Market Failure vs. Government Failure

Too often, economic policy questions are characterized as an over-simplified debate over whether or not markets work.

On one side you have Chicago School Economists or “fresh water economists” (so called since, historically, they have tended to be located away from the coasts). These thinkers articulate the reasons why markets can be expected to work. 

On the other side are various market-failure theorists, sometimes called “salt water economists” or Keynesians (at least when they are talking about macro phenomena). These thinkers point out that, ahem, markets sometimes mess up big time.

But as Harold Demestz pointed out over 40 years ago, it is not enough to condemn market failure and call for some government intervention to correct the error. One also needs to analyze the government’s actions and see whether or not it is prone to failure. After all, if the government cure is worse than the initial disease, maybe we are better off with the disease. Yellow fever sounds pretty nasty, but that doesn’t mean Benjamin Rush was right to prescribe bloodletting.

This, in a nutshell, is the raison d’être of the public choice school of economics. Public choice economists have varying beliefs about the efficacy of markets. Some think markets work quite well most of the time, others take the idea of market failure seriously. But they don’t assume—as most Keynesians seem to—that government corrections will be flawlessly executed. Instead, they study the ways in which government intervention actually plays out. And more times than not, they find that real world policy is far less equitable, less efficient, and less just than the Keynesian model assumes. 

Oddly, even prominent Keynesians regularly observe and complain about government failure (Google Krugman and the Iraq War). Why, then, do they persist in counseling more intervention? Do they assume that, miraculously, this time will be different?

All of this was going through my mind when I read:

The federal government last year sent about 89,000 checks of $250 each to dead or incarcerated people through the Obama administration’s economic stimulus program, according to a watchdog report.