David R. Henderson  

"Most Economists?" Really?

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Sari, Ed.

My friend Edward Lopez, who blogs here, linked on Facebook to a great story from the New York Times about an entrepreneur's solution to the challenge of dry-cleaning saris. It's neat and the piece is short.

Then Ed went on to say:

Most economists stop at the first blush, say "market failure," and conclude that governments should subsidize dry cleaners. But entrepreneurs look at "market failure" and see dollar signs. The profit motive is what solves market failures -- not bureaucrats.

My policy is never to reveal on this blog, without permission, what people wrote in the privacy of FB. So I got Ed's permission, telling him up front that I would be criticizing his statement.

First, I agree with him that entrepreneurs often do wondrous things. In doing so, they often solve what many non-economists might see as market failures. But would "most economists" see as market failure the fact that, before this entrepreneur came along, there were no apparent low-cost ways of solving the problem? I don't think so. When I talk to economists who see market failure in many areas, they at least try to make the case that the market failure is one of public goods or externalities. I don't think they would see either in the sari case.

But I'm interested in what you think, especially if you're in one of two categories. First, If you're an economist, what do you think? Before this solution came along, was the market failing? Second, if you follow what economists write, can you give an example where an economist looked at such a situation and claimed market failure? Please "show your work."


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COMMENTS (32 to date)
Daniel Kuehn writes:

I agree with you. When I clicked through the link I wasn't getting what the market failure was. Lopez seems to be thinking that any time we imagine something we'd like the market to do that it isn't currently doing is a market failure I guess?

I've never liked the term "market failure" because it's really not the market that's failing in most cases. In the prominent cases (public goods and externalities, that you note) the whole problem is that the market is NOT operating due to the nature of the good or transaction, not that the market is operating but that it is failing.

I'd also disagree with Lopez that most economists think the government should step in to address a market failure. We generally identify a lot of market failures without advocating intervention. Take Bloomberg's public health crusade. Most economists would agree that there are public health ramifications - externalities - that go along with unhealthy eating. But I would guess that very, very few economists would say what Bloomberg has been doing is really justified. You can identify a market failure without it being actionable. Most textbook accounts discuss Coase very prominently. I don't think there are much of any economists that fit the caricature that Lopez presents.

Steve Miller writes:

I think my colleague Ed is right. "Most economists" have no trouble finding a source for any given "market failure" -- and it's certainly not just limited to public good or externality critiques (you have many more, including asymmetric information (often combined with adverse selection), moral hazard, the winner's curse, bounded rationality, price rigidity, etc. etc.

And this would, at first blush, appear to be a market failure. You have people willing to pay top dollar for dry cleaning, you have dry cleaners willing to charge it (because cleaning saris is so specialized), but due to bounded rationality (most) dry cleaners refuse to clean saris at all. Why? Because to do so they'd have to charge a lot, and that premium for a garment with a clear ethnic association runs the risk of making customers angry (and not just the customers who want clean saris!). In other words, even when price discrimination would be more efficient, it is often not practical because of social and behavioral constraints.

It turns out that analysis is largely wrong, but it took an entrepreneur to learn how wrong it is.

Daniel Kuehn writes:

Seeing Steve Miller's response, I wonder if the answer to your question depends on whether the respondent considers himself part and parcel with "most economists" on the question of market failure.

I do and I think Ed Lopez is clearly wrong.

If you're the sort of person that doesn't affiliate with "most economists" you are ultimately an outsider looking in and likely to answer differently.

RPLong writes:

Obviously we get ourselves into trouble whenever we use the phrase "Most ________." Whenever that happens, you can bet that there is enough evidence supporting and refuting the claim that determining what is true of "most whoever" will probably be impossible.

However, it's not uncommon to see statements like this:

It's a worthwhile project, but financial institutions won't touch it due to some form of market failure. I don't think we can rule this out. If there is, in fact, some form of market failure than government intervention can be justified. If the market is failing to provide capital to expanding businesses, however, then we have a problem that goes well beyond Diamond Aircraft. What is the source of the market failure? Is there a way we can systematically eliminate this market failure, so we no longer need governments to be approving and issuing loans on a case-by-case basis.
Why do some economists believe that if businesses choose not to undertake certain projects, it's an example of market failure (even a possible one)?

I can't provide an exhaustive list of every instance of such statements on economics blogs, but it happens quite often, in my opinion.

David R. Henderson writes:

@Steve Miller,
Your case would be stronger if gave an example of something similar where economists claimed market failure.

David R. Henderson writes:

@RPLong,
Thanks. That's the kind of evidence I was asking for. Notice, though, that even in this case, Mike Moffat posits it as one of three possible explanations. So this is the best I've seen so far but not enough, IMO, to justify how strongly Ed made his claim.

Ed Lopez writes:

Three responses:

1. I will fall on the sword for exercising brevity within a Facebook status update. Indeed, whenever I read the phrase "most economists" I either get suspicious or bored. So I'm at fault there.

Had I indulged in a few more sentences I would have invoked Peter Boettke's distinction between mainstream and mainline economists. I would then have worded my claim as "Most mainstream economists stop at first blush..."

2. All market failures can be described as the absence of markets. In other words, markets don't fail they just are not always present, sometimes because the good in question resists propertizing (think common pool resources absent Ostrom-style emergent institutions), other times because social norms disallow exchange (think repugnance as with vital organs). Conventional economic thinking makes us want to seek out the externality or find the non-excludability.

3. Market failure arguments are ubiquitously behind a very large share of arguments for government action. And in response to Daniel Kuehn, we frequently see these arguments amounting to no more than wishing for more of a favored good, and we frequently see the people who make this argument concluding that government action is needed. David asks us to "show our work" so here is an example from journalism. http://www.fee.org/the_freeman/detail/is-the-decline-of-newspapers-a-market-failure

In education, as well, we have a positive externality argument behind the argument for government schools. Yet there is evidence that the external benefits taper off, and all the gains to further education are internalized, after a certain grade level (I don't recall which grade at the moment). In other words, the externality is inframarginal in the Buchanan and Stubbelbine (1962) sense. Besides this, even if the market failure argument were to hold up in this case, that would justify government FINANCE of education rather than government PRODUCTION.

A.C. Pigou in 1920 criticized this type of thinking. He said that identifying a market failure is only a prima facie case for government intervention. That case only goes beyond prima facie if it can be determined that the process of government action actually would improve economic efficiency relative to the identified market failure. Despite this, we still see prominent mainstream economists merely identifying a market failure and thereby concluding that government intervention is justified. Again, showing my work on this, see the issue of the holdout problem as justification for eminent domain. http://politicalentrepreneurs.com/the-problem-with-the-holdout-problem/

Okay, a fourth response.

4. I do not consider myself a mainstream economist.

Alexandre Padilla writes:

@David Henderson,

First, this case somewhat reminds me of Joel Waldfogel's book "The Tyranny of the Market" and he might see this as evidence of tyranny of the market, which I think Joel Waldfogel would argue is a market failure.

Is your question that it's inaccurate that most economists jump to the conclusion that when there is a market failure government must jump in or are you stating it's inaccurate that most economists would point this as a market failure?


I think the proper way to answer this question is to look at economic textbooks and see how they define market failures.
Then we should ask ourselves, how many textbooks mention market solutions and mechanisms to minimize or mitigate these market failures? How many textbooks talk about Coase theorem and quickly emphasize the importance that Coase theorem is only true when transaction costs are zero (not even low or low enough that there are gains to be made by trading/negotiating)? How many economists have happily followed Cass Sunstein and Richard Thaler toward government nudging people for their "failure?" How many textbooks talk about Public Choice, government failures, andu unintended consequences of government attempt to correct failures?

Since you are asking an example, let me ask this question: How many economists have paid attention to George Akerlof's section IV in his 1970 paper on the market for lemons that notes that there are many market institutions existing to counteract adverse selection problems? Do most economists do like Akerlof point these market institutions or do they run recommending government stepping in with transparency laws, disclosure laws, labeling laws, quality of safety and control laws, etc?

Now do I think that Ed Lopez is right and most economists would see that specific example as a market failure? I am not sure. Do I think most economists quickly jump to the conclusion that market failures warrant the government stepping in? I would say that even when they acknowledge market solutions, they often argue that government should still step in to "help" the market.

Dan Klein has done a lot of research on the economic profession, he might be better able to answer your question.

David R. Henderson writes:

@Ed Lopez,
No time to comment on your whole comment here. But one question: in the FTC report that you cite in your link, are these people who claim there is a market failure identified as economists? It wasn't clear.

DWM writes:

Some of Dan Klein's work on polls of economists indicate that most economists are quick to advocate governmental intervention- though these polls do not quite prove Ed's point. I find the idea of "market failures not being actionable". If we think of M-F as failure to achieve welfare maximizing 1st best competitive equilibrium, then M-F is truly pervasive, but usually not actionable. Coase defined true market failure as failure of markets to achieve results that could be obtained through some other institutions- and this kind of failure is always actionable, though less common than guys like Stiglitz indicate.

Ed Lopez writes:

@David,
Not sure whether the authors of the FTC report are economists or lawyers. But the report expressly begins with the argument that journalism is a public good and, therefore, that the decline of legacy newspapers is a market failure that requires government intervention to correct.

Daniel Kuehn writes:

That just seems like a bad argument on the FTC part. I buy that media is a public good. There's a good Jeffersonian case there.

But newspapers are failing precisely because they're being superseded by by other forms of media.

If the question is "can we find people making poor arguments" or "can we find anyone that will advocate intervention at the drop of a hat" then I'll have to change my position - of course we can. To a certain extent David and my intuition on this is hampered by the fact that we're proving a negative.

The fact that a bad argument is made at the FTC is not particularly surprising or persuasive to me. You mention Ostrom - she's a Nobel laureate! Even at the undergraduate level no one teaches market failures without teaching Coase. This is all mainstream stuff. These aren't voices crying in the wilderness.

Dan Klein's surveys show most economists aren't libertarians essentially. This should not be surprising at all. But I don't think they show the full Lopez claim.

Daniel Kuehn writes:

I probably shouldn't say "public good". It is excludable. Let's just say that there are positive externalities associated with news media.

The way I generalize the concept of market failure is to call it a coordination failure, which is a failure of the market to optimize. This happens with externalities, asymmetric information, public goods, et cetera. That the market doesn't provide something doesn't mean it's necessarily a market failure, because it could be that it's currently non-optimal to provide that good/service. I think the whole debate on what's the best way of solving market failures (including the option of letting them be) is superfluous to the definition of the concept itself.

Steve Miller writes:

David,

Other examples? It seems to me that Sari cleaning is like flood insurance. Owning a Sari is like owning a waterfront home. The market doesn't serve you, even if you are willing to pay high premiums.

Roger Sweeny writes:

I can't think of any economist who would describe this with the technical term "market failure."

However, lots of economists--and even more commentators and politicians--would have said that "the market is failing" in regard to dry cleaning saris.

David R. Henderson writes:

@Ed Lopez,
Not sure whether the authors of the FTC report are economists or lawyers.
Right. Me neither. But if they're not economists, then so far you have given zero support for your claim. Remember that your claim wasn't about "most people" or "most lawyers." It was about "most economists."

David R. Henderson writes:

@Roger Sweeny,
However, lots of economists--and even more commentators and politicians--would have said that "the market is failing" in regard to dry cleaning saris.
Your claim about commentators and politicians is not at issue here, as I made clear with the title of this post and the content.
Your claim about "lots of economists" is germane, though. Evidence please.

Silence Dogood writes:

[Comment removed for supplying false email address. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

Ed Lopez writes:

@David,

I won't take the time to look up whether the FTC report on journalism was written primarily by economists. Even if it were all lawyers, or, to be fanciful, even if it were all journalists, it's still an economic argument being made -- it's the mouthpiece of neoclassical welfare economics being used.

Now even if the journalism example is dead in the water, your claim that I "have given zero support for" my claim is overstated. Check out the holdout problem example. And keep in mind that that's just an existence proof because there are many, many examples of mainstream economists today making prima facie justifications for government correction of market failures.

David R. Henderson writes:

@Ed Lopez,
Even if it were all lawyers, or, to be fanciful, even if it were all journalists, it's still an economic argument being made -- it's the mouthpiece of neoclassical welfare economics being used.
All true. But it's not "most economists." Remember your original claim.
I'll grant you the holdout problem one. For those who are wondering, it's excellent. But it has little to do with this dry-cleaning issue, which is what you made your claim about.

Roger Sweeny writes:

@David R. Henderson
Your claim about "lots of economists" is germane, though. Evidence please.

I can't come up with anything specific at the moment. Perhaps I should adjust my prior :)

A few months ago Ronald Coase wrote in the Harvard Business Review on "Saving Economics from the Economists". He noted: "Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate."

It seems that many economists do jump to the conclusion that if a market doesn't immediately solve a particular problem perfectly at the price they would prefer, that there is a "market failure" (or at least a "failure of the market" even if they may not use the term "market failure") that therefore it needs to be solved by government.

I'm an entrepreneur with an interest in economics, so I see examples of that all the time, where there is a niche an entrepreneur might jump in and solve, but the government steps in too quickly (or the threat of government stepping in scares entrepreneurs off from solving the problem, so politicians can then claim the market is failing). There are economists backing those government actions in many cases, even if we might not think much of their analyses, and even if they aren't widely published or high profile economists.

The economists posting here may have selection bias in their view of economists based on those they associate with and focus on. Healthcare economics is full of examples where they argue the government needs to step in since the market has "failed" without giving the market time to act or considering government failure (such as regulations scaring off entrepreneurs or preventing competition, as that link details) as the explanation.

Here are some general types of examples that shouldn't be news to readers here : an accident occurred therefore they conclude safety needs to be handled by government (rather than giving the market time to react, or time to evolve better standards as technology and wealth have improved to allow that). Someone got ripped off by a cab, therefore the government needs to heavily regulate them. A healthcare price was too high therefore government needs to step in, etc. Consumer demand isn't up to par? It must be a market failure so government needs to step in to prop it up (rather than letting businesses have time to find ways to create demand by lowering prices or inventing new products, both of which require investment money the government is borrowing instead). Someone doesn't have health insurance therefore the government needs to handle it (rather than considering government failure as the cause, and governments operation of charity as a reason the private sector doesn't step in). A poor person exists, therefore the government needs to handle it without considering that government handling charity is what keeps the private sector from handling it. We see private solutions as possible to these things, others react to prevent them.

Glen Smith writes:

Most market failures are just the market doing part of its job as a social institution. Clearing out that which society puts no value on and limiting resources to unsustainable projects. In fact, if there were markets where markets should not be, that is a possible example of market failure.

David Friedman writes:

This is not what I would describe as market failure.

My preferred definition is that a market failure is a situation where individual rationality fails to lead to group rationality. That isn't what is being described in that article. I wouldn't be surprised if some economists used "market failure" to describe any situation where a market failed to produce a desirable outcome, whatever the reason, but I would regard that as the misuse of a technical term and would have reservations about an economist who used it that way.

awp writes:

I have never in my life heard an economist explicitly describe the fact that a trade didn't happen because the cost of service was higher than its value, as a market failure.

David R. Henderson writes:

@awp,
I have never in my life heard an economist explicitly describe the fact that a trade didn't happen because the cost of service was higher than its value, as a market failure.
I have. In fact, I blogged about it here. Sometimes economists get goofy when they think about information and monitoring, which is what Rosen did. But I don't think even Rosen would say that the "failure to dry clean" is a market failure.

Greg Jaxon writes:

@David Friedman: Your definition sounds good, do you have an example? I presume you're using the term "rational" just to mean the choice of outcome by individual or aggregate cost/benefit analysis. I suspect the "failure" is always one of collective actions not yielding what the plaintiff prefers. What's the example of it not yielding what any individual prefers?

Andrew writes:

@Greg Jaxon,

Wouldn't the most prominent example be the Prisoner's Dilemma?

Greg Jaxon writes:

The dilemma models a market with a severed communication link. It only amplifies an existing distortion (or failure), it doesn't define one - it only detects 'em.

I can sell both Prisoners a phone connection so they have the "Dial A Friend" lifeline and extract a profit from the market inefficiency inherent in the Prisoners' Dilemma.

Peter Calcagno writes:

I agree that the use of the term "most economists" was unfortunate, but I do not think that negates Ed larger point. Recently at a Liberty Fund conference Roberta Herzberg used the term "market model failure." I think is the point that Ed was trying to make that mainstream economists see markets that do not conform to the model of perfect competition and see inefficiencies if not "market failure."

David Friedman writes:

Greg:

My standard example is a pre-modern army running away and mostly getting slaughtered, when most of the soldiers would have survived if they had stood their ground--but each soldier is better off running, given what other soldiers are doing. It's a many person equivalent of the prisoner's dilemma.

I don't see the relevant of your "I can sell" point. How do you enforce the contract between the prisoners? What if they happen to be in a situation where communication isn't practical?

Rational ignorance is an example on the political market. Even if the cost and value of the information needed to vote for the better candidate is such that everyone is better off if everyone acquires the information and votes accordingly, each voter is worse off if he does so.

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