Clifford Winston on Market Failure and Government Failure 12/28/2009

Price mechanisms (taxes or charges on emissions/noise) would achieve the same pollution-reduction benefits more cheaply than command-and-control technology mandates, because mandates impose an 'engineering mentality' that pursues a technological goal while treating cost as secondary—as shown by Honda being forced to install catalytic converters even though it already met the same pollution standard.

“explosively pricing emissions believe it or not these days we could actually monitor you know the social cost if you will a pollution... you can tax impact tax for emissions would be certainly a way to do it”

The Boeing/FAA case illustrates market-versus-government failure: Boeing has strong incentives not to crash planes, but the economist's nuance is that firms may cut corners for short-term profit; government 'can' help by checking corner-cutting—but the real question is whether the FAA in practice reduces corner-cutting or merely makes life harder for Boeing without adding expertise the manufacturer lacks.

“they care about profits tomorrow and profits today to the extent it's a organization that is ongoing with repeated interactions its incentives are going to be probably very closely aligned with consumers”

Safety has improved across every dimension of life (auto, workplace) for as long as data exist (50-100 years) because safety is a normal good—positively correlated with income—so as people grow more prosperous they devote more resources to safety and firms compete to provide safer products that consumers will pay a premium for.

“safety as a normal good that is the jargon is it's a good that's positively correlated with with income and prosperity as we get more prosperous we're willing to devote more resources”

In practice, true (actual) Pareto improvements are very rare; most policy analysis relies on 'potential Pareto improvements' where winners could compensate losers and still be better off—meaning the pie gets bigger even though some people may actually be made worse off.

“really what we're talking about are what we would say potential Pareto improvement because usually what's necessary is to actually compensate some people so that they're no worse off and then you still have something left over”

Auto congestion is a consumption externality: a driver in peak periods delays other drivers and imposes a social cost without accounting for it, and the market cannot respond because no one owns the roads—government owns them—raising the question of what could make drivers internalize that cost.

“auto congestion you're driving around and you're in peak period you delay other people and you don't have to account for that in your decisions you're imposing a social cost on others”

Even superior price mechanisms remain vulnerable to politicization: while economists can estimate bounds on social costs (of pollution, value of time for congestion tolls), the actual tax or toll levels get set politically rather than at the economically optimal level, as seen with intercounty connector tolls being set high and likely facing pressure to reduce.

“it's true as a practical matter these things can become politicized very quickly and even though no economic research will have particular bounds of what these pollution costs are this doesn't mean that in practice that that's what we wind up getting”

Rather than asking whether the textbook market failures are real, the more useful question is empirical: when government is brought in to fix them, does it actually do a good job, make things worse, or is the extent of the failure overstated—and the accumulated body of evidence should guide policy rather than starting from square one each time.

“who actually performs better due to markets make effort to try to correct these failures and in fact the extent of them is greatly overstated or this government come in and they actually can do a good job”

The Austrian critique holds that perfect information is an unrealistic policy goal—analogous to demanding the elimination of friction in physics—since imperfect information is inherent to the world, making information-failure arguments a 'strawman' when judged against an idealized benchmark.

“the Austrian perspective is to suggest that it's a little unrealistic to have perfect information be the goal the world is inherently it's like saying you know friction is a physical externality physical imperfection we need to get rid of friction”

A hidden cost of antitrust and regulation is that the political economy can be gamed—competitors (as arguably with Microsoft) instigate cases, imposing large transaction costs and management attention, and fostering a culture where managers spend more time gaming the government than producing better products.

“this can create a culture in which you get a mindset where your managers spend more time worrying about gaming the government than they do producing better products”

The reliability of empirical conclusions depends heavily on the nature of the work: results based on simple, transparent descriptive data, averages, and reality checks are more trustworthy than those requiring sophisticated statistical techniques with many simplifying assumptions.

“if it requires a lot of sophisticated statistical techniques with lots of assumptions along the way to simplify things that to me is different than averages and facts”

Because the long-term safety trend is unchanged by the creation of OSHA, the burden of proof falls on regulation's defenders to demonstrate that top-down mandates—rather than bottom-up emergent improvements—actually averted worse outcomes, and to specify the mechanism by which inspectors teach firms something they don't already know.

“the key point to me is that puts the burden improve on the osha defenders not to just say well look the law says it's more safety”

Any proposed regulation—especially financial regulation—should be evaluated by demanding the specific mechanism: exactly how it will reduce risk or correct the problem without throwing out important incentives and innovation, rather than relying on the abstraction that 'there's a problem, government should do something.'

“what I'm looking for in any sort of you know proposed legislation is tell me exactly the mechanism you know by what you really are going to reduce risk without you know truly throwing out major incentives and innovation”

Markets exhibit robustness by endogenously responding to externalities: congestion costs are partly under individuals' control through residential and job-location choices (people with high value of time choose shorter commutes), and noise externalities are mitigated by sorting (e.g., locating a School of the Deaf near Logan Airport on cheap land), so markets reduce externality costs even without policy.

“people who have the highest value of time tend to have shorter commutes and people with with low value of times have longer commutes and it says that's the markets way of trying to respond to an externality”

Major policy reform requires a political entrepreneur who sells a broad vision to the public to head off interest groups; intercity transportation deregulation succeeded not by selling technical details but by framing it during 1970s inflation as a way to increase competition and fight inflation.

“when you see major policy reform you really need some political entrepreneur to try to sell this to the public in a very effective way that can head off the interest”

Because the underlying problem is interest-group political economy, the policy conclusion is not the wishful thinking of improved government policy but more privatization and reliance on markets—supported by the natural-monopoly/regulated industries that, after deregulation, produced gains by withdrawing government intervention.

“that leads us to an answer that really calls not for the wishful thinking of improved government policy but I think more privatization”

Market failure has a precise economic meaning focused on efficiency: a situation where resources could be reallocated to make at least one person better off without making anyone worse off (Pareto optimality), as opposed to the colloquial sense of markets simply not delivering what someone wanted.

“economists have a very precise notion of what market failure is and it does focus on what we call efficiency issues as the allocation of resources”

The deterrence defense of antitrust—that without it collusion and monopoly would run rampant—has been tested via international comparisons of antitrust-law strength (US vs Canada, US vs UK), and even those studies do not find that antitrust laws produce a meaningfully more competitive economy, though this remains an open empirical question.

“the efforts really have been made on international comparison... compare differences and the strengths of antitrust laws US and Canada u.s. the United Kingdom... even though studies really just don't see you know anything that we seem to be doing that that that is all that productive”

Across the board, government interventions to correct market failures have turned out remarkably disappointing: while real failures like pollution and congestion exist, there is little academic empirical evidence that government interventions—whether justified or not—significantly improved outcomes, even against the modest benchmark of merely producing net benefits rather than optimal policy.

“how well do we know that government interventions have turned out remarkably to be disappointing if you will across the board”

Reviewing antitrust collusion and monopoly studies reveals an absence of positive evidence: government prosecutions (e.g., Microsoft, IBM) cannot be shown to have produced significant price decreases or consumer benefits, which should give pause before launching further large cases such as the Intel investigation.

“I just didn't find evidence of significant price decreases I didn't see evidence of cases on and I'm monopoly cases at Microsoft being the most recent one where you really could sort of point to benefits to consumers”

Pollution regulation has produced real benefits (air and auto pollution have declined), but government's preferred 'command and control' approach pushed too far, so net estimates show the gains from reduced pollution are roughly balanced out by the higher production and product costs imposed—a cautionary lesson for heavy-handed climate policy.

“most of the net estimates appear to be is that it's fairly balanced if you will that what gains we have made from pollution have often been pretty much balanced out by the higher production costs of doing so”

Public production projects (e.g., the Dulles Metro extension) proceed despite large cost overruns because the costs are diffused across taxpayers while benefits are localized—so each taxpayer says it costs little, enabling inefficient projects to move forward.

“this sort of general distribution if you will of cost incurred by the taxpayers you know it enables these sort of policies to move forward with with the cost being spread out”

The primary driver of government failure is political economy—interest groups and rent-seeking—rather than mere incompetence; this is often not classic regulatory capture but broader well-organized lobbying for protection or government expenditures, and America is increasingly effective at lobbying with high returns.

“I think it's the latter I think the political economy is is really what's driving an awful lot of these things and it's just just interest groups in general”

Distribution and efficiency are often presented as conflicts but need not be: when an economy is inside its production frontier, one can both expand the pie and divide it more favorably, though Roberts is skeptical of this in practice.

“these things are often presented as conflicts but they need not be you know if you're inside the front ear as we put it you often can actually get ways of expanding the pie and even cutting it up then in a way that may be more favorable as a distribution”

Markets provide powerful incentives for workplace and product safety through liability/court systems, loss of market share, and compensating wage differentials for risky jobs—and these forces have grown stronger as information about employers spreads more freely (e.g., job-market blogs), making it hard to hide unsafe conditions.

“the market in this case provides huge incentives for firms to have safe workplaces and to produce a products because obviously they can be heard in the courts... and of course killed in the market if things are unsafe”

Antitrust policy is an area of economics pervaded by 'religion'—people hold strong positions regardless of evidence and write pro or con without ever reconciling with what the empirical record shows—even more so than macroeconomics, where at least there is a concerted effort to generate evidence.

“this is one area of economics where I honestly think that that it is seems to be pervaded by religion”

Studies of OSHA workplace-safety regulation generally fail to find a statistically significant effect: workplace accidents are declining, but regression analysis isolating the counterfactual cannot attribute the improvement to OSHA, and regulatory agencies are often understaffed and cursory in their inspections.

“when you try to isolate what the effect of OSHA interventions are... people tend not to find a statistically significant effect of the OSHA regulation”

The California/Enron energy crisis does not show the dangers of deregulation per se, but rather of badly designed and mismanaged 'deregulation' that ran counter to genuine market liberalization—indeed it was the market, not the government, that exposed Enron—so it is a caution about how to withdraw government intervention via carefully designed experiments.

“we have an example where something is called deregulation that that was so mismanaged and sort of went when in the face of what we really were trying to accomplish there”

Monopoly creates a deadweight loss because, to maximize profit, the monopolist reduces output below the level where consumers would willingly pay the cost of additional units—forgoing exchanges that would benefit both monopolist and buyer—because lowering price to capture those marginal sales would require lowering price on all units.

“a deadweight loss is occurs in the situation where there's just actually a loss of resources to society in the process of maximizing their profits the monopoly would reduce output”