Market failure and what government can do - Essay Example

?Market Failure and What Government Can Do Market failure is the failure of the market to yield efficient outcomes (Stiglitz 2000, p. 77). Elaborating further, Stiglitz said that there are six situations in which markets are not efficient and these are referred to as market failures that provide a rationale for government activity (2000, p. 77). The six conditions in which markets fail to lead to efficient outcomes are those in which competition fails, situation in which public goods are involved, market situations in which there are externalities, situations in which markets are incomplete, situations in which information is imperfect, and situations in which there are macroeconomic disturbances (Stiglitz 2000, p. 77-85). For markets to lead to efficiency, markets must be perfectly competitive (Stiglitz 2000, p. 77). This means that there are no constraints for competition to prevail in the market. Examples of situations in which competition does not prevail are those involving monopolies and oligopolies. Monopolies are market situations in which there is only one seller while oligopolies are market situations in which there are only few sellers. Both monopolies and oligopolies can charge consumers prices that are higher than those which can prevail in perfectly competitive market settings.1 Public goods are those whose consumption is non-rival and non-excludable as opposed to private goods whose consumption are rival and excludable. Non-rival means consuming the good will not deprive others of the good. Road services or city lighting services, for example, are goods or services that are not deprived to others when an individual consume or use the good or service. They are also non-excludable in consumption because it is costly, feasible, or impractical to exclude others from consuming or using the good or service. In the literature of economics, economists usually use the term pure private goods and pure public goods to refer to pure cases but they recognize that there are goods in-between or public goods that have private goods characteristics as well as private goods that have public goods characteristics. Sometimes, these goods are also referred to as mixed goods.2 Externalities refer to effects on third parties other than the consumer or producer of the product. For example, consumer may use gasoline but parties other than the producer or consumer of the product receive the pollution. Externalities can be positive or something good such as the benefits to the environments of a certain car that does not use fossil fuel or it can be negative like that in car that pollutes the environment. Economic literature holds that when markets are competitive, prices almost equals costs and goods are produced at costs. However, because of externalities, markets can lead to situations in which goods may be overproduced or under-produced, depending on their effects to society.3 Incomplete markets refer to situations in which although the cost of providing the good is less than what consumers are willing to pay, the good is not produced just the same (Stiglitz 2000, p. 81). The situation of incomplete markets implies that there are things missing in the market because otherwise the good or service would have been produced if there is nothing that is missing in the market (Stiglitz 2000, p. 81). Incomplete markets can emerge when complementary services are lacking, transaction costs are too high, and the like (Stiglitz 2000, p. 81-82). It is possible that incomplete markets are one of the least studied market situation in the academic literature. The literature on the topic does not seem many. Information asymmetry or imperfection in information is also another cause for market failure to happen. For example, borrowers can know their risks as borrowers but lenders may not know the risks of lending to the borrowers. In another scenario, investors want to invest but they do not know the potential returns and possible risks in investments and, thus, they are constrained from investing. Finally, many scholars interpret macroeconomic crises as one instance of market failure (Stiglitz 2000, p. 85). One example of a macroeconomic crisis is the great depression of the 1930s. The great economist John Maynard Keynes is widely known to have pointed out that the great depression of the 1930s is a testimony to the inability of the market to continuously move itself towards equilibrium: markets can move itself towards equilibrium but it can also fail doing so. Another crisis is the Asian Crisis of the late 1990s. Recently, the United States sub-prime crisis was the immediate cause of a worldwide crisis that affected several countries of the world. One interpretation of the crises mentioned is that all the crises manifested a failure of the market, consistent with the arguments of Stiglitz (2000, p. 85). However, it is also viable to argue that the said crises were simply part of the adjustment mechanisms of the market and, therefore, do not constitute market failure. With regard to the question of how government can address market failure, it is important to grasp that oftentimes government also fail. A good discussion on government failure can be found in the work of Datta-Chaudhuri (1990). Generally, it is not appropriate for government to handle the production and distribution of private goods. Even in the case of public goods, government has the option of mobilizing the private sector in producing the public goods. Public services can also be privatized and operated via public-private partnerships. Some of the reasons why governments can fail were discussed in Stiglitz (2000, p. 200-202). As mentioned, Stiglitz (2000, p. 77) identified six conditions for market failure. The following discussion on what government can do to address market failure refers to the said six conditions. In the first condition, market fails because of monopoly and oligopoly. To this, government can create anti-monopoly and anti-trust laws. However, there are situations in which demand is too low and the good requires large investments. In other words, there are situations in which only monopolies and oligopolies may be the only viable markets. One option for government in this case is to do nothing and wait for technological improvements that can reduce costs that can pave the way for the elimination of the monopoly. Another option is for government to require a monopoly license and regulate that monopoly through price and output regulations. The second option can backfire and can perpetuate rather than end the monopoly because technological innovation that can reduce costs in the industry can be discouraged by the regulation. Perhaps, the best way to address the situation is to assess the welfare losses from the monopoly and tolerate the monopoly if public welfare losses are not large enough. If welfare losses are large enough then perhaps there can be an economic rationale for government intervention as well as the political pressure for government to act. From the perspective of theory, regulating the monopoly can be “easy” provided we know the costs and demand conditions of the industry. However, it is the opinion of this writer that tolerating the monopoly or oligopoly may be appropriate if the welfare loss is not so high. There would be monitoring and implementation costs in the regulation anyway and we are not be sure if these costs would be justified by returns. With regard to public goods, government can ask mobilize the private sector to produce roads, government buildings and facilities, and the like. Government has the option of mobilizing the private sector to operate hospitals, educational facilities, as well as many types of public services. Government can have a key skeletal force but the major force of many government services can be offered for public bidding to the private sector. In general, government can specify the quality and volume of services needed, determine the qualifications that it should require among the private companies who will be allowed to offer bids. Government must make sure, however, that the bidding companies have the reputation, deep commitment to corporate social responsibility, track record, solid experience, qualification, capabilities, and adequate assets to fulfil obligations. The bid must be both the price and quality of the services. The bidding companies must have the appropriate bonds, of course, and the service contract should be for a limited period. In general, government should allow private companies to provide public services for a term so other private companies can have the chance to build capacities and offer bids in the future. Externalities like pollution problems can be addressed through regulations, better laws, and assignment of rights. Anti-pollution laws and pollution liability laws should be strengthened. Fines should be high to deter violation of pollution laws. Incentives or loans may be offered for the private sector to adopt technologies that are clean and green. Localities should be given more rights to sue, fine, and imprison violators of pollution laws. In addition, liability laws of private companies to private individuals damaged or harmed by the pollution must be strengthened. With regard to incomplete markets, government must undertake consultations with private sector to identify what seem to be missing the appropriate laws and policies can be made. The private sector should include corporate as well as individual citizens. Information asymmetry can be addressed by the private sector themselves with government providing data support services provided privacy laws are not violated. Finally, perhaps no government wants a macroeconomic crisis but how macroeconomic crisis is prevented and how it should be addressed is an area of knowledge that is being subjected to continuous study by government, the World Bank, the International Monetary Fund, and by all stakeholders. Hopefully, as the phenomenon of globalization is understood better, crises will be managed better. Incidentally, the World Bank is focusing on the use of grants to address market failure. The work of Meer and Noordam (2004) focused on this. References Datta-Chaudhuri, M., 1990. Market failure and government failure. The Journal of Economic Perspective, 4 (3), 25-39. Meer, K. and Noordam, M., 2004. The use of grants to address market failures. Washington: The World Bank. Stiglitz, J., 2000. Economics of the public sector. 3rd Ed. New York and London: W. W. Norton & Company, Inc. Read More