Thursday, April 14, 2011

Market Failure? Really?

Good afternoon, folks. Once again, I'm sorry I'm so late in submitting this week's post.

In the interest of time, I'm going to take a slightly different approach – instead of longer commentary, I'm going to ask a central question about market failure. What do you think about it, and what does Hayek have to say?

So, market failure basically talks about overprovision of bads (negative externalities) and under-provision of goods. The bads are more easily handled, with decent property rights (if not perfectly), so I'll focus on (alleged under-provision). The theory goes that, in most cases the market will get things right. But sometimes, the market simply won't provide enough: this will happen in cases where the social benefit of goods is greater than the private benefit of providing them (hence the need for government), and typically when the profit can't be captured or the transaction cost is too high. (Note that I’m intentionally shying away from the traditional public goods definition of goods that are non-rival and non-excludable; that never made much sense to me… does it to you?).

So Hayek gives us rules for government involvement in the economy (chapter 15): basically, rule of law does not imply NO government involvement, but involvement that follows the generality rule of rule of law, and intervention only to fix a market failure, but nothing permanent, monopolistic, exclusive, or geared towards social justice or redistribution.

Fine. But what about the knowledge problem? Let's assume (1) indeed there are goods that are under-provided by the market; and (2) that the government can correct this market failure consistent with rule of law. How do we (and who is we? Voters? Government? Politicians? Bureaucrats?) determine the optimal level of public goods? What mechanism is used to aggregate information about what people – somehow – want, but aren't willing to pay a private entrepreneur enough for him to provide it?

I see a few explanations or possibilities:

1. Hayek is simply a 19th century classical liberal, rather than a libertarian, and is thus willing to bend the rules a bit on private sphere and the role of government… and maybe even on the rule of law.

2. Hayek was tired of being discredited as a policy hack (for his 1945 _Road to Serfdom_ which was considered radical and non-scholarly) and tired of not being invited to cocktail parties, because he's too radical for the left-leaning economists (Keynesians or market-failure Chicago Boys, if not outright socialists). So he throws a bone to the enemy, in the form of some economic intervention, and part III of _Constitution of Liberty_, which allows for some coercion in the provision of social/public goods, beyond the protection of individual spheres.

3. I'm missing something. Sorry. I simply can't square this in Hayek's thinking. Isn't market failure just a demonstrated preference? Doesn't the knowledge problem still apply? Or are there really cases where we need collective action through government – like for roads, or zombie attacks or asteroids? Or is that still an excuse for violating rule of law? To be perfectly honest, I do have some thoughts on this, but I wanted to see what you thought.
OK. I can't help myself. A quick comment on rule of law… Chapter 16 didn't seem terribly innovative, compared to other parts of the book, but it did offer a nice restatement: in brief, there is a decline in respect for rule of law and constitutionalism. Just as democracy has become its own end, rule of law today ends up being procedural (see chapter 13) and democracy has been conflated with rule of law. And, I particularly liked the critique (239) of "the positivist doctrine that the state must not be bound by law" – because, of course, the state makes the law!

Those of you who want to go to law school may enjoy a new book that's out, by Walter Olson, _Schools for Misrule: Legal Academia and an Overlawyered America_. I have not read it, but have read two different reviews. The book argues (1) that law was originally rejected from the university, because it was considered to be a trade, rather than intellectual – lawyers thus are still overcoming an inferiority complex, which manifests itself in academia but also point #2; think also of the fact that a law degree used to be an LLB (bachelor of law), but was inflated to a JD (juris doctor), even though it's not at all a doctoral degree!; (2) lawyers have become the social engineers. This fits in perfectly with Hayek's worries about the administrative state (administrative "expertise" and coercion over emergent order) and the school of legal positivism (law – legislation, technically – as the will of the legislator, rather than (true) law, which is general and emergent).

Sorry, once again, about the delay. Eager to hear your thoughts on market failure especially.

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