I want to propose a new definition of market failure. For me, market failure exists to the extent that innovation is blocked by incumbents. If innovators can succeed by out-competing incumbents, then the market is working. If incumbents have a self-reinforcing system that keeps out innovators, then we have market failure.
This post ties together a couple of recent bitter themes. It is not intended in any way to persuade people who disagree with me (if you disagree with me, you may just want to skip the post). It is simply a grand unified theory of my bitterness.
First, why am I bitter about Jonathan Gruber? I am bitter because in my view he has received funding and accolades far out of proportion to his skills. He is being treated as a supreme authority. In theory, that is because his skills are exceptional. Instead, I suspect that, on the contrary, his success has less to do with how he uses his critical thinking functions than how well he has repressed them. In short, he is paid to tell progressives and politicians what they want to hear.
Suppose that we have a group that wants enormous political power. The group rewards people who justify its power by calling them "experts." It punishes those who question its power by dismissing them as "hacks." If you want money and status, you want to be labeled as an expert. In order to be labeled as an expert, you produce analysis that justifies concentrated political power for the elite group.
This process is self-reinforcing. It is like the Harvard-Goldman filter. That filter says that only "reliable" people are allowed to be bank CEO's or policymakers. A requirement for being "reliable" is sharing the views of other "reliable" people as to what constitutes reliability.
It is like the tenure system in academia. Who gets tenure? Above all, it is people who support the existing tenure system.
Incidentally, that is my explanation for why the Internet has failed to alter the academic journal system. People who go through the tenure process have an enormous stake in not changing the process. The process is self-reinforcing.
Of course, incumbents never want to change the process, but markets can force change. So far, all the phenomena that I have been talking about represent market failures, by my definition. There is a market failure in health care. Instead of innovation, what gets rewarded are ideas and policies that entrench the existing system. There is a market failure in finance. Bad firms and bad policies are not weeded out. Instead, what gets rewarded are bank CEO's and policy makers who promise to make the system "too regulated to fail" and who bail out their friends when that promise breaks down.
There is a market failure in education. Educational institutions are evaluated not on the basis of rigorous standards but instead on the basis of a system of credentialism that is self-referential. X is acceptable because X has been certified by Y, which is acceptable because it has been certified by Z, and so on. In order to climb the ladder in academia, you have to display allegiance to the credentialist ideology. You have to reinforce the incumbents and help snuff out innovation. Our program is accredited, and yours is not. So there.
As a high school AP teacher, I have had to suffer through "audits" by the College Board. My students' scores on the AP are not part of the audit. Even if a student gets a perfect score on the AP, that student cannot be said to have taken an AP course unless I passed the audit. Now that I have passed the audit, however, no matter how many of my students fail the AP, my course will count as an AP course as certified by the College Board. Credentialism at its best.
I should point out that I think that reputation systems are necessary. I am not against audits and reputation systems in general. As consumers, we need reputation systems in order to sort out quality. The key is whether a reputation system is reasonably open to innovation, or whether it serves primarily to maintain the status of incumbents.
The reputation system that elevates Jonathan Gruber to a status of supreme authority is not a system that serves the consumer. It serves the incumbents, who want to centralize political power. The relationship between politicians and experts is the most serious market failure of all. It is our version of what I have called the Moral Rot Factor.
Ben Bernanke is one of the most decent people I have ever met. Yet he is part of the moral rot. As Scott Sumner has pointed out ad nauseum, most economic theory favors rules over discretion in monetary policy. Yet Bernanke's ad hoc, discretionary actions and departure from rules are what made him the Person of the Year, everybody's hero. Bernanke, Paulson, and Geithner are heroes for maintaining the Mystique that we have a great banking system that only requires wise regulation. Ultimately, it is Bernanke's willingness to go along with the big bankers' view of the world that accounts for this high status.
Several commenters object that our moral rot is not as bad as it was in the Soviet Union. That is true. Dissidents are not being sent to Siberia. The U.S. today looks less like a one-party state than it did a year ago, but I still do not think that the Tea Party represents a reliable, effective opposition. I think that there is still a high probability that we are on a path to a system in which a political elite ruthlessly rewards its friends and punishes its enemies, leading to a society with much less innovation and much more corruption. I do not foresee gulags and mass murders, but there is plenty of potential for moral rot in cronyism, and that I do fear lies ahead.