Friday 26 August 2016

My Market Preference is Conditional because of Market Failures



One reader of this blog (in an email exchange) has found it very hard to accept that I have been propounding only a “preference” for the market rather than gung-ho adherence to market capitalism. Consequently, I take this opportunity to set the record straight and review briefly[1] the reasons why our preference should be conditional; the market is not a perfect means to achieve Christian goals. We must recognize the existence of market failures, instances where, if the market were left uncontrolled, it would not achieve Christian goals. Each of the following ten[2] issues calls for government intervention. However, the extent of that intervention remains in doubt and will, no doubt, give grounds for debate until the Lord comes back.

1. Rules of the Game—the Justice System



Due to the “depravity of man", God has instituted governments "in order that the licentiousness of men be restrained."[3] The government obviously has the task to maintain justice so that the evildoers are punished and the good may lead a peaceful life. In economic life, that means the government must set the "rules of the game"-- to maintain a system of justice with a legal framework and a means to ensure compliance with it--laws, regulations, courts, police, etc. Without such a system a free market could not even exist; the strong would just “take” from the weak. Market transactions would, at best, take place only between those who are equally strong. Laws and regulations are obviously necessary to protect people and property[4]. These laws must, obviously be enforced. Moreover, justice must not be unduly delayed.[5] The degree and method of regulation will, of course, always remain in debate.

Two major economic institutions deserve special mention since they are “creatures” of the government. Corporations owe their existence to legislation providing “limited liability” which permits shareholders to be put at risk for only the amount invested in the corporation instead of all their wealth. The invention of “limited liability” was essential to the modern world. However, it allows managers of corporations to take more risk than otherwise—since their total personal assets are not at stake. Similarly, unions are legal entities sanctioned by government. Government must, therefore be held responsible to adequately regulate these institutions.

2. Lack of information


In a perfect market, buyers and sellers have equal knowledge about the product or service being offered for sale. Buyers are assumed to be able to evaluate what they are getting. With some of today’s highly technical products, that is simply not the case and, without government intervention, injustice may prevail. Consequently, laws such as those concerning the safety of the product, the required information to be made available and forced recalls of defective products can readily be justified. Moreover, the court system mentioned above can be used to bring suit where necessary—although that process is too costly and cumbersome to make  relevant regulation unnecessary. We can’t just leave it to the courts.

3. Undefined Property Rights


The justice system, as noted above, must protect private property to even allow markets to function.  Proponents of free markets tend to assume that everyone knows what property rights are; they seem to think these rights are easily recognized and unchanging—e.g. the right to own your own land, house, car etc.  The reality is more complicated. Property rights are not always clearly defined. Rather they may change as society and government changes. Consider, for example, such things as computer software,pharmaceutical drugs or “air rights” above your property (Can you put up tall buildings, wind turbines etc. as you please?). Without protection, new inventions could be copied leaving no incentive for inventors to develop new products or service.

To deal with this problem, governments have over time introduced copyrights on books, patents on new products, etc. Moreover, we now have water rights, air rights, radio and television rights to airwaves, rights to pollute etc.. All of these intangible property rights have varying degrees of clarity and enforceability.

The point is, that the market can work only after government and/or society have defined (an possibly assigned) property rights and developed the necessary means to enforce them.

4. Unjust Distribution of Wealth of Income


If you don’t have money, you can’t participate in the market; only dollar votes count in the market! Many may be wholly or partially excluded from the market because the “initial distribution” was unjust. For example, the white man owns most of the land taken at gunpoint from indigenous people. Where wealthy landowners own the bulk of the acreage, the markets are unable to improve the lot of the poor. Without government action, they remain unjustly marginalized.

A related market deficiency concerns those who are unable to offer their services for pay in the labour market. Those who cannot work—the physically or mentally handicapped, the unskilled, the single mothers with small children cannot adequately participate in the free market. While family and altruism have their place, they have proven to be insufficient and a role is left for the government[6].

5. Boom  & Bust: the Business Cycle

Most economists agree that the market, if left to itself , would not settle at a satisfactory “equilibrium”, i.e. at full employment and without inflation. Rather, we have inflationary boom followed by recessions or depressions. While the government’s exact role at any point of time is hotly debated, the government no doubt has a role through using macro-economic tools -- fiscal policy (e.g. increasing spending, reducing taxes and running a deficit in periods of unemployment) and monetary policy( the central bank reducing interest rates to encourage investment and increasing them to fight inflation).

6. Monopolies and concentration of power.


 I have recently discussed the importance of competition and the need for governments to control monopolies[7]  Overall, I concluded, with Chewning, that “competition has an overall salutary effect on fostering business conduct that provides the best economic outcomes for the most people in a fallen world.” Consequently, we must be careful that, in considering solutions to the economic ills of the day, we do not unnecessarily reduce competitive forces. In addition, we should generally be supportive of government actions which seek to maintain and increase competition.  Moreover, governments themselves must not establish or protect monopolistic industries. Markets, if left to themselves, would lead to concentration of power unless products are perfectly homogeneous and many buyers and sellers can freely participate.

7. Insufficient Necessary Goods and Services


While the market goes a long way to provide the goods and services that society needs, there are certain goods that will not be produced in a free market or will be produced in insufficient amounts.  Pure public goods such as defense, policing and infrastructure such as roads and highways would not be provided voluntarily by individual business. Other goods such as education and health care would be provided by the market only to some—those who could afford to pay for them. Such “pseudo-public” goods would not be provided in the quantities that we as society believe are necessary. How much of these goods are necessary remains debatable. For instance, we tend to agree that elementary education is necessary but is university for all?

While the government has a role to ensure that goods considered necessary are available, it does not follow that the government must provide them itself. For example, instead of building and operating schools, the government could simply distribute money or vouchers to parents/students and leave it up to the market (including non-profit entities) to build and operate schools from which parents could choose. A conditional preference for the market implies that we leave as much scope as possible for using the market while ensuring that all receive an adequate share of these necessary goods and services.

8. Neighbourhood Effects


A related, well-recognized market failure is caused by what are referred to as “externalities” or “neighbourhood effects”.  These are situations when “third parties”—those not involved in the market transaction bear costs or receive benefits from the market transaction. By definition, these costs or benefits are not reflected in the market price of goods produced and are not considered in the decision processes about whether or not a seller will produce the product or whether a buyer will purchase them.

Pollution and other environmental effects are, probably, the most pervasive of these “externalities”.  If a steel making plant sends toxic particles up its smoke-stack during the production process, these particles fall upon its neighbours and their properties. In an uncontrolled market, the company would not have to pay for the damage caused by its effluent. Rather, the neighbours bear that cost in pain and suffering as well as the actual cost of medical care, clean-up etc.  The company does not have to include that cost in deciding whether to produce the steel or in how much to charge for it.

On the other hand, if the government was to charge the company for the amount of particulate that it discharged[8], that cost might cause it to produce less of the steel or change the process involved to discharge less pollution. If they increase their selling price to reflect the extra costs, some buyers will buy less of the final steel product. Thus, the cost of pollution will be reflected in the production, marketing and buying decisions. The “market” would reflect the true costs involved; the externality would be internalized.

Many more examples of neighbourhood effects could be mentioned. Obviously, if the market is left uncontrolled, serious injustice may be done to innocent neighbours who God requires us to love.

9. Non-economic goals ignored.

Moreover, markets have little concern for non-economic goals such as maintaining strong families, providing for the poorest, observing Sabbaths, treating employees "rightly and fairly." In addition, without constraints, the market would unquestioningly cater to the demands for abortions, prostitution, pornography, narcotics, etc. Certainly, the market is not a perfect means to attain Christian goals; it will simply reflect the sinful preferences of depraved people.

10. Short-run orientation.


It is also argued that the market is oriented too much to the short-run. Public companies are fixated on improving the next quarter’s earnings while long-term impacts are said to be insufficiently considered. There is some truth to this but it must be noted that markets have an amazing ability to adapt. Before the current situation of low oil prices and oil glut, it was (surprising in retrospect) common to see references to “peak oil”; oil production would soon peak, eventually, we would run out of it. Action must be taken to ensure that these resources were available for our grand-children. However, long before a resource such as oil is actually used up, the market price would rise. This increase would provide an incentive for users to conserve, for producers to search out substitutes and improve techniques for discovering and producing previously unknown or inaccessible deposits. That is exactly what has occurred with the discovery and utilization of “off-shore” oil, oil-sands, shale deposits,solar and wind. As long as prices are allowed to reflect true scarcity, the market has the capacity to encourage the stewardly utilization of the resources God has provided for us.

Moreover, it is questionable that the government can do a much better job than the markets. In spite of the fact, that our prime minister, Justin Trudeau, has just encouraged his caucus to look forty years ahead, the sad reality is that politicians are primarily focused on the next election.

In Sum


We have reviewed some of the market’s imperfection.Proper recognition of these imperfections is important for Christians; it should keep us from becoming uncritical market ideologues or unconditional proponents of the view that the free market is the Christian economic system. However, we must also not jump to the left and believe that the government must take care of it all. Rather, as I’ve been at pains to point out in this blog, we should have a preference for the market and seek government action only to the extent that is absolutely necessary.

RELATED POSTS
Competition is Good; A Biblical/Economic Perspective

Choice of Economic Systems: A Conditional Preference for the Market—what does that mean?


Note: Most of the market deficiencies noted above can form the basis of a future blog post; if you would like me to expand on a specific area let me know in a comment or directly to johnboersema@rogers.com.


[1] See my book, p. 165-173, I have set these out in more detail.
[2] They could easily be rearranged to come up with a different number.
[3].Article 36 of the Belgic Confession. See Rom 13, 1 Tim 2:1 and 2, Deut 16,18-20, Jer 22:3.
[6]  Boersema, p.111
[8]  And use that money to compensate the “neighbours”. Of course, government can also simply forbid such discharges and force the company to adjust or close down.

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