11.6: Why Public Policy? The Market and Market Failure
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You might be wondering why governments are involved in any of the policies listed above? What justifies the system of, say, public education or Medicaid? Why does a government build and maintain streets, roads, bridges, and highways? This section will attempt to answer that question. It will begin with a discussion of what economists call the marketplace, the relationship between supply and demand, the difference between public goods and private goods, and how each impacts the desire of people to make money. After coming to an understanding of the benefits of an efficient marketplace, the concept of market failure, will be explored and how political pressures can be placed on governments to provide cures for it.
The market is a place where individuals can exchange goods and services. In the abstract, it describes the totality of the relationships that exist that allow for those who supply goods and services to connect with those who demand them, what is referred to in economic terms as supply and demand. At its simplest, the national government is set up to allow for the development and maintenance of a national market. States and local governments do the same. The previous discussion of infrastructure development illustrates part of what is necessary to allow market transactions to occur, providing the communications and transportation systems necessary to allow a market to develop and flourish. Other relevant actions on the national level include coining money and providing bankruptcy protection, a post office, patent and copyright protection, security, and a court system that allows for business disputes to be reconciled.
Ideally, these allow for buyers and sellers to meet and efficiently bargain over whatever items are at issue. Amounts to be purchased can be determined, as well as the prices of those items. The term efficient is important since it means that the bargain is fair to both sides of the transaction. The suppliers will be able to cover their costs of production, and the demanders will not pay too much for the product, and the product will meet at least a minimum level of quality. Other conditions should also exist. Production will not negatively affect those not involved in the transaction, and those who demand items have a reasonable certainty that their demands will be met. Someone will almost certainly exist that will want to profit by filling that demand.
But efficient markets do not always exist, and certain goods and services are difficult to provide in the standard marketplace. The term market failure has developed in order to describe areas where markets are not able to perform as intended. These are also areas where political pressures emerge compelling a government to become involved in a market transaction. There are four distinct types of market failure: public goods; monopolies; uneven information; and negative and positive externalities.
Public Goods The marketplace, if run ideally, allows for all needs to be efficiently met. Demand for products and services is supplied by private individuals because they receive information about what people want. People choose to provide those products and services because they can profit from doing so. There is a direct connection between the good or service provided and the compensation for the good or service. If a person does not pay for the good or service, that person does not receive it. If they are unable or unwilling to pay for the service, they will not have receive it. This leads to a problem at the root of the private sector: the assumption that if there is a demand for a certain product, someone will supply the good or service that meets the demand. That is not always the case. This is the problem with what are called public goods.
These includes things like public safety, paved streets, sewage systems, outdoor lighting, and anything else that meets a demand by the general public, but there is little incentive for a private person or organization to provide these because of the difficulty of making people pay for them.
Monopolies A monopoly exists when only one producer exists for a good or service. This means that there is no competition for it, which prevents people from being able to select similar goods and services from different producers based on costs, quality, or any other factor they choose. Without choices, costs can increase, and quality can suffer. The national government—with authorization in the Interstate Commerce Clause—specifically focuses on this by making monopolies illegal, and also being able to prevent a merger from happening if it will create a monopoly. The Texas Constitution also contains language in its Bill of Rights—Article 1, Section 26—prohibiting them: “monopolies are contrary to the genius of a free government, and shall never be allowed.”70
There are certain goods and services, however, that don’t lend themselves to competition. For example, while there is competition in the state of Texas for energy production, and consumer choice exists for oil and gas, wind, nuclear, and solar energy, there is no competition for the transmission of electricity. There is one electric grid in the state, and it is operated by ERCOT under the governance of the Texas Public Utility Commission as well as the Texas legislature.
The reason is sensible. There is little chance that competition could exist in transmitting electricity. In order to ensure that prices and quality do not suffer, the grid is regulated. As of this writing investigations into the shutdown in February 2021, and the spike in pricing, are ongoing (Figure 11.9). Some of the services provided by local governments, like providing sewage for raw waste, are also examples. These are called natural monopolies.
Technological change can disrupt natural monopolies. This is what happened with electric service in Texas. At one point it seemed impossible for there to be competition in telephone communications nationally. There seemed no sense in stringing up multiple wires in order to allow it. But technological development not only allowed for various signals to be sent over the same wires, it also allowed for the development of cell phones. Wireless communication opened up a range of ways to communicate.
Uneven Information The phrase buyer beware reminds us that the producer of a good knows more about it that the consumer. This includes its true values and costs, as well as any problems associated with it. Think about what a person has to go through when that person considers whether to purchase a used car. What does that person really know about what the car has gone through? The owner would, but the owner might also has an incentive to lie about it. Doing so, however, is illegal. There are several areas where uneven information affects citizens. Here are a few:
- Lemon Laws: In 2001, the Texas legislature passed legislation detailing the rights of vehicle owners, which included the right to have a replacement vehicle if they purchased one that proved to be defective71;
- Consumer Protection Laws: In 1967, the Texas legislature passed the Deceptive Trade Practice Act which made it a criminal offence to tamper with state seals on commercial items, and to engage in any deceptive advertising. This includes misrepresenting a business as “going-out-of-business”72;
- The Veggie Libel Law: In 1995, the Texas legislature passed a civil statute called the False Disparagement of Food Products Act. It made critical comments about food products subject to a lawsuit. The act became well known in 1998 when it was the basis for a lawsuit filed a Texas beef feedlot operator against Oprah Winfrey. Winfrey won the case, but stopped speaking on the issue of food safety.73
Externalities –Negative and Positive Part of the efficiency promise in a market system is that all of the costs associated with the production of a good is absorbed by the consumer. But the producer has an incentive to reduce costs by putting them elsewhere. That is what is meant by the term externality. The classic example of a negative externality is pollution. Generally, pollution is created when a manufacturer fails to clean up the by-products associated with production. These can find their way into the land, air, and water, which imposes costs on people external to the economic transaction. Regulations in general, but environmental regulations specifically, are justified economically by the requirement that these costs be made part of the transaction between producer and consumer and not imposed on external parties. One example is the environmental fee often charged when you get your oil changed. The purpose is to pay for the costs associated with the safe disposal of the used oil. The most convenient way to dispose of it would be to dump it in an alley, or down a drain, but this creates costs down the line.
Economic impacts on external actors need not only be negative. Positive externalities can occur if a government encourages, with tax abatements and subsidies, for example, activity beneficial to a community. If an individual is encouraged to purchase a house that is falling apart, and repair it, their activity might result in an increase in property values. Neighbors may be able to sell their homes at higher prices than they would have been able to previously. They profited from an activity that they had no involvement with.
70. Tex. Const. art. I, § 26, https://statutes.capitol.texas.gov/D...N/htm/CN.1.htm.
71. Tex. Statutes. Title 14. Chapter 2301. Subchapter M. Section 2301.601, https://statutes.capitol.texas.gov/D.../OC.2301.htm#M.
72. Tex. Statutes. Title 2. Chapter 17. Subchapter A. Section 17.01, https://statutes.capitol.texas.gov/D.../htm/BC.17.htm.
73. Aman Betheja, “The time Oprah Winfrey beefed with the Texas cattle industry,” Texas Tribune, Jan 10, 2018, Texas beef feedlot operator against Oprah Winfrey. Winfrey won the case, but stopped speaking on the issue of food safety.