In a fiery, though somewhat stilted speech with long pauses for translation, Javier Milei delivered this final message to a cheering crowd at the Conservative Political Action Conference last week:
Don’t let socialism advance. Don’t endorse regulations. Don’t endorse the idea of market failure. Don’t allow the advance of the murderous agenda. And don’t let the siren calls of social justice woo you.
The reactions on econ twitter were unsurprisingly less positive than the CPAC crowd about calls to boycott market failure, one of the most well established facts in economics. James Medlock, for example, begs libertarians to get a step past econ 101.
The people cheering in the crowd and self-righteously quote tweeting on X are cheering for the wrong reasons. Medlock is correct that these credulous fans need to get a grip on the basics before they start denying established economic theories.
Milei, on the other hand, is an accomplished academic economist. Far from an infallible group, but we can be confident that he understands the concept of market failure well, and he’s right that we should treat it with suspicion.
What is the idea of market failure?
Market failures arise when a decision maker does not account for some costs or benefits that accrue to others. A West Virginia coal plant, for example, only considers the cost of fuel and electricity, not the cost of air pollution which accrues to people living in the surrounding mountain hollers.
In situations like this, West Virginians would be willing to pay coal mines to produce less and save them from the smog, but it is too costly to coordinate as a large group. These coordination frictions sully the conclusions of the fundamental theorems of welfare economics and drain value from the economy.
This is an uncontroversial example of the phenomenon of market failure, but the idea of market failure is more susceptible to motte-and-bailey strategies.
Here is the most common and easily defensible motte: Define “the idea of market failure” to be the claim that markets are not perfect; that there are > 0 market failures. This claim is true, and anyone who denies it plants themselves on the far left side of the mid-wit meme.
There are imperfections in every market and there are many markets with massive externalities. All the econ 101 examples are correct. Pollution, traffic, science and invention all impose costs and benefits that are difficult to trade onto people who are difficult to transact with. It is important to identify and understand these failures.
But when market failure is taught in econ classes or wielded in policy, the idea reclaims the bailey: markets are not perfect, therefore governments are capable of consistently improving them using taxes, subsidies, rules and regulations. The concept of market failure is never taught without using it to study and justify government intervention in markets, implicitly or explicitly defining the government as a “social welfare maximizer.”
It is this idea, that the imperfection of markets is easily improved by government intervention, that Milei is imploring us not to endorse.
Governments don’t automatically care about market failures
Lets return to our mountain town in West Virginia. We know there’s a market failure here: too much coal burning and too much of the smog it produces. On our econ homework we would call for a tax on coal producers to add the social cost of pollution into the coal plant’s optimization problem.
But look at West Virginia in the real world. They are full of coal plants pumping out ash without any extra tax bill. In fact, the coal industry in West Virginia is subsidized and protected by the state. All economists agree that coal plants have massive negative externalities that could be corrected with an optimal tax. Governments have lots of control over energy production and taxes, more than enough to implement this correction. Instead, they use their control to protect and expand the coal industry at deadly expense to many West Virginians.
This isn’t at all unique to West Virginia. The US doesn’t have a carbon tax. The German Green party shuts down its nuclear power plants in favor of coal. Environmental permitting regulations make it easier to frack for gas than geothermal and easier to set up offshore oil rigs than offshore wind farms. Europe and the US subsidize their fossil fuel industries.
It’s not unique to pollution or climate change either. Governments massively underfund research and development despite it being the world’s most important positive externality. Governments impose huge negative externalities across borders with tariffs and immigration restrictions. They also ignore the burden that debt places on future generations.
In general, governments are not social welfare maximizers. They are personal welfare maximizers, just like the firms involved in market failures. More accurately, they are large collections of personal welfare maximizers who are loosely aligned and constrained by lots of internal and external forces.
Some of these forces improve social welfare, like democracies expanding civil rights and avoiding famine. Others do just the opposite. Powerful lobbying by concentrated interest groups makes it profitable for legislators to spread out costs a few dollars at a time among millions of unaware voters while the benefits are concentrated a few million dollars at a time among highly motivated rent-seekers. Self-interested local governments tax or ban construction in their city as a massive negative-sum transfer from disenfranchised migrants to landholding voters. Internal bureaucratic career incentives at the FDA caused tens of thousands of deaths during the Covid-19 pandemic. Nationalism among voters and personal power seeking among leaders often makes war appealing to governments, though it is almost always negative for social welfare.
The morass of incentives and agents that make up government do not aggregate into a social welfare maximizer.
Governments are not reliable stewards of social welfare, so identifying imperfections in markets is not enough to consistently improve them. If we want governments to help us correct market failures, we need better ways to monitor, constrain, and incentivize the people inside to do so. This is the true challenge of market failure but the intellectual culture in economics too often obscures it. Once Milei’s fans (and detractors) get past econ 101, I am begging them to get started with public choice 101 before they start making policy recommendations that could easily make things worse, even in response to market failure.
Javier Milei is a politician and he is susceptible to incentives at least as much as anyone else. One of his incentives pulls towards sloganeering and shallow takes that spread quickly. “Don’t endorse the idea of market failure” can be easily interpreted as a shallow rejection of economics, which might be popular, but is false.
Still though, the automatic connection between identifying a market failure and justifying government intervention in response is worth arguing against. Governments have no inherent incentive to correct market failures and often have incentives to exacerbate them. We can and should work to improve these incentives but that can only happen after we acknowledge the serious failure of the current ones.
The argument of this post seems to be:
“There are problems with the results of markets, you say? Sure, but government probably won’t make things better, so we should just give up on improving the situation.”
That is dumb. Government actions change depending on the pressures on government, and they can be improved by popular awareness of issues. Saying “stop thinking about issue X” is never going to be a good strategy—not rhetorically, practically, or philosophically. What you can reasonably say is “problem Y is currently more important than X, so we should focus on pressure against Y for now”. That approach involves clearly elucidating problem Y, its causes, and what the effects of potential mitigations would be.
This doesn’t capture the argument. It’s more like “Empirically, when the government does things which are purported to solve these problems, it often actively makes things worse (not merely failing to improve them), to the point where the expected value of its intervention is negative; and I can point out some theoretical reasons to expect this to continue to happen. Therefore, it would be good if we had a general rule of ‘the government shall not attempt to do anything about this category of problem’, or at least a default of intense skepticism towards any such attempts.” In some cases we have such a rule enshrined in law; for example, the problem of deciding which religions are nice and benign and should be promoted, and which are bad and should be discouraged and possibly suppressed, is screened off from government intervention by the First Amendment.
It doesn’t suffice to say “We should deprioritize government attempts to fix X, because Y is more important”. That runs into “Oh, but here’s a ready-made proposal to fix X. And, in fact, the people are clamoring for it, so the cost in political capital is negative!”.
Is that not “giving up on improving” market failures?
There can be non-governmental actions to improve them, so, yes, it’s not the same. Also, the bigger problem was the fact that you summarized with the weaker statement “government probably won’t make things better” rather than the stronger statement “government will probably make things worse”; the former led you to the weak conclusion “Therefore we should focus on other stuff” rather than the strong conclusion “Therefore we should oppose permitting the government to touch this stuff”.
Non-governmental actions are either markets, which won’t solve market failures, or they’re non-market solutions, which are either governmental or pseudo-governmental with the same potential problems as government solutions. Or can you give an example of a solution to a true market failure that avoids the problems that government action has?
New technology, such as the internet and myriad apps based on hyperconnectivity, can enable market solutions to what were previously market failures. Innovation in legal structures (Dominant Assurance Contracts are an interesting recent idea; prediction markets seem to be expanding and carry some promise) can also enable market solutions (one could categorize this as contractual “technology”). Thus, one non-governmental path to improving a market failure is to try to develop a technology to fix it.
New technology could also create new market failures, eg by enabling new kinds of collusion or creating new externalities. You could see the RealPage suit or PFOA pollution for examples.
Is your proposal to selectively direct technological progress towards techs that solve market failures and away from techs that create them? How would you do this besides...government involvement?
No, I don’t think such a proposal needs to be made. Market failures that the market doesn’t subsequently correct aren’t a big enough problem that something “needs to be done” about them, especially given the risk that government intervention will make things worse.
I’ll note that, if there exists a positive-sum solution to a problem, then it could be done via a voluntary transaction (possibly involving transferring cash, to make it net positive for all parties), and therefore could in theory be done by the market. And the higher the net benefit, the stronger is the incentive of potential profit for someone to make it happen; transaction costs can get in the way, but only if they manage to exceed the net benefit. So these are theoretical reasons to expect market failures to either not be that bad, or to be corrected by the market after not too long.
So, we’re back to “giving up on improving” market failures, because you don’t think they’re actually a significant problem?
Anyway, most people disagree with you here. In the real world, you’re outvoted and will lose elections, and I guarantee the above argument won’t change most people’s minds.
This is probably true. Do you consider that evidence against the claim that the government’s purported solutions would make the problem worse?
Do you not count something as a market failure if the market subsequently corrects it? If so, does that mean anytime someone claims that a thing is a market failure, then I get to say “Prove that the market will never subsequently correct it, or else it doesn’t count”?
Yes, I’m defining “market failures” as things that more markets don’t solve, but macroeconomics and sociology aren’t fields where such things are mathematically proven. We have to go on empirical evidence, and my interpretation of the empirical evidence is that such market failures exist and are significant.
I googled a bit, and Investopedia gives some examples:
How confident can you really be that no one will come up with a market solution, especially as technology advances? As mentioned, the bigger the “failure” is, the bigger the incentive for someone to fix it. And if it stays unfixed, this raises another possibility:
In some cases, the failure, and/or the absence of a market solution to the failure, is caused by government intervention. This is amusingly true of the first example the article gives of a government solution:
That’s where the problem is obviously directly caused by the intervention, and the proffered solution is to reduce the intervention. But it can be less direct, and possibly be a contributor while not necessarily being the entire cause. I would say that, in any scenario where a particular market is dominated by one or a few big companies that are all misbehaving in the same way [for example, by charging above-market prices or mistreating customers in a way not justified by reduced costs], then the ideal market solution would be “I create a new company that behaves better, and makes better profits by doing so”, and then any and all governmental barriers to entry are contributing to the problem. (And any grant of monopoly obviously 100% prevents this solution.)
I would say that, for any apparent “market failure”, the contribution to it of government interventions is usually not zero, and I suspect that, the bigger and longer-term the “failure”, the larger that contribution tends to be. (Again, because bigger failures mean bigger incentives for the market to fix it.) So any analysis of a “market failure” should specifically investigate how much it is caused by government intervention.
Governments don’t care about anything, the people in governments do.
And the USG is large enough that quite literally every second of the day there’s likely at least 1 person who cares intensely about ‘market failures’, likely even far more than you do in writing this. (And conversely at least 1 person that couldn’t care less.)
But this group is not static, it’s constantly fluctuating depending on the actual people in the USG, their positions, expectations, experiences, resources, opportunities, etc...
So the thrust of your post doesn’t quite make sense, since your opinion will literally always be outweighed, at least on a yearly basis, by virtue of the fact that this constantly fluctuating group will inevitably include people with real authority over time.
Can you write down an actual argument, step by step, that can persuade someone with real authority that it’s a net positive/net negative?
Just because the US government contains agents that care about market failures, does not mean that it can be accurately modeled as itself being agentic and caring about market failures.
The more detailed argument would be public choice theory 101, about how the incentives that people in various parts of the government are faced with may or may not encourage market-failure-correcting behavior.
I agree, just the fact that it contains such does not necessarily imply anything for or against. e.g. It’s entirely possible for two or more far flung branches of the USG to work towards opposite ends and end up entirely negating each another.
Can you lay out this argument with more detail?
To lay out some of the foundation of public choice theory:
We can model the members of an organization (such as the government) as being subject to the dynamics of natural selection. In particular, in a democracy elected officials are subject to selection whereby those who are better at getting votes can displace those who are worse at it, through elections.
This creates a selection dynamic where over time the elected officials will become better at vote-gathering, whether through conscious or unconscious adaptation by the officials to their circumstances, or simply through those who are naturally better at vote-gathering replacing those worse at it.
This is certainly not a bad thing per se. After all, coupling elected officials’ success to what the electorate wants is one of the major purposes of democracy, but “what gets votes” is not identical to “what’s good for the electorate”, and Goodhart’s law can bite us through that gap.
One of the classic examples of this is “doling out pork”, where concentrated benefits (such as construction contracts) can be distributed to a favored sub-group (thus ensuring their loyalty in upcoming elections) while the loss in efficiency from that favoritism is only indirectly and diffusely suffered by the rest of the electorate (making it much less likely that any of them get outraged about it enough to not vote for the pork-doler).
The application of this to market failures is that you can look at a market under government regulation as two systems (the market and the government), each with different incentives that imperfectly bind their constituent actors to the public good. The market generally encourages positive-sum trades to happen, but has various imperfections, especially regarding externalities and transaction costs, and the government generally encourages laws/regulations that benefit the public, but has its own imperfections, such as pork-doling and encouraging actions which look better to the public than their actual results would merit.
The result of this is that it is not necessarily clear whether whether changing how much influence market vs government dynamics have on a specific domain will improve it or not. Moving something to more government control may fix market failures, or it may just encourage good-looking-but-ineffective political posturing, and moving something to the market may cut down on corruption, or may just hit you with a bunch of not-properly-accounted-for externalities.
In the particular case of “government action to solve market failures”, the incentives may be against the government actors solving them, as in the case of the coal industry providing a loyal voting bloc, thereby encouraging coal subsidies that make the externality problem worse.
Therefore, my presentation of the market-failure-idea-skeptic’s position would be something like “we should be wary of moving the locus of control in such-and-such domains away from the market toward the government, because we expect that likely the situation will be made worse by doing so, whether due to government action exacerbating existing market failures more than it solves them, or due to other public-choice problems arising”.
Thanks, you’ve listed some plausible downsides, but the upsides also need to be enumerated too, and then likely several stages of synthesis to arrive at a final, persuasive, argument, one way or the other. I’m not saying you have to do all this work, just that someone does in order to advance the argument.
So far I’ve never seen such, anywhere online.
This post reads as a call to action (or inaction), but it’s not clear what you’re saying people should do. Can you be more explicit about that?
My guess is this is a defense of someone being mocked on twitter, and so we aren’t really getting (or care about) the context.
I think the term “Market Failure” describes an interesting phenomenon and there should be some term that describes situations where negative externalities are being generated, there is suboptimal production of a social good, etc. At the same time, it is easy to see how “market failure” easily gives laypeople additional connotations.
Specifically, I agree that this phenomenon generalizes beyond what most people think of as “markets” (i.e. private firms doing business). I can see where this would bias most peoples’ hasty analysis away from potential free-market solutions and towards that status quo or cognitively-simple solutions (“we just ought to pass a law! Lets form a new agency to enforce stricter regulations!”) without also taking the time to weigh the costs of those government interventions.
In some spaces, there are private self regulatory organizations, consumer watchdogs, civil liability, and licensing firms that can align firms closer towards socially optimal outcomes while having a greater incentive than the government to pay attention to the costs of those “regulations.” But otherwise there’s not really a market for law and regulation itself within the borders of any one country.
In short, I fear many people perceive the words “market failure” as a local condemnation of capitalism and free markets when perhaps the better solution to these “market failures” is making more market in the form of a more responsive and accountable ecosystem of firms performing the currently monopolistic regulatory function of government.
It’s important to distinguish hoaxes and scams. Hoaxes are about whether or not something is true: in this case, do whatever you normally do for determining truth. Scams are something to do (usually taking your money): they can be just as bad whether or not the problem they purport to solve is real; reject these.
The problem is that the same term often gets used for both.