Do you believe in market failure?

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Clayton replied on Sun, Aug 8 2010 3:14 PM

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Suggested by Jon Irenicus

Clayton, actually it looks like I predicted your response pretty well. You assert that transaction costs are circumstances we can't fix and then skip along to how you dislike the political solutions that are typically offered for solving market failure because they involve coercion.

Of course, none of what you said justifies your original assertion that market failures can only be defined with reference to sort of collective ideal outside of individual valuation. *shrug*

You must appeal to some sort of collective in order to define market failure. Taking the intersection, for example, we can say that "if everybody waited their turn", they would all get home sooner. That is, if people acted "collectively", there would be a more desirable outcome. But this outcome (everybody getting home earlier) can only be desired by a "collective" valuation, since rational individuals are indifferent to whether others get home earlier or not. Yes, the valuations of an individual happen to coincide with the "collective" valuation in this instance, but I posit that that is a coincidence of the chosen examples.

Slippery fish arguments are never very fun for me, so this will likely be my last post in this thread. But I will take a second to address 3 of your specific points.

Think what you like. I'm more interested in debating substance and learning something in the process than exchanging pre-canned "my experts versus your experts" posts.

#1. I guess I have a philosophical problem with the idea of market failure because it conceives of the market as something that is designed. Transaction costs, like any other cost, are simply a circumstance. We cannot fix, alter or even redistribute costs without resort to coercion.

Not true. The definition of market failure doesn't require anything about markets being designed or how they are created at all. In fact, it takes the existence of a market as given and says that this market is not able to do its job

"[the] market [does] not do its job" - this is exactly what I mean... "its job" is a collective valuation. You are applying a criterion for success and asserting that the market fails to meet this criterion. You are reasoning about the market as if it has an end, such as being more efficient or maximizing prosperity or whatever. The market - like biological evolution - has no end or purpose, it is atelic.

when transactions costs are high (for example, I never described the creation of the air quality market in my example because it is irrelevant for the *definition* of market failure). Now, that doesn't mean that how markets are created isn't an important question--especially when it comes to considering how to *solve* market failures. But I should stress that defining market failures and solving them isn't the same thing. Based on your post I wonder if you are drawing any distinction between the two concepts.

I doubt the ROI of pondering the concept of "market failure". Yes, mainstream economists spend a lot of time talking about it and think that it's an important problem. I dissent. Entrepreneurial endeavor is the "solution" to the "problem" of market failure. What's the big deal?

#2. I understand what economists mean when they talk about market failure. I do think the term is loaded but so what? That's what economists call it. The trouble I have is not with the idea of market failure itself but with the idea that market failure can be corrected via coercion. If you look at each example of market failure on a case-by-case basis, you will find that coercion is not needed to solve whatever problem is at hand.

I actually have no problem with this statement. I would just note that this isn't what you said in your previous post. If you scroll up, you will see that the first sentence of your post stated that market failure itself cannot even be defined without appealing to some collective ideal. Bad choice of words, right? :D

OK, so then we are in agreement anyway. It appears that the disagreement is either a "bad choice of words" or some other form of verbal crossed wires. 

#3. However, I do have a technical quibble with market failure. Rational action sometimes leads to results that are suboptimal based on the individual valuation of each individual, such as Friedman's example of the "busiest intersection in the world" and if everyone just simultaneously cooperated by doing what seems to be irrational on individual valuation, the end result would be more optimal based on individual valuation. But this idea presupposes that the actions of others are not as much a part of the circumstances of "the world as it is" as anything else. <snip>

Rationality is not measured with respect to some counterfactual world where, for example, everyone cooperates at the intersection to reduce total time to get home.

But the state of affairs where everybody just magically* cooperated to get home sooner is, indeed, a counterfactual world. The actual world we live in is characterized by rational actors who choose the "locally optimal" action irrespective of the larger consequences.

It is measured with respect to this, actual world and the choices that people actually do make, even when those choices frustrate the ends of most or all participants in the market.

I am not sure what you are getting at. Rationality is not being measured with respect to a counterfactual world. Its the desirability of the OUTCOMES that are being measured and compared.

Yes, but the outcome is the outcome of collective action, not the outcome of individual action. If I choose route A over route B and get home faster, the outcome is the result of my own action. This, in turn, influences my future actions. But the outcome of the choices of many individuals cannot influence my future actions since I cannot control the actions of others. If I choose A and achieve a reward, then I may alter my decision-making strategy to incorporate A more of the time. But if I get rewarded or punished regardless of my own choices (as a consequence of the choices of many other individuals), my decision-making cannot be improved since my decision was not the controlling factor in the outcome.

Let me see if I can clarify. Our choices are not made in a vacuum. They are made in the context of institutions. Going back to Friedman's intersection example, how does each individual decide when to cross the intersection? In the real world, the institution in place is a combination of ques and traffic signals. Cars line up, single file (first come first serve) and wait for "their turn" to cross the road. However, as Friedman describes, each individual is only interested in getting home earlier (regardless of whether that means other people get home later). So you effectively wind up with some individuals trying to "cheat" by clogging the intersection after their light turns red so they can effectively steal a turn from individuals going in the other direction. Knowing this will happen, other individuals do the same to avoid getting cheater out of their turn later, and everyone winds up getting home later than if everyone simply waited their turn.

Are people acting irrational in Friedman's intersection example? No. But the institution in place for deciding who gets to cross the intersection is channeling everyone's rational self-interest in a way that creates an ***outcome*** that is undesirable from the perspective of each driver (each of whom is making decisions with the goal of getting home earlier). Maybe you could call it a "coordination problem" if that suits your anarcho-capitalist fancy.

I don't really like the term "anarcho-capitalist", I just prefer anti-state or anti-statist. And I'm no fundamentalist. I grew up in fundamental right-wing churches and I've gotten more than a lifetime's worth of pulpit-pounding. I understand the issue of market failure and I assent to your above description of Friedman's example as accurate. Nevertheless, I think that it's either an unimportant problem or a poor way to think about the important problems it touches on. I understand that most economists disagree.

This coordination problem arises because there are externalities (the cost of my decision to cheat are felt by others and not myself), transaction costs (it is very costly to bargain with other drivers over who will cross the intersection next), and ill defined property rights (i may think it is "my turn" to cross the intersection next, but you seem to think it is your turn because you're blocking my way by sitting in the intersection and no one is around to settle the disagreement).

Yes, transaction costs are important. There are problems with Coaseanism, however. This is one area where I disagree with David Friedman... he thinks that Coase is, generally speaking, the "solution" to transaction cost problems and property rights disputes. I think the solution is a lot more complex.

Clayton -

*In other words, irrationally

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Modus Tollens replied on Sat, Aug 14 2010 10:16 AM

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Suggested by liberty student

Maybe it should be called "failure to create a market" instead of "market failure."