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See Market Failure

We have discussed how markets operate and how they may fail. This part focuses on the tasks of government and why it may fail to accomplish these tasks appropriately. Most economic issues can be placed on a continuum that stretches from problems efficiently resolved in markets on one end, to issues that seem to require collective action at the other extreme. Whether a particular issue is best resolved in markets or through government is sometimes murky in the broad middle of this continuum. The answer may depend largely on the relative speed and precision with which these allocative mechanisms correct errors or adjust to changing circumstances.

Self-Corrections

On average, markets tend to respond quickly and efficiently to changes in consumer wants and to mistakes made by business decision-makers. For example, if markets fail to synchronize the plans of the buyers and sellers of a pure private good (thermal underwear or guacamole dip, for example), price adjustments tend to cure the resulting shortages or surpluses rather quickly. On the other hand, markets may never adequately provide such public goods as national defense, so these goods are provided through government.

Political adjustments are inherently slow in a democracy, however. When an elected official becomes extremely unpopular, voters must normally wait for the next election to throw the rascal out: coups or assassinations are undemocratic. If a legislature enacts a disastrous policy, it may take years to repair the damage by changing the law. Once on the books, laws, regulations, and spending programs are hard to remove. Even though political solutions may be slow and inexact, government policy may be superior to private decision-making when markets fail because of concentrated economic power, nonrivalry, nonexclusion, or inequity. Table 5 summarizes some failings of both the marketplace and government as allocative mechanisms.

Table 5 Market Failures vs. Political Failures

Market Failure

Political Failure

1. Uncertainty about the future.

2. Rational ignorance about consuming and investing.

3. Free riders for public goods.

4. Asymmetric information creates such problems as consumer fraud and principal–agent problems (e.g., between firms and employees).

5. Positive and negative externalities (e.g., inadequate public health measures and and pollution.)

6. Monopoly power.

7. Inequity in the distributions of income and wealth.

8. Fosters greediness and unhealthy competitiveness.

1. Uncertainty about the future.

2. Rational political ignorance.

3. Rational apathy and nonvoting.

4. Asymmetric information and principal–agent problems (e.g., between constituents and their elected representatives).

5. Tie-in-sales aspects of voting. All voting systems fail to fine-tune spending patterns to reflect the intensities of voters’ preferences.

6. Disproportionate political power for special interests.

7. Majorities may inefficiently or inequitably vote against interests of minorities.

8. Fosters bureaucracy and empire building.