Get the right counterfactual!

Arnold Kling makes an important point when discussing market failure on Econlog:

Instead, it says that every industry is dysfunctional in its own way. But every industry is dysfunctional.

He points out that this may lead people to the conclusion that:

And in every case, experts wielding the power of the state are presumed to make things better.

Now, to the sheer majority of people this conclusion would seem suspect – which in itself tells us that there is something amiss.  The “something” that is missing is the imperfection of government policy.

Yes markets fail, but the state isn’t able to perfectly correct for such things.  In order to justify intervention, we need to be able to say that the cost of market failure exceeds the costs associated with government intervention.

This raises an interesting issue – if it is up to policy makers to make a judgment call on these costs, and for some reason they believe that their abilities are greater then they are are (say because they don’t face punishment if they fail, and so never have to update their beliefs with regards to their abilities) then we are more likely to get government intervention when it is inappropriate then no intervention when it is appropriate.

That is just a little point to keep in mind – and is probably one of the justifications for having a Treasury department that looks at the quality of spending rather than just balancing the books.

8 replies
  1. Eric Crampton
    Eric Crampton says:

    Heh. That’s week one of my Public Choice undergrad class: markets fail, so do governments, there are other econ classes that’ll tell you all about market failure, this one covers why policy isn’t always meliorative. I don’t think there’s any other econ department that covers public choice. Fortunately, a reasonable number of my students make it into Treasury and MED.

  2. Matt Nolan
    Matt Nolan says:

    @Eric Crampton

    I think economists are often so busy trying to show that we don’t hate the rest of the world, we forget to properly discuss the limits of government intervention. Public policy at Vic covers public choice from memory.

    Treasury and MED sound like the right places to put your students since they do realise these limitations.

  3. WH
    WH says:

    Eric – your students are not needed at Tsy and MED, they are really needed in the other departments. TSY and MED end up fighting rear guard actions, if there was better policy analysis in the first place – Govt policy could all take up step up in the value chain, maybe a little proactive work instead of constant reactive activity – although it is hard to stop politicians from wanted a knee-jerk response.

  4. Eric Crampton
    Eric Crampton says:

    @Matt: I have a love-hate relationship with the rest of the world, and it’s reciprocated.

    @WH: A few do wind up at other places. Transport, RBNZ…

  5. Paul Walker
    Paul Walker says:

    The point I like to make when dealing with “market failure” is that a failure in one market brings about a another market to deal with it, eg adverse selection problems with second hand cars bought about another market for the checking of cars, by outfits like the AA, before they are sold. So any government answer to “market failure” has to be compared to the market answer, taking into account, as you note, government failure.

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