Your point is perhaps best illustrated by the rarity of Pigouvian taxation as pointed out by Bryan Caplan recently. The simple solution to most negative externality cases is seldom actually implemented by governments. And when it is implemented, it is rarely fine tuned.
Whenever I hear that phrase, "market failure", especially when used to justify government meddling, my first thought is that markets thrive on failures because that is how entrepreneurs know where the opportunities are. Markets with no failures do not exist.
I think you misunderstand what a market failure is. A market failure is not the same thing as an underserved market. A market failure is a failure of incentives, not of product. A market failure will lead entrepreneurs to do the wrong things. Markets do not thrive on market failures, quite the opposite. However, this is not to say that a government solution is likely to do better. Its simply a situation where the market has incentives to avoid the optimal solution.
My reply was short and flippant, and dotyloykpot has a better answer.
I don't know enough econ lingo to actually know "that is how economists think". What I do know is that some academics get so caught up in their lingo, like "rent", that they forget to see the big picture.
So I take back my flippant answer. I don't really care how economists use that phrase. To me, a market failure is where the market doesn't satisfy those in the market, and that is the excuse used by statists to claim government is necessary to fix the market.
They are wrong. Government almost by definition is incapable of fixing market failures as well as people with skin in the game and a better motive than growing their bureaucratic fiefdom. The bottom line is that government *could* fix market failures as well as entrepreneurs, *if* they cared about something other than growing their fiefdom, and *if* they had as much knowledge as those with skin in the game. But they don't.
Whether entrepreneurs find the optimal solution or not is irrelevant. They will find a better solution, and if it is not optimal, there's another market failure, and if it's lucrative enough, some other entrepreneur will find a better solution, which still may not be optimal, but that is still irrelevant. What is optimal today may be pessimal tomorrow, and vice versa.
I stand by my layman's understanding. Markets thrive on market failures, entrepreneurs jump in where failures provide enough incentive, and regardless of how good the entrepreneurial fixes are, they are better than conditions before, and government always has the wrong incentive.
You aren't wrong. Market failure's include producing too little/too much of a good or service, as well as coordination problems where if everyone agreed to do X everyone would be better off but it is hard to do. Entrepreneurs do in fact find ways to deal with those problems every day.
Yes, and I know that is how economists think. But economists also use "rent" weirdly, so I figure it's my turn to mangle their definition back into ordinary English.
Entrepreneurship often involves rejiggering of incentives. For instance collective action problems often become network effects with proper product design
What? Externalities are inherently a collective action problem because as Coase showed, if we remove transaction costs they can be resolved through private bargaining.
Yes.. all that is true. But none of that makes entrepreneurship able to solve negative externalities. Entrepreneurship can solve positive externalities by figuring out how to gate or monetize what they produce, but negative externalities are things entrepreneurs exploit to their own gain.
Coase wrote a lot of things but what I'm referring to specifically is his work on private bargaining to resolve market failures from negative externalities, not positive ones.
Perceiving entrepreneurs as Exploiting a problem versus solving it is a matter of resentment. My belief is that status goods are undersupplied, partly because they are taxed heavily. This causes resentment from people and a turn to socialism. This market failure can be fixed by entrepreneurs finding new ways to deliver status goods to thr public.
You mean a negative externality like that oyster book example, where sniffer squads tracked down the polluters? That certainly seems like entrepreneurs at work and solving a problem for their own gain. They apparently annoyed the polluters, and the government, so much that the courts and government stopped them. I don't have the book now, probably donated it to one of those free libraries, so I can't check the details.
I'll give an example of how I think academics constrain themselves too narrowly. There was a discussion the other day about regulation, perhaps on Arnold Kling's substack. Someone said there are two solutions to pollution: regulations and taxes. That's wrong. There is a third way, victim prosecution. I've mentioned this many times before, so I'll paste it in again:
===================
What matters is that statist solutions, such as regulations and taxes, all assume government knows best, which is a lie; and that individual prosecution is too clumsy, expensive, and slow, which is true, but only because legacy systems intentionally and artificially make it so. Every step from victims to politicians to legislation to bureaucrats to regulations to prosecutors to courts to verdicts to enforcers relies on ignorant third party transformations with their own peculiar incentives. Remember, bureaucrats don't want to solve the problems which created and sustain their employment; solutions are threats to their prestige as measured by budgets, underlings, and regulations.
A book on the history of New York City oysters, details of which I have forgotten but may be "The Big Oyster" by Mark Kulansky, tells of New York City sniffer squads, from the 1800s into the 1900s, tracking down pollution sources and analyzing evidence such as soot on clothes drying outside to show who to sue. This individual responsibility began to be outlawed by courts and legislatures on the grounds it did not take the public good into account; it was up to the government to decide how much pollution the nation could tolerate, and woe betide any individual who thought otherwise (Supreme Court of Georgia, Holman v Athens Empire Laundry Co., 1919: "The pollution of the air, so far as reasonably necessary to the enjoyment of life and indispensable to the progress of society, is not actionable").
In that case, all of society is entirely at government's beck and call. They allow people to sue over contract violations, OJ got sued for murder, and most people would not call those government actions. If people track down polluters and sue them for damaged paint or dirty clothes, using government courts doesn't make it a government action.
Lawsuits can solve externalities as long as the cost of the suit is less than the benefit of winning the suit (including any cathartic benefit of seeing the culprit punished). But undeniably there are significant kinds of harm done where the cost of suit vastly outweighs the benefit of winning a suit. These are the cases where other remedies can be more efficient.
You're assuming the current idiotic practice of each party paying their own costs. The loser should pay everything — lost wages, travel expenses, investigation, court costs, so on and so forth.
Not only does it put the burden where it belongs, it encourages both parties to resolve their dispute sooner rather than later.
For instance, in the case of a polluter faced with thousands of individual lawsuits, once a few have won their cases, the lawsuits will start piling up, and it behooves the polluter to settle claims with the least fuss and without quibbling over inane details. If a car's or house's paint is damaged, the cost to touch up or repaint the car will be well known within certain parameters. Sure, some people will have some prior damage; contest them. But if it looks like the typical damage from your pollution, cut them a standard check and sign off on the claim. Maybe you pay $100 too much to a lot of claimants. That's cheaper than paying two lawyers, lost wages, and all the rest of it if you lose anyway.
Entrepreneurship is an excellent way to address market failure. Definitionally, a true market failure means people would prefer a different outcome, so would be willing to pay for it voluntarily. The unfortunate limitation is how advanced our society is in both it's technology and it's stock of capital. Asset Security is a good example; money service businesses are heavily regulated because they have such a huge incentive to "fix" the books in their favor. Blockchains solve this issue without regulation by cryptographically proving the true transaction history that can't be changed. However, blockchains required advances in cryptographic technology and deep venture capital markets, both of which did not exist 100 years ago. Thats why I expect our future to become more stateless; as technology advances and capital deepens, more intractable problems become solvable through entrepreneurship.
Transaction costs are resolved by entrepreneurship. Most successful startups from the internet era are about resolving transaction costs- Google for finding information, Amazon for finding products, Oracld for managing data, Microsoft for computer use. All of those things could be done before those startups exist but transaction costs prevented them from being used as widely.
Taxes are always a result of market failure. The reason is that taxes are compulsory and painful, so if there was a different way to provide public goods through voluntary payment, people would be willing to pay more for the same provisions of goods to avoid stress and threat of violence. An efficient market with no friction would find a way to bring tax burdens to zero while simultaneously delivering the same level of public goods voluntarily.
Market failure, an exception in the private market, is the rule in the political market. OK. Faced with this observation, you propose to prevent the creation of the political market (of the state). But do you believe that the market is a "creation"?
The other solution is to admit that the political market exists (because humanity wants to solve the problems of failure in the private market) and to find solutions to remove externalities in the political market.
I don’t think it can be done, at least for large polities. Can you describe a political system where the individual actors – voters, legislators, bureaucrats – each bear most of the net cost of their decisions? I can’t.
The conclusion of my argument is not the elimination of the state, although that is one possibility. It is that the existence of market failure is not an adequate reason to have a decision made on the political market. It is still possible that there are cases — the obvious candidate is national defense — where the consequences of market failure on the private market are so bad that it is worth putting up with the costs of market failure on the political market.
I was born in Santa Monica. My father was at UCLA getting his PhD. My two sisters and I received our BAs from UCLA. One sister went to law school, another got an MA from UCLA, and I earned an MBA from NYU. We are rational people from a rational family. We did not call that intersection the worst intersection anywhere. We called it The Devil’s Vortex.
I remember watching a YouTube clip from the 1970s: Milton Friedman said economics is actually a trivial field but some people find it complicated because individual rationality often conflicts with group rationality and vice versa
"If you spend time and effort figuring out which candidate will be better for the country — a problem sufficiently difficult that in every election about half the voters get it wrong —"
I get the joke, but it's not a very good joke. For one thing, even if they were all being patriotic and selfless, there is no single, shared objective way to measure the good of the country, so in a close election all the voters could still be 100% right with their choice of candidate if their relative evaluations of the scenarios under each candidate differ accordingly. And of course voters don't actually vote selflessly, so those past close election results do not provide any evidence at all that anyone was wrong in their evaluations of which candidate would better serve their differing, rival, personal interests, something that is particularly likely when big changes in redistribution and discrimination are on the table.
Your point is perhaps best illustrated by the rarity of Pigouvian taxation as pointed out by Bryan Caplan recently. The simple solution to most negative externality cases is seldom actually implemented by governments. And when it is implemented, it is rarely fine tuned.
Whenever I hear that phrase, "market failure", especially when used to justify government meddling, my first thought is that markets thrive on failures because that is how entrepreneurs know where the opportunities are. Markets with no failures do not exist.
I think you misunderstand what a market failure is. A market failure is not the same thing as an underserved market. A market failure is a failure of incentives, not of product. A market failure will lead entrepreneurs to do the wrong things. Markets do not thrive on market failures, quite the opposite. However, this is not to say that a government solution is likely to do better. Its simply a situation where the market has incentives to avoid the optimal solution.
My reply was short and flippant, and dotyloykpot has a better answer.
I don't know enough econ lingo to actually know "that is how economists think". What I do know is that some academics get so caught up in their lingo, like "rent", that they forget to see the big picture.
So I take back my flippant answer. I don't really care how economists use that phrase. To me, a market failure is where the market doesn't satisfy those in the market, and that is the excuse used by statists to claim government is necessary to fix the market.
They are wrong. Government almost by definition is incapable of fixing market failures as well as people with skin in the game and a better motive than growing their bureaucratic fiefdom. The bottom line is that government *could* fix market failures as well as entrepreneurs, *if* they cared about something other than growing their fiefdom, and *if* they had as much knowledge as those with skin in the game. But they don't.
Whether entrepreneurs find the optimal solution or not is irrelevant. They will find a better solution, and if it is not optimal, there's another market failure, and if it's lucrative enough, some other entrepreneur will find a better solution, which still may not be optimal, but that is still irrelevant. What is optimal today may be pessimal tomorrow, and vice versa.
I stand by my layman's understanding. Markets thrive on market failures, entrepreneurs jump in where failures provide enough incentive, and regardless of how good the entrepreneurial fixes are, they are better than conditions before, and government always has the wrong incentive.
You aren't wrong. Market failure's include producing too little/too much of a good or service, as well as coordination problems where if everyone agreed to do X everyone would be better off but it is hard to do. Entrepreneurs do in fact find ways to deal with those problems every day.
Yes, and I know that is how economists think. But economists also use "rent" weirdly, so I figure it's my turn to mangle their definition back into ordinary English.
So there!
I agree that "rent" is used weirdly. I realized I and most people have used it wrong for most of my life.
Entrepreneurship often involves rejiggering of incentives. For instance collective action problems often become network effects with proper product design
Sure, but none of those are externalities and so aren't related to market failure.
What? Externalities are inherently a collective action problem because as Coase showed, if we remove transaction costs they can be resolved through private bargaining.
Yes.. all that is true. But none of that makes entrepreneurship able to solve negative externalities. Entrepreneurship can solve positive externalities by figuring out how to gate or monetize what they produce, but negative externalities are things entrepreneurs exploit to their own gain.
Coase wrote a lot of things but what I'm referring to specifically is his work on private bargaining to resolve market failures from negative externalities, not positive ones.
Perceiving entrepreneurs as Exploiting a problem versus solving it is a matter of resentment. My belief is that status goods are undersupplied, partly because they are taxed heavily. This causes resentment from people and a turn to socialism. This market failure can be fixed by entrepreneurs finding new ways to deliver status goods to thr public.
You mean a negative externality like that oyster book example, where sniffer squads tracked down the polluters? That certainly seems like entrepreneurs at work and solving a problem for their own gain. They apparently annoyed the polluters, and the government, so much that the courts and government stopped them. I don't have the book now, probably donated it to one of those free libraries, so I can't check the details.
I'll give an example of how I think academics constrain themselves too narrowly. There was a discussion the other day about regulation, perhaps on Arnold Kling's substack. Someone said there are two solutions to pollution: regulations and taxes. That's wrong. There is a third way, victim prosecution. I've mentioned this many times before, so I'll paste it in again:
===================
What matters is that statist solutions, such as regulations and taxes, all assume government knows best, which is a lie; and that individual prosecution is too clumsy, expensive, and slow, which is true, but only because legacy systems intentionally and artificially make it so. Every step from victims to politicians to legislation to bureaucrats to regulations to prosecutors to courts to verdicts to enforcers relies on ignorant third party transformations with their own peculiar incentives. Remember, bureaucrats don't want to solve the problems which created and sustain their employment; solutions are threats to their prestige as measured by budgets, underlings, and regulations.
A book on the history of New York City oysters, details of which I have forgotten but may be "The Big Oyster" by Mark Kulansky, tells of New York City sniffer squads, from the 1800s into the 1900s, tracking down pollution sources and analyzing evidence such as soot on clothes drying outside to show who to sue. This individual responsibility began to be outlawed by courts and legislatures on the grounds it did not take the public good into account; it was up to the government to decide how much pollution the nation could tolerate, and woe betide any individual who thought otherwise (Supreme Court of Georgia, Holman v Athens Empire Laundry Co., 1919: "The pollution of the air, so far as reasonably necessary to the enjoyment of life and indispensable to the progress of society, is not actionable").
Your solution is still government action as long as it is the government running the court system and deciding what harms are actionable.
In that case, all of society is entirely at government's beck and call. They allow people to sue over contract violations, OJ got sued for murder, and most people would not call those government actions. If people track down polluters and sue them for damaged paint or dirty clothes, using government courts doesn't make it a government action.
Lawsuits can solve externalities as long as the cost of the suit is less than the benefit of winning the suit (including any cathartic benefit of seeing the culprit punished). But undeniably there are significant kinds of harm done where the cost of suit vastly outweighs the benefit of winning a suit. These are the cases where other remedies can be more efficient.
You're assuming the current idiotic practice of each party paying their own costs. The loser should pay everything — lost wages, travel expenses, investigation, court costs, so on and so forth.
Not only does it put the burden where it belongs, it encourages both parties to resolve their dispute sooner rather than later.
For instance, in the case of a polluter faced with thousands of individual lawsuits, once a few have won their cases, the lawsuits will start piling up, and it behooves the polluter to settle claims with the least fuss and without quibbling over inane details. If a car's or house's paint is damaged, the cost to touch up or repaint the car will be well known within certain parameters. Sure, some people will have some prior damage; contest them. But if it looks like the typical damage from your pollution, cut them a standard check and sign off on the claim. Maybe you pay $100 too much to a lot of claimants. That's cheaper than paying two lawyers, lost wages, and all the rest of it if you lose anyway.
Entrepreneurship is an excellent way to address market failure. Definitionally, a true market failure means people would prefer a different outcome, so would be willing to pay for it voluntarily. The unfortunate limitation is how advanced our society is in both it's technology and it's stock of capital. Asset Security is a good example; money service businesses are heavily regulated because they have such a huge incentive to "fix" the books in their favor. Blockchains solve this issue without regulation by cryptographically proving the true transaction history that can't be changed. However, blockchains required advances in cryptographic technology and deep venture capital markets, both of which did not exist 100 years ago. Thats why I expect our future to become more stateless; as technology advances and capital deepens, more intractable problems become solvable through entrepreneurship.
Transaction costs are resolved by entrepreneurship. Most successful startups from the internet era are about resolving transaction costs- Google for finding information, Amazon for finding products, Oracld for managing data, Microsoft for computer use. All of those things could be done before those startups exist but transaction costs prevented them from being used as widely.
Taxes are always a result of market failure. The reason is that taxes are compulsory and painful, so if there was a different way to provide public goods through voluntary payment, people would be willing to pay more for the same provisions of goods to avoid stress and threat of violence. An efficient market with no friction would find a way to bring tax burdens to zero while simultaneously delivering the same level of public goods voluntarily.
Market failure, an exception in the private market, is the rule in the political market. OK. Faced with this observation, you propose to prevent the creation of the political market (of the state). But do you believe that the market is a "creation"?
The other solution is to admit that the political market exists (because humanity wants to solve the problems of failure in the private market) and to find solutions to remove externalities in the political market.
I don’t think it can be done, at least for large polities. Can you describe a political system where the individual actors – voters, legislators, bureaucrats – each bear most of the net cost of their decisions? I can’t.
The conclusion of my argument is not the elimination of the state, although that is one possibility. It is that the existence of market failure is not an adequate reason to have a decision made on the political market. It is still possible that there are cases — the obvious candidate is national defense — where the consequences of market failure on the private market are so bad that it is worth putting up with the costs of market failure on the political market.
On the first point, we could invent a system of sanctions for elected officials that goes beyond simple non-re-election.
On the second point, yes, this is true, but for a simple logical reason implied by Hume's guillotine.
I was born in Santa Monica. My father was at UCLA getting his PhD. My two sisters and I received our BAs from UCLA. One sister went to law school, another got an MA from UCLA, and I earned an MBA from NYU. We are rational people from a rational family. We did not call that intersection the worst intersection anywhere. We called it The Devil’s Vortex.
I remember watching a YouTube clip from the 1970s: Milton Friedman said economics is actually a trivial field but some people find it complicated because individual rationality often conflicts with group rationality and vice versa
"If you spend time and effort figuring out which candidate will be better for the country — a problem sufficiently difficult that in every election about half the voters get it wrong —"
I get the joke, but it's not a very good joke. For one thing, even if they were all being patriotic and selfless, there is no single, shared objective way to measure the good of the country, so in a close election all the voters could still be 100% right with their choice of candidate if their relative evaluations of the scenarios under each candidate differ accordingly. And of course voters don't actually vote selflessly, so those past close election results do not provide any evidence at all that anyone was wrong in their evaluations of which candidate would better serve their differing, rival, personal interests, something that is particularly likely when big changes in redistribution and discrimination are on the table.