Monday, April 16, 2012

Market Failure

Mention "Great Depression" to most Americans and what do they think of? High unemployment and poverty, certainly. ("I see one third of a nation ill-housed, ill-clad, ill-nourished." -- FDR.) What they might not think of is failure of the free market. But at the time, it was a different story. There was serious doubt about the viability of America's free market economic system, whose failure was on such dramatic display. There was an alternative system that was increasingly attractive to many Americans, the revolutionary communist system in the Soviet Union ("I have seen the future and it works." -- Lincoln Steffens.)

But in the end, Americans of the day rejected revolution and communism. Americans of our time forget, or never learned, that that wasn't inevitable. We can thank the success of FDR's New Deal in creating a safety net for those suffering the most from the failure of the free market. And on the other side of the coin, the totalitarian nature of communism in the Soviet Union gradually became clear to Americans. With the atomic bomb and ICBMs, the USSR posed an existential threat to the US. Partly in reaction to the threat of Soviet communism, memory of the failure of the free market during the Great Depression faded and was replaced by its opposite, a glorification of the free market. It became a matter of self-evident truth: the free market could do no wrong.

The pendulum had swung too far. After the jump, restoring some balance.

Paul Krugman, winner of the Nobel Prize in Economics, points out the obvious way that free markets often get things wrong. It's by failing to adequately price the effects of negative externalities like pollution. In a 2011 column, he refers to a study that quantifies those effects and finds that the costs are huge and concentrated in a few industries, whereas the price is paid by other industries, or by all of us:

At one level, this is all textbook economics. Externalities like pollution are one of the classic forms of market failure, and Econ 101 says that this failure should be remedied through pollution taxes or tradable emissions permits that get the price right.
Those are negative spillover effects that the free market gets wrong. There's a corollary to this market failure, where the market fails to exploit positive spillover effects because there's no incentive for individuals to do so. Gene Sperling, director of President Obama's National Economics Council, recently attempted to explain how manufacturing firms can potentially generate important economic benefits for society at large, but don't because individual firms themselves cannot capture those benefits for themselves. Instead, the firms shut down or never start up in the first place. Economics journalist Ezra Klein quotes Sperling:

"While we know that economists often start from the premise that any type of preferential treatment of a single type of investment over another is viewed as distortionary," Sperling says, "we also know that when an economic activity has positive spillover effects that an individual firm cannot capture, there is a risk we as a nation under-invest in areas that can be beneficial to the economy at large." In other words: There's a market failure here.
Americans still have the mindset that the free market is always right. It isn't. Market failure is possible. In fact, it's visible all around us, literally, in the dirty air we breathe. Market failure is also all around us, invisible, in lost opportunities. It's time we restore some balance in our thinking. It starts by admitting that the free market does, sometimes, fail.

What lessons can we learn from this locally? Does the Richardson City Council have the right balance? What are some examples where Richardson has prevented or compensated for failures of the free market? What are some examples where Richardson is failing?


dc-tm said...

380 Agreements and Abatement for a special few.

Andrew said...


Almost any Richardson homeowner can get a 380 tax abatement with the City of Richardson.

It is called the "Home Improvement Incentive Program." Yep. That is right. The Home Improvement Incentive Program is a 380 program.

So any homeowner that spends the minimum and meets the other conditions can get an economic development deal with the city. Richardson is the only city around, that I know of, that allows citizens to participate in economic development directly.


I think "failure" is the wrong word. I see these phenomenon as natural outcomes of systems. For example, with pollution some may see it as a trade off and it is a matter of deciding whether that trade off is worth it. Whether or not people realize their contributions is another matter and not unrelated. Some may see bankruptcy of huge corporations (or even small ones) and the subsequent hardship as preferable to too much control. I am not saying I hold those values but I am just saying that this view exists.

Your question about Richardson and local issues is easy to answer. Typical suburban decline is market driven and cities do things to try to intervene. I would think that the six study zones in the comprehensive plan are a response to the fact that the land use in those zones does not line up with changes in the market that have occurred in subsequent years. That is to say, planning and land use must respond to market changes to make parcels in those zones more viable.

So I don't think "failure" is the right word. There are reactions and consequences to human systems and how they work. That is true for all human systems from bridge clubs to corporations to rock bands to families to sports teams.

Mark Steger said...

Home improvement is a classic source of market failure of the kind that insufficiently recognizes positive spillover effects. Improve your own house and all your neighbors benefit (a little) in higher resale value of their own homes. But the homeowner that does the renovations assumes all the cost. Richardson's "Home Improvement Incentive Program" addresses that market failure.

Mark Steger said...

Zoning is a good example of correcting for market failure. Spillover effects (usually of the bad variety) lead cities to adopt zoning laws. Over time, changes in market conditions result in the zoning laws becoming outdated and failing to achieve the corrections to market failure they were originally designed for. That leads to a need for a city to continually evolve its zoning laws. This blog has highlighted local examples where that evolution is on the mark and where it has come up short.