Government and Market Failure

February 3, 2008

[Response to Thomas, Part 3 of 3]

Finally, we can state the question. Is there some option for addressing market failure available to a legitimately monopolistic and coercive government that would be unavailable under anarchy?

The easy solution to most market failure situations is the assigning of property rights. Overfishing is a problem because nobody owns the ocean, so the only incentive in place for fishermen is to get all the fish they can before someone else does. There is no reason for any individual to try to preserve and protect the stock of fish, because the actions of a single person cannot alter the incentives of everyone else. This problem could be resolved by granting property rights to certain areas of the ocean, such that fishermen can reap the rewards of current investment in fish, something impossible under the current system.

Unfortunately, with air pollution, actually assigning property rights would be a logistical nightmare. Even if a person could be said to own the air above their house, it would be impossible to show that a violation of that space is occurring, and impossible to prove where any pollution came from if a violation did occur. Trespassing in the air is much harder to monitor than trespassing on land.

So I’ll agree that climate change is a legitimate market failure, and also that it’s impossible for anyone to overcome the problem via the usual first-best solution, granting of property rights. An improvement is theoretically possible, however, if we are able to bring the cost of pollution for the producer in line with the total social cost. One way to do that is through a carbon tax. Turning again to that government run by a benevolent dictator, the dictator could declare that for every ton of carbon dioxide a person releases into the atmosphere, a tax of X dollars must be paid. That could bring about a genuine improvement. I therefore reject the claim that there is no theoretical improvement that can be made to any actually-existing system in the world.

Improvement is possible, and if you had a government that determined its strategies for solving problems by picking at random among all possible solutions, you would expect that once in a while, the government would hit upon a strategy that brought about a genuine improvement.

The problem is, governments don’t pick their strategies at random. The fact that the government has control over markets leads inexorably to rent-seeking behavior by firms that stand to profit from market restrictions.

In his essay, “Pigs Don’t Fly,” Russ Roberts, Economics Professor at GMU, illustrates the point:

In the 1970s, sulfur dioxide released by the smokestacks of American midwestern utility companies created acid rain in the American northeast. A clamor arose to clean up the air—environmentalists and everyday citizens demanded legislation. That should have been relatively easy. We know how to get less of something—make it more costly. So the cheapest solution to the sulfur dioxide problem would have been to tax smokestack emissions. That would give utilities the incentive to find the cheapest way to reduce emissions. Over time, better and better technologies would be developed as a way to reduce the burden of the tax.

But Congress didn’t impose a tax. Congress imposed a technology. The 1977 amendments to the Clean Air Act required every utility to put a scrubber on its smokestacks. These were incredibly expensive—about $100 million each. They made the air cleaner. They also made the makers of smokestacks richer. The makers of scrubbers were the bootleggers. They joined environmental groups in lobbying for the legislation. That’s not so bad. Maybe scrubbers were the best technology and even if a tax had been put in place, the scrubber makers would have profited.

But the real bootleggers were the West Virginia coal companies. If a tax had been used to reduce sulfur dioxide emission, there would have been an incentive to clean up the air. One way to clean up the air is to use technology like a scrubber. A second way is to burn cleaner coal. Cleaner coal (low in sulfur) comes from out West. Dirty coal (high in sulfur) comes from West Virginia. Senator Byrd is from West Virginia. He made sure that scrubbers were mandated. For the environment of course. For cleaner air, of course. For the children, no doubt. But also for his friends in the coal business. We got cleaner air, but we achieved it at a much higher price than was necessary.

Sure, when we’re talking about climate change, a carbon tax is theoretically possible, but there is no chance that government regulators are actually going to enact a tax. There are too many groups that stand to benefit more from particular solutions, like mandating specific technologies, than general solutions, like a broad tax on emissions.

Such situations are what lie at the heart of the claim that “government cannot solve problems.” The incentives just aren’t in place for getting the best solutions. I’ll concede that my claim that government can never, ever make anything better is too strong; some regulations probably result in a net benefit to society, even if these regulations aren’t first-best solutions.

But it pays to be cognizant of the relationship between private incentives and government policy. When a few people can gain a lot by tilting laws in their favor, that is a recipe for bad policies. This dynamic is the reason we have farm subsidies and sugar tariffs. A few people gain and lobby hard for maintaining these policies. The vast majority of people are actually made worse off by these policies, but each person is hurt only slightly.

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2 Responses to “Government and Market Failure”

  1. Thomas Says:

    Bill-
    Nice work dude!
    Your last paragraph in particular rings true; when a few people can gain a lot by influencing public policy, the public will ultimately lose. Your cynicism about the carbon tax is well founded. Indeed, the current ethanol craze is a 21st century version of the sulfur scrubber story, with agribusiness companies winning out instead of coal companies.

    It sounds like you are wary of the amount of power that corporations wield in government, another favorite talking point of that Ralph Nader fellow.

    I also like that you reiterate the fundamental truth that the idea of the free market is intrinsically connected to the idea of private property.

    Your logical deduction that the air and water must be divided into pockets of privately owned property for the system to be complete and consistent strikes me not only as infeasible, however, but as ludicrous. It sounds like a classic “reductio ad absurbum” to me.

    If you happen to believe that man is an independent, profit-maximizing, rational actor, who is out and has always been out to maximize his own pleasure (or to get the highest surplus) no matter what, then you will also believe that the notion of collective property does not work in any circumstance. Regardless of it being impossible to divvy up the air and water.

    If, on the other hand, you believe that man is smart but not particularly rational, instead co-dependent and feelings-driven, then perhaps you can envision a circumstance in which collective property might work after all.

    ~T


  2. […] from my regular advocacy of the position that government is in practice extremely bad at solving problems, the truth is that […]


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