Economy
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How ‘Market Failure’ Arguments Lead to Misguided Policy

2/16/19
from CATO Institute,
1/22/19:

"Market failure” is a common justification for new government policies. Proponents of interventions love to point to instances of apparently imperfect markets and assume that government taxation, subsidies, and regulation can seamlessly perfect them, thus maximizing social welfare.

Academic economists have long doubted this way of thinking. Comparing market outcomes to some unattainable and unidentifiable ideal is not useful in a world of imperfect knowledge and government failure. It is far better to compare outcomes from an intervention against actual realistic alternatives. Yet public debate often seems stuck on this rudimentary understanding of what market failure is and how it should be dealt with. Worse, in many instances this basic framework of market failure is misused, leading to misguided policies. Government services, for example, are often labeled public goods even when they do not fulfill economists’ definition of public goods as being nonrivalrous and nonexcludable, and in situations where markets have clearly found means of delivery without government. This creates the public perception that some goods and services must be provided by government simply because they are or could be. Likewise, proponents of Pigouvian taxation to address negative externalities often exaggerate how high these taxes should be by including private costs (such as lost productivity) as external costs, failing to apply the logic of dealing with externalities consistently, and ignoring how taxes affect the demand for substitute products, which themselves can generate negative externalities. Externality arguments are also often used to justify uniform consumption taxes even when only certain consumption levels generate the external costs, and they are increasingly used to justify outright bans on various goods. Both responses can lower social welfare.

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