Tuesday, September 24, 2013

Market Success Versus Government Success

Public choice is a theory of ‘government failure’ here in the precisely analogous sense that theoretical welfare economics has been a theory of ‘market failure' - James M. Buchanan
Before I use a title for a blog entry, sometimes I'll conduct a Google search to determine just how (un)original it is...

  • "Market failure versus government failure" - 32,200 results
  • "Government failure versus market failure" - 28,500 results
  • "Government success versus market success" - 0 results
  • "Market success versus government success" - 0 results

Right now when you search for "government success"...the second result is the Wikipedia entry for "government failure".  Not sure how personalized the results are though.  But let's have some fun by Google bombing the heck out of "government success" by linking it to the Wikipedia article for government failure.  Like so...government success.

We often hear of market failure...but what exactly does it mean for markets to fail?  The standard answer typically contains concepts such as irrationality, wealth inequality, information asymmetries, negative externalities, monopolies and public goods.  These concepts are frequently used to justify government intervention.  But in order to truly understand market failure...I think it's essential to first understand market success.

Right now you're surrounded by examples of market success.  Every product/service that you purchase is an example of market success.  The toothpaste that you purchase is an example of market success.  Yet, for most of recorded history, the private sector did not supply toothpaste as we know it.  The market failed, but now it succeeds.

But isn't it reasonable to believe that there's still room for improvement when it comes to toothpaste?  It's hard to imagine that 200 years from now people are still going to be using exactly the same toothpaste that we use.  I'm pretty sure that in the future you're simply going to put a tablet in your mouth that will quickly dissolve away anything that shouldn't be in there.  Not having to brush your teeth will free up your time for more valuable uses.  That's progress.

Because there's always room for improvement...there's no such thing as perfect success.  Every product/service we purchase is successful because consumers decided that it reduced the shortcomings of previously available products/services.  Therefore, consumers incentivize entrepreneurs to not just find where there's room for improvement, but to actually make the improvements.  It's relatively easy to find where there's room for improvement, but actually making the necessary improvement takes considerable amounts of effort, skill, ingenuity, perseverance...and a good dose of luck.  This is why incentives matter.

The key concept is that the only way we can measure the extent of an entrepreneur's success is by observing how consumers react to the new product.  If Erin, the entrepreneur, develops a tooth tablet, then the success of her product will be determined by how many consumers stop buying toothpaste/toothbrushes and buy tooth tablets instead.  If toothpaste and toothbrushes become as outmoded as buggy whips, then we can definitively say that Erin successfully corrected a market deficiency/inadequacy/shortcoming/failure.

We know that the market succeeds because people are willing to pay for products.  We also know that the market fails because there's always room for improvement.  But can we say that the government succeeds?  Nope nope nope nope.  Why not?  Simply because consumers don't have the freedom to demonstrate how effectively/efficiently the government is taking up the slack.

Here's how I've illustrated this...





The point of these graphs is to illustrate that the success of government depends on how accurately the supply of public goods reflects the true breadth/depth of market failure.  

Graph 1 - what government success would look like
Graph 2 - what government failure looks like
Graph 3 - government success depends on knowing the breadth/depth of market failure

If we don't know the breadth/depth of market failure, then we can't truly know how well the government is complementing the private sector.  For all we know it could be making mountains out of mole hills...and whatever the opposite analogy is.  

The theory of pragmatarianism is that allowing taxpayers to choose where their taxes go will show us the breadth/depth of market failure.
It is, of course, not desirable that anything should be done by funds derived from compulsory taxation, which is already sufficiently well done by individual liberality. - J.S. Mill, Principles of Political Economy with some of their Applications to Social Philosophy
If education is sufficiently well done by individual liberty, then taxpayers won't spend any of their taxes on public education.  The more money that taxpayers do spend on public education, the greater the depth of market failure and the greater the height of government success in terms of education.

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