31 March 2011

“Market Failure”

This approach provides a way to see the problems government has in allocating resources even remotely well: It’s not just that government gets it wrong at various points but that political processes do not have the same error detection and correction abilities that markets have. Political actors are far less likely to know when they’ve erred and to have the right incentives to correct things. Government is not only less able to get it right; it’s also less able to know when it’s got it wrong.
A whole new light is now shed on the idea of “market failure.” In this more Austrian view, markets frequently “fail” by not allocating resources optimally at a given time. But calling this a “failure” ignores the Austrian point that what markets are particularly good at is telling us that resources are not optimally allocated and providing the knowledge and incentives necessary to correct the errors. From the Austrian perspective, “failure” should refer not to suboptimal allocation at a given time, but rather the inability to detect and correct error. If we understand that the crucial question is how well alternative processes do those things, we realize that supposed market “failures” are better seen as opportunities for market successes.

“Market failure” occurs quite often in the free market because costless, infinite, perfect information does not exist.  As such, there will always be times when resources are not allocated as efficiently as possible.  What statists fail to realize is that the same holds true for state-governed markets.  Switching from a demand to a command economy doesn’t magically cause costless, infinite, perfect information to appear.  Rather, what happens is that those in charge of a command economy take on the pretense of knowledge.

Another flaw in analyzing “market failure” is analysis makes use of static models even though the market is a dynamic entity.  This usually leads to calls for intervention at the slightest sign of trouble, even though the market has repeatedly proven to be self-correcting.  A simple glance at any growth chart, whether of nations or businesses, or any other market entity, will show that growth is not perfectly linear.  Sometimes, say, a business will experience market growth; other time it will experience losses.  Some strategies will work spectacularly; others will flop like a dead fish.  Trying to pronounce judgment on a given system in response to just one small sliver of data is foolish, to say the least.

A better method of analysis is to compare a system’s historic performance in relations to its purpose/ability.  No one claims that the free market serves as a system of social justice, nor does anyone claim that it operates smoothly and flawlessly.  Really, the only claim that anyone can make is that the free market is the most efficient of allocating scarce resources to those who desire them the most.  Historically, the free market has done a very good job of accomplishing this goal, particularly in comparison to the alternatives.  America’s market slowdown in recent years is due to the government’s attempt at imposing a soft statism over the economy.

Does the free market fail occasionally?  Most certainly.  But is that failure permanent or uncorrectable?  Most certainly not.  More importantly, the free market, even with all it imperfections, is still the best method of allocating scarce resources.


  1. I am having alittle trouble with your terminology. The concept that a "market can fail" is strange. This implies that the market as awhole has some cognitive and volitional function.

    What is closer to the truth is that invididual actors in the market fail and pay a personal price for their failure. That price is their incentive to fail less as well as their indicator that they are failing.

    Every market has lots of failures at the same time as lots of successes. Ideally, a government is not deciding who will be the winners and losers but market forces themselves will be making the distinctions.

  2. @Professor Hale- It's not my terminology. I have found that a critique is only effective if it is delivered using the terms set forth by the one I'm criticizing. As it stands, "market failure" (hence the title in quotation marks) is used to mean that the market sometimes allocates resources in an inefficient manner. My point was simply that this is true for any economic system, though it occurs less frequently in the free market, and that this is never a permanent state of affairs in the free market (i.e the market is self-correcting). Thus, even though the market may "fail" from time to time, there is no reason to become alarmed or abandon ship, so to speak.