Empirical question?

"Market failure precedes regulation." Pithy way to put it by JM Roth. True? Seems likely to me and since it appears to be a matter of fact, it would a useful way to forward this discussion as it gives us something firm upon which to base our opinions.

The only proviso I have is that zoning emerged as a way to systematize and apply broadly the results of many discrete nuisance law cases as much as from market failure i.e. the courts were analternative but it appeared more efficient to zone an area for so that the sresult which would come after a court case could be applied before there was a problem. That's my understanding, anyway.

But in general, it seems like a pretty plausible theory. In fact, by way of exception, can anyone think of a regulatory regime which has developed in the absenece of market failure. (Of course I imagine we can now push back the matter and debate where and when there is indeed "market failure.")

Comments

[Aaron Armitage]

"Of course I imagine we can now push back the matter and debate where and when there is indeed 'market failure.'"

And behind that, the question of how you're defining "market failure". What would be a core, inarguable example and why?

[back40]

Regulations are as often imposed for political objectives as any other. As Aaron notes, 'market failure' is in the eye of the beholder. Among political motivations for market interventions we find political revenue raising objectives, cronyism, vote buying and for the last several decades 'regulatory failure', the never ending pursuit of new regulations to overcome social and economic damage done by prior regulations. The all purpose term 'market failure' is code for 'we want to do it and we have the power'. Unpacking the concept and considering causes closer to the root of the issue is useful.

[JRoth]

If you return to the original post in question (maybe an internal link back, Mr. Sucher?), you'll see the concrete examples that I gave of market failure: dead citizens.

Perhaps back40 can explain to us all how preventing dead citizens constitutes "political revenue raising objectives, cronyism, vote buying." Me, I think of it as the purpose of government.

I'm not defending every regulation in particular, nor do I think that every regulatory regime traces back to a market failure as egregious as deadly meat, drugs, or buildings. But my fundamental point, and I'm glad of David's appreciation for it, is that regulations don't arise ex nihilo. We live in a democratic society, and government generally responds to the wants and nees of the people. Those responses can be inappropriate and even unfair, but the all-too-common belief among libertarian types is that the 'real' explanation for regulation is "'we want to do it and we have the power.'" That's simply not honest or realistic, and ascribing cynical motives to others isn't the same as being realistic - it's just bitter.

[praktike]

Let's be clear about what market failure is and isn't. It's still quite possible for markets to function efficiently and have people die of, say, disease from living next to a power plant.

The question is how you value things like a human life. It may sound callous, but it's necessary if you want to really understand whether, say, a local zoning ordinance is worth doing.

[back40]

JR your recourse to death and the L word to justify sloppy thinking doesn't help. Democracies use regulatory powers to achieve whatever objectives they choose for whatever reasons they have. A well regulated society must expose regulatory abuses as well as incompetence, must understand that system interventions are always risky and have no hope of positive outcomes when based on deceit and narrow interests.

It is naive to think that there is a political solution to every problem. It is naive to think that political solutions aren't also problems. Having a mature view of regulatory systems - what they can do, what they can't do, good frameworks and bad ones, and the price we pay - helps us become well regulated rather than merely highly regulated.

[JRoth]

I'm sorry, I can't help but notice that both praktike (in contrast to his/her nom) and back40 seem desperate to avert their eyes from the concrete evidence I've given.

Back40: is it sloppy thinking to say that, when inadequate regulation of the market-driven building market in Boston the early 1940s led to hundreds of deaths, the response was increased fire codes? Because, please, make the argument, if you can, that modern fire codes had nothing to do with hundreds of deaths at the Cocoanut Grove, and everything to do with "regulatory abuse."

Praktike: of course the actuarial value of human life needs to be part of the logic of regulation. The problem with this concept is twofold: the public that directs regulators is rarely willing to say, "that person's life is not worth a safety regulation;" conversely, the private industries that incidentally kill people rarely face the actuarial cost of their negligence - even in a regulated society. The NYTimes' recent expose on OSHA (in)action against companies that violate the law, resulting in workplace deaths, illustrates this point quite nicely. Industry is all too happy to make the calculation of what the loss of human life is worth, and all too often that calculated value is, in fact, far below where even informed citizens would place it.

I want to clarify my point again, since it seems to be being glossed over: I don't think that, because regulatory regimes arise in response to market failures, every regulation is unimpeachable. I never said it was, and your (pl.) objections seem to hinge on the idea that I did. Furthermore, the L word, I can only assume, is libertarianism, and, again, I raised in direct response to comments in the original thread. It's not sloppy thinking, it's a response to people making clearly libertarian statements.

Finally, I will concede a sense in which I have used sloppy thinking, in that "market failure" is a term of art in economics, and one that does not entirely coincide with "dead citizens." However, I stand by my insistence that, if you walk around saying, "the free market will kill lots of innocent citizens as a matter of course," then most citizens will identify that as a sign of market failure.

Actually, I would probably argue that, because of the way humans judge probability and risk, this subject does constitute a classical market failure. Example: unregulated, industrialized meat production. In an unfettered free market, some people will be willing to eat meat that is so inexpensive that it can only be sold so cheaply through unhealthy production - bad meat, sawdust, rat droppings, what have you. Arguably, this is the market properly in action, and regulation will surely result in some people who want meat being unable to afford it. But, of course, Armour didn't sell meat labeled, "Likely to Kill You Brand," perhaps with a happy cartoon e. coli mascot. People who bought Armour's deadly meat products reasonably assumed that Armour wouldn't want to kill its customers, but, in fact, Armour was OK with some calculated number of consumer deaths. Asymmetrical information, you could call it. Classic market failure.

[David Sucher]

I'd be curious to hear of a regulatory regime which (in at least someone's opinion) did not come about because of a "market failure."

[back40]

Every economy has a regulatory regime whether it is a market economy or not. Regulation is a human behavior that needs no cause, desire is sufficient. Regulation has excuses more often than reasons.

Recognizing this helps us develop effective regulatory mechanisms. The impulse to regulate can be better resisted when inappropriate and better formulated when proper.

[Stirling Newberry]

I'd be curious to hear of a regulatory regime which (in at least someone's opinion) did not come about because of a "market failure."

The medieval period had excess of market regulation - including sumptuary laws - which don't correlate to any "marketplace" failure.

In the modern period, regulatory regimes associated with mercantilist economies again preceded market failure - such as Britain's currency laws. In many cases, bad regulations, designed to profit those in charge, often preceded, rather than followed market failure - and arguably in some cases caused market failure. Perhaps the most obvious of these is restrictions on slave importation in the United States and regulation of the slave trade in general. There had been no "market failure" driving these, instead they were designed to constrict supply for the benefit of those who owned slaves, and to protect that supply.

However, human beings being what they are, removal regulation also creates failure - as the ending of the Bank of the United States set off a wave of currency crisis in the US that was to culminate in the Civil War.

Summary - regulation has a variety of ends - some positive, some negative - and cannot be covered by a blanket ideology.

[Aaron Armitage]

In the first place, I still see no serious definition of market failure. Someone proposed that it's a market failure when citizens die. Um, yeah. So we still lack a definition.

In the second place, the motive for creating a regulation has very little to do with the case for that regulation. A person or government can get involved with things that are none of its business from noble motives. Regulations could "work" in some sense while being worse than potential alternatives. And something which once made sense may no longer do so.

[Kevin Brancato]

I'd be curious to hear of a regulatory regime which (in at least someone's opinion) did not come about because of a "market failure."

How about these?:

1) Taxi-cab medallions
2) Cartelization of Airline Industry under CAB
3) ICC control of Trucking as common carriers
4) Blue laws
5) Sugar Price Supports (Almost the entire agricultural regulatory apparatus, actually)
6) Monopolization of the Postal Service
7) The breakup of Standard Oil (for the crime of charging continally lower prices while increasing output dramatically)

In none of these markets were public goods an issue, nor were negative externalities. In none of these industries were prices too high or supply limited. In none of these industries were people getting killed more before than after regulation.

The economic theory of regulation (as developed by George Stigler and others) states that economic regulation is a good supplied by government actors to private parties who desire it.

Those private parties might want it to correct for market failures, or they might want it to hit competitors over the head, or they might seek to profit from regulations themselves. It's a very complex matter, but there is no reason, apriori, to believe that the "public interest" folks overpower the other demanders.

[JRoth]

I'll get to Kevin's productive post in a moment, but first:

As I said, "market failure" is a term of art in economics:

market failure: A condition in which a market does not efficiently allocate resources to achieve the greatest possible consumer satisfaction. The four main market failures are--(1) public good, (2) market control, (3) externality, and (4) imperfect information. In each case, a market acting without any government imposed direction, does not direct an efficient amount of our resources into the production, distribution, or consumption of the good. [from http://www.amosweb.com/cgi-bin/gls.pl]

I'd say that if I went out for a nice night of dinner and dancing, then died in a fire resulting from unregulated construction, then my consumer satisfaction was not at the greatest possible point. Maybe that's just me.

To expand upon that, my point is that the default presumption among a lot of people who oppose regulations is that they are inefficient, and that the free market would take care of whatever the problem is on its own. When Alan Greenspan was an Objectivist (and I pray to God that that is, indeed, a past tense thing), he actually argued that building codes are unnecessary, because the free market (invisible hand, whatever) will lead to uniformly well-built buildings. This is laughably absurd, and I think that the Cocoanut Grove fire illustrates quite well the flaws in this line of reasoning. To spell it out: market fundamentalists insist that regulations, such as building codes, are inefficient, in the sense that the unfettered free market will more efficiently allocate the necessary resources to provide for safe buildings. They have been proven wrong - the market failed.

Now if we can please stop arguing over terms and get to the real discussion....

[JRoth]

Now, another definition of terms: when I referenced "regulations", I had no intention of meaning "all laws affecting commerce," which some of the above examples seem to be. For instance, anti-regulatory Republicans, as a pretty consistent rule, are not objecting to blue laws (much less medieval church law).

At this moment, I don't have a pithy summary of what regulations I mean, but I think that the usage I intend is the common one, and, again, not one relating to morality laws or subsidy. Any government action inherently includes regulations to direct the government agencies involved, but that doesn't mean every government action is regulatory.

Seeing as how the USPS was conceived as a fundamental function of the federal gov't by the Founders, I have trouble seeing it as a regulatory agency, any more than I do the Army (which arrogates to itself the exclusive role of protecting the nation's borders, an activity that clearly could be better done by the free market).

Getting to some other examples:
The myth of SO being broken up as some sort of punishment for good free market behavior is historical and economic nonsense. First, the history: the "raising supply while lowering price" shibboleth refers to kerosene in the era of gasoline cars and electric lighting - kerosene was no longer a critical resource at that time. WRT gasoline, Rockefeller's monopoly was used in exactly the way it should: to ensure market dominance without regard for consumer benefits. Which gets to the economic point: monopolies are often given as a prime example of creators of market failure, so how can you argue that regulating a monopolistic condition is not a response to a market failure? More savvy defenders of monopolies like to argue that they are always temporary, rendering their regulation redundant.

My impression of trucking regulation is that it began as a response to safety concerns regarding a conveyance of interstate commerce; your reference to "common carrier" status may mean that you are referring to something else, but as I said above, I don't claim that every extension of regulation is right or driven by market failure. A very logical and reasonable regulation of truckers (who would have every market incentive to minimize safety, seeking to register in the states with weakest inspections - a nice analogy to corporations in Del., BTW) may well have led to other, bad regulations that are driven by base motives.

Your other examples also seem to be bad regulatory response to reasonable regulatory needs: making sure that taxis and airplanes are safe. But these have probably spun far out of control.

Last time: Some regulations are Bad, and many derive from backroom dealings that wouldn't survive the light of day. But the campaign to delegitimize regulations as a whole, by suggesting that the very origins of the regulatory state are nefarious, is just as damaging to the process as claims that every act of gov't is wrapped in a holy glow of nobility.

One comment about the noble or base origins of regulation: the landmark Pure Food and Drug Act was inspired by (what else?) citizen deaths, but was also strongly pushed by HJ Heinz for his own company's benefit. It seems that the promise of pure food embodied in Heinz's clear jars (when competitors used disguising brown) was insufficient to drive impure horseradish from the market. So Heinz encouraged Congress to regulate food, but not in isolation from public support for reform. The two worked hand in hand to effect what those of us who don't die from salmonella and botulism largely appreciate.

[Kevin Brancato]

JRoth--

The myth of SO being broken up as some sort of punishment for good free market behavior is historical and economic nonsense. First, the history: the "raising supply while lowering price" shibboleth refers to kerosene in the era of gasoline cars and electric lighting - kerosene was no longer a critical resource at that time. WRT gasoline, Rockefeller's monopoly was used in exactly the way it should: to ensure market dominance without regard for consumer benefits. Which gets to the economic point: monopolies are often given as a prime example of creators of market failure, so how can you argue that regulating a monopolistic condition is not a response to a market failure? More savvy defenders of monopolies like to argue that they are always temporary, rendering their regulation redundant.

SO was a monopoly, but monopolies are not de facto inefficient or harmful to consumer welfare--especially when a monopoly is the low cost producer, in an expanding market, with vigorous new entry. There is no reason to assume that this type of monopoly looks anything like the price at MC=MR monster in the literature.

In the literature, bad monopolies raise price and restrict output. We cannot argue that since SO was a monopoly, it was therefore bad; to be bad, it must have actually done something to harm consumers.

I think it didn't. But, since I disagree with you about the facts of history, I would ask you to please give an academic or historical reference for the following points about SO.

SO harmed consumers
SO restricted the supply of kerosene or gasoline.
SO raised the price of kerosene or gasoline.

I will look up the record when I get my hands on it, but I don't think it supports the consumer harm theory.

[David Sucher]

Perhaps I mis-remember my law school class in antitrust, but I believe that consumer welfare is only a johnny-come-lately criterion when it comes to monopoly. (I believe it started with Bork as a make-weight to justify monopoly.)

Not only monopoly but conspiracy to monopolize is such a threat to a free market that the conspiracy itself was made illegal by the Sherman Antitrust Act of 1890. To show a crime, there was no need to demonstrate harm to the public; conspiracy to monoplize was a crime by itself.

So whether SO helped consumers is not germane.

Monopoly (and conspiracy to form a monopoly) is a crime because it distorts the free flow of information -- the central nervous system of capitalism -- and consequently, corrodes faith in free markets etc etc.

[praktike]

JRoth, sorry to confuse matters and turn the discussion away from your point.

I'm no slave to cost/benefit analysis--the room for bias and manipulation is too great for C/B to be taken as definitive by any sense.

I was merely trying to make the point that depending on your assumptions, you might or might not conclude that "market failure" exists. Measuring externalities is tough in the real world.

But one's sense of justice comes into play wrt regulation as well. Surely a utilitarian viewpoint has fatal flaws.

For instance:

Behind Rawls' veil of ignorance, what kind of zoning regulations would you want places to have? If you didn't know whether you'd grow up near a slaughterhouse, for instance, you might think that the appropriate zoning would prohibit such noxious uses near residential areas.

[Stirling Newberry]

"In the first place, I still see no serious definition of market failure."

Market failure can be defined as a signficant variation from supply/demand equilibrium, or the externalization of risk which produces a non-Hetroskedastic catastrophic event which is not reflected in price.

In otherwords, markets fail when the definition of a functioning market, first ennunciated by Adam Smith - and variously refined over time - ceases to function - or when a cost that should be priced into the supply/demand equation isn't, and that unpriced factor causes a irreversible event.

[Kevin Brancato]

So whether SO helped consumers is not germane.

Under the law, yes. But then the law is not concerned with the outcomes of market failure. The law assumes firms are guilty, simply because of their structure or market share, etc.
Markets can fail for many reasons, but the outcomes of market failure are prices or outputs that are too high or too low.

Monopoly (and conspiracy to form a monopoly) is a crime because it distorts the free flow of information -- the central nervous system of capitalism -- and consequently, corrodes faith in free markets etc etc.

I don't know what, specifically, you mean by "information".

IMHO, there is greater information flow out of a public company that is a monopoly than a privately held firm in a competitive market, but I don't think you mean to imply all firms should be public.

The efficient functioning of a firm is a complex matter, and most information internal to the firm is not relevant to those who want to trade with it. Trading partners look at the observable parameters--prices and outputs.

In fact, what type of information makes capitalism work? For the free-market to work, prices must not only free to flow, they must accurately reflect opportunity cost.

There is no evidence that the prices charged by SO distorted the market in any way.

[Aaron Armitage]

"I'd say that if I went out for a nice night of dinner and dancing, then died in a fire resulting from unregulated construction, then my consumer satisfaction was not at the greatest possible point."

And if the construction was regulated but the building burned down anyway, you'd be in the land of bliss?

Everyone dies. If you make citizens dying the justification for regulation, there can never be enough regulation in any possible world. Which is probably the point.