cannot get any more food without denying the greedy one the small pleasure of eating. If both of them had 2250kcal/day, this would not be Pareto efficient. However, it intuitively seems like a much fairer allocation of resources.

This example is, of course, an oversimplification. However, the tragedy is that it is an oversimplification of how our food markets currently run. Billions fend off starvation, while others eat simply for the pleasure of it. This is what happens when we use markets – excellent at getting Pareto efficient outcomes – to make our decisions for us. The failure is not with markets themselves – they simply operate and produce allocations – the failure is with those who assume that there is no other conceivable allocation. Pareto efficiency is all too easily conflated with actual efficiency, and both are too easily conflated with just outcomes. The fault for these failures resides with those who insist on using markets to allocate resources, such as food, where lack of that resource is a grave injustice.

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