In January 2019, co-blogger Bryan Caplan wrote:
The theory of market failure is a reproach to the free-market economy. Unless you have perfect competition, perfect information, perfect rationality, and no externalities, you can’t show that individual self-interest leads to social efficiency.* And this anti-market interpretation is largely apt. You can’t legitimately infer that markets are socially optimal merely because every market exchange is voluntary.
Contrary to popular belief, however, market failure theory is alsoa reproach to every existing government. How so? Because market failure theory recommends specific government policies – and actually-existing governments rarely adopt anything like them.
What we also often see and, depressingly, even usually see, is that economists who are pro-government intervention to fix market failures have a much lower standard for the government than they have for the market. So the odds are that avoiding the specific government policy being proposed would get us closer to the optimum than implementing the government policy.
A case in point is Paul Krugman and his views on the recent $1.9 trillion spending bill. In Benjamin Wallace-Wells, “Larry Summers versus the Stimulus,” March 18, 2021, Wallace-Wells makes that point, although I’m not sure that that’s his intention.
Wallace-Wells, describing a recent debate between Krugman and Larry Summers about the Biden spending plan, writes:
Krugman asked, rhetorically, which elements of the package Summers would cut. Not the public goods, like vaccination and funds for school reopening, and surely not the needed income support. What was left was the part that members of Congress had most vociferously demanded: the aid to state and local governments (which Krugman agreed probably exceeded the fiscal need) and the checks to people who had not much suffered. Krugman said, “The checks, which are the least-justifiable piece in terms of standard economics, are also by far the most popular, and I don’t think we can entirely disregard that.”
Put aside the fact that the funds for school reopening are almost certainly not justified because the risks to students and teachers are so low. Notice what even Krugman admits. First, that the aid to state and local governments is too much, even by his standards. Second, the checks to people who hadn’t suffered much, which are a huge part of the package, are the “least-justifiable piece in terms of standard economics.” And what’s Krugman’s justification for those payments? That they are “by far the most popular” and, for that reason, we can’t “entirely disregard that.”
In short, in order to get hundreds of billions in spending that Krugman thinks are justified, he is willing to have the government spend other hundreds of billions for things that are not justified. Such is the nature of many, perhaps most, economists’ advocacy of government policy.
Note: The picture above is of a Rube Goldberg machine, which is what I think a lot of government policy is like. There is one difference. The Rube Goldberg machine always worked.
READER COMMENTS
David Seltzer
Mar 23 2021 at 8:51pm
“Unless you have perfect competition, perfect information, perfect rationality, and no externalities, you can’t show that individual self-interest leads to social efficiency.” There may not be perfect information but how can a handful of government policy makers have more “perfect information” than the information possessed by some three hundred and thirty million economic agents in order to achieve social efficiency?
Phil H
Mar 24 2021 at 12:02am
I find this quite convincing, and I wonder what conclusion to draw from it. I think Henderson wants me to draw the conclusion, “government spending is wasteful, and there should be much less of it.” But that seems a bit hasty to me.
I like the TV show Kitchen Nightmares, and reading about it again last night, I saw the often-repeated stats: 80% (or something) of restaurants fail within X years. So if 80% of private sector investment is wasted, and only about half of public sector investment is wasted (and popular to boot!), then it seems to me like the public sector is well ahead.
Obviously I’ve phrased that in a deliberately provocative way. But I’m still not convinced I’ve ever seen a balanced comparison of the effectiveness of public vs private investment.
robc
Mar 24 2021 at 6:55am
Who said money is wasted because 80% fail within 5 years?
Were there no customers at all during that time frame? They benefited. If the business lasted 4 or 5 years instead of 1, the owners benefitted somewhat, even if not enough.
So even if you want to call that waste, it is no where near 80% waste.
Phil H
Mar 24 2021 at 8:57am
Yep, fair enough. But obviously, exactly the same argument applies to “wasted” public sector investment. What we would need is a *quantified* measure of how “wasted” each type of bad investment is. Is pouring a dollar into a bad business better or worse for the economy than pouring a dollar into a bad stimulus package? I honestly don’t know the answer to this, but I also don’t see many attempts by economists here to answer the question.
robc
Mar 24 2021 at 10:28am
I know government spending is wasted because it is not being used in the way the producer of the money prefers (although that is not entirely true – some people are probably okay with the way it is spent).
If the government spends my tax money exactly as I would have spent it, then it isn’t wasted, but any deviation from that optimal form is a waste.
Throwing back to the original bit, that means none of the money I lost in my one failed business (I have started two, the other did pretty good) wasnt wasted at all, as it was used as I preferred.
Bingophil
Mar 24 2021 at 1:40pm
This seems to equivocate on how we should define “waste.” Typically, I think we mean waste as in “unwise investment.” Government investment is less wise than the market because it has imperfect information.
But your definition of waste is basically a moral one “against the preferences of the producer.” Under that concept government spending is “wasteful” almost by definition. But that begs the question and is also simply a moral position and not an economic one.
Phil H
Mar 24 2021 at 7:23pm
Yeah, I think this is just incorrect, and the reason lies in the definition of what investment is. If I buy a shop because I like shops; and I put things in my shop because I enjoy having inventory; and I sell to whoever I want for my own pleasure, then that’s all fine. But it’s *not* investment. It’s consumption.
Investment is by definition a future-oriented action, with intended future consequences (in the private sector, making more money) built in. You can’t later say, “This investment didn’t make money, but it was still good because I wanted to spend my capital that way.” Or rather, you can, but then you’re redefining it as consumption instead of investment.
robc
Mar 25 2021 at 6:58am
Yes.
Yes.
While you did, I never used the word investment, I referred to spending.
Jon Murphy
Mar 24 2021 at 9:23am
The conclusion is to avoid the Nirvana Fallacy. Many economists act like a given market failure necessarily justifies government intervention. But that is not the case.
There’s literally an entire field of inquiry dedicated to answering that question: public choice.
KevinDC
Mar 24 2021 at 11:56am
Indeed – and the contents of that field and how it relates to that question is given frequent and detailed discussion here as well.
Phil H
Mar 24 2021 at 7:29pm
Hi, Jon.
Pretty much by definition, the field of public choice only looks at half of the question I asked. My question is, what are the relative efficiencies of the public and private sectors? You can’t answer that by interrogating only one side.
Jon Murphy
Mar 24 2021 at 11:24pm
Except, by definition, the field of public choice does not look at only one side.
TMC
Mar 24 2021 at 9:32am
Phil,
80% of new businesses fail. They are about 1% of the private sector. When you redo your math the public sector looks much worse.
KevinDC
Mar 24 2021 at 12:43pm
Hey Phil –
There’s a few things off with your admittedly provocative comparison. You note that 80% of new restaurants fail within a few years – I’ve heard similar numbers before and I’ll assume that’s basically accurate. But then you go from that, to this statement:
In order for that conclusion to follow, new restaurants would have to be 100% of all private sector investment! Which, obviously, isn’t the case. The fact that 80% of new businesses in one small sector of the economy fail after a few years does not entail that “80% of private sector investment is wasted”! New businesses are only one small fraction of private sector investment, and new restaurants are only a small fraction of that fraction. So, not exactly an apples to apples comparison there.
Also, there’s an important difference between an investment failing, and an investment being wasted. The two can overlap to some degree (and often do!) but they aren’t the same thing. This is especially true considering one of the main criticisms made of government waste – part of what makes it so wasteful is that it’s preventing the failure of businesses or industries that ought to fail. Failure, as such, isn’t inherently “wasteful” – failure is a healthy part of a healthy economy, and part of the process of creative destruction and of discovery, which drives progress forward. And you correctly highlight a key difference between the market process and government by noting how quickly restaurants can fail. In a market, when a business isn’t generating enough value to sustain the resources it uses, failure comes very quickly. This is a feature, not a bug! It allows resources to more quickly be reallocated to where they can be used more productively. This is why the “loss” part of the profit-and-loss system is so important. But wasteful government programs can carry on being extravagantly wasteful, year over year, for decades.
If you’re looking for a balanced approach to government vs market failure, then I would recommend this as a good place to start. It’s a PDF copy of Clifford Winston’s book Government Failure vs Market Failure: Microeconomic Policy Research and Government Performance. Dr. Winston is an economist from UC Berkley, and wrote this for the Brookings Institute, a center-left policy research center – so it’s not like I’m directing you to Rothbard or Rand or some highly partisan ideologue here. (Also, I wouldn’t direct people to Rothbard or Rand anyway, because I find both of them unimpressive as thinkers and often dishonest.)
Phil H
Mar 24 2021 at 7:32pm
Awesome, that book looks like literally the very thing I was asking for. Thank you!
Jon Murphy
Mar 24 2021 at 1:33pm
To build on KevinDC’s point above, to say that a business failed is not the same as to say a market failed. Firms shutting down are not an indication of wasted resources. Just the opposite: they are an indication of resources moving from a less valuable use to a higher use.
Market failure is when some mutually-beneficial trade does not take place for some reason. Government failure is the same thing but with government: when some mutually beneficial action doesn’t take place for some reason. If a firm does not provide a mutually beneficial service, then them going out of business is the market succeeding, not failing.
Phil H
Mar 24 2021 at 7:56pm
Yep, I completely agree with that point. I don’t think waste is an indicator of market failure. I just think that efficient markets still inevitably include a lot of waste. Markets mostly turn out to allocate capital more efficiently than other mechanisms. But it’s just an error to assume that this means markets allocate capital with perfect efficiency. They don’t. What I would like to see is comparisons between the the relative efficiencies of the allocation in the public and private sectors, taking the stated goals of the investment properly into account, and without resorting to ideological arguments like robc’s above. Just simple, “Did this investment do what it said on the tin?” E.g. did welfare investment improve welfare? Did health spending improve health? Does investment in the justice system make more justice? Vs. does private investment (in comparable areas?) succeed in its stated goals (usually, making money).
To give an example, I know charitable giving often flows to fluffy animal charities. There is an argument to be made that this is a major inefficiency in the charitable sector, one the the effective altruism movement and the Gates Foundation popped up to redress. But I have no idea of how that looks when quantified. Compared to the waste in the public sector, how bad are charities? Those are the questions I’d like to see more answers to.
David S
Mar 24 2021 at 9:03pm
A good contrast can be seen in the space launch industry. For many years, government space launch was the only type allowed. Indeed, if a private provider appeared they were attacked legally and their customers were given “free” rides on government vehicles to eliminate the non-government competition.
Then a decade ago, the government promised they wouldn’t do that any more (and sort of kept the promise). Shuttle cost about $200B total, a bit over $1B/launch. SLS cost $20B so far, and has had no (orbital) launches, and is anticipated to cost more than $2B per launch.
SpaceX quoted development costs for the same class of vehicle at $2.5B and $300M per launch. Starship is in the right class, but unfortunately SpaceX does not tell everyone how much they spent on it. Starship is planned to have a much lower per flight cost due to being reuseable, however.
It does look like government aerospace projects are roughly 10x the cost of non-government aerospace projects, though.
Phil H
Mar 24 2021 at 11:16pm
That seems like a fair kind of comparison, and constitutes a good beginning to answering my question, thank you.
Jon Murphy
Mar 24 2021 at 11:24pm
That’s quite the strawman.
robc
Mar 25 2021 at 7:40am
“I spent half my money on gambling, alcohol and wild women. The other half I wasted.” — WC Fields
I think part of the problem is defining efficiency and waste as opposites. It is possible to spend inefficiently and not have any waste. It may be “ideological”, but it all comes down to preferences.
Fields is making the same point, just better than I could.
Phil H
Mar 25 2021 at 7:29pm
Sure, but once again, this is the distinction between consumption and investment. Wild women are for enjoying; building roads is for producing a *future* benefit. This distinction is so big and important that it’s programmed into the GDP formula (C+I) and into tax law, and everything else.
robc
Mar 29 2021 at 9:09am
G is neither C nor I.
SK
Mar 24 2021 at 9:25am
The sad fact is there is an absence of leadership. Leadership means sometimes going against the wind and not giving in to what a politician thinks voters want or say they want. Leadership may require going against that view and explaining why so all can understand.
Sadly leadership from elected officials is wholly absent.
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