A classic example of a market failure is pollution. Pollution is an negative externality — a negative result of the manufacturing process that is borne by society at large, not just by the manufacturer. Although manufacturers produce pollution, they aren’t the only ones to pay for it. Manufacturers actually have an incentive to pollute if they can make their products more cheaply, because they don’t bear the costs of higher pollution. The solution is simple: The market needs to be tweaked so manufacturers pay the cost of pollution. Once the costs are passed along to manufacturers, they suddenly have an incentive to minimize the costs imposed on the public.
Cap and trade is a popular method for dealing with the problem of externalities. The advantage of this method is that it still allows the market to function — it simply turns pollution from an externality into a natural component of the free market. We’ve used cap and trade before in the United States, in fact, to reduce sulfur dioxide emissions which lead to acid rain. The Environmental Defense Fund has some charts that show just how well cap and trade has worked for SO2 emissions, such as the chart to the right.
Market failures can weaken our economy; they can also cost the public billions of dollars in the case of externalities like pollution. Right now, Americans are working to remake our economy in the wake of a major recession; we’re moving towards a green economy in which the United States once again manufactures things. It only makes sense that one component of that change should be reducing the externalities in our market and bringing the costs of carbon pollution into the marketplace.
Free market proponents will always say that companies will pay the cost of pollution through public image. If a manufacturer is exposed as a big polluter, people will rise up in some moral revolt and boycott their productions and/or go to the competition….there are countless flaws about how that works out in reality, number one is that companies will focus on image campaigns rather than fixing pollution to solve the issue.
Wow. That’s a pretty chart. Are you getting grad school credits for this?
“The advantage of this method is that it still allows the market to function — it simply turns pollution from an externality into a natural component of the free market.”
I was talking to my friend the other day and he said the same thing! Perhaps you should go join the wonks at MN progressive project.
I think you are setting up a straw man in order to fit your conclusion. A Reagan conservative, or at least a believer in free and open markets does not believe “the free market is the solution to everything — that the market is a benevolent force that always does good”. Not being a believer in them yourself I don’t fault you for not knowing this but believers in the free market believe that the free market is neither good, nor bad and can therefor do neither good nor bad. The market is simply the most fair and rational arbiter of outcomes because it is a forum that allows people to vote with their feet as well as their dollars.
Obviously to one that does not believe that people should be free to vote with their feet or their dollars the free market represents a consumate evil. For example, in a free market, money would likely not be lent to individuals with little to no hope of paying it back so that they could purchase homes that they had little to no hope of maintaining. That is, a free market would not almost universally engage in extremely high risk behaviour without some tacit guarantee on their initial investment. Guess what Fannie and Freddie offered lenders of subprime loans? Certainly the laws of supply and demand increased housing values dramatically but the demand that drove those prices was fed by well intentioned regulators that encouraged easy money through the use of GSE purchase policies.
Frankly the term “market failure” is one of the most misused in recent history. It isn’t a market failure when an unsustainable practice collapses of its own weight but rather an institutional or systemic failure. Blaming the free market for failures like the housing crises is a bit like blaming gravity for the bird crap on your head in that it completely excuses the bird’s role in the event. For this reason it should come as no surprise that the people that talk about “market failures” are often the ones that advocate policies that could never succeed in a free market.
Thanks for the Fox News explanation of the housing market crisis. Unfortunately, its a total lie. While its convenient for conservatives to blame programs that enouraged low income lending, those are only a very small part of the problem. This was truly a failure of the free market, that resulted directly from decisions that freed up this market.
Yes, I hear this repeated quite often but rather than claiming that I’ve given “the fox news” answer, why don’t you explain why banks and investment firms thought that mortgage backed securities were safe investments. I’ve just stated that wall street thought they were safe investments because GSE’s like fannie and freddie were behind them.
I’m sure you haven’t thought much beyond your fox news dig but if you have, please try to explain to us what needed regulation if not the excess reliance on mortgage backed securitiies and credit default swaps? Then, if you can keep that thought in your head, take a moment to ponder what made the excess reliance on said securities and CDS’s a risk that needed curbing? Was it because “the market failed” or was it that more loans were made than could be paid off and niether the lender of last resort nor the insurance company could cover the debt?
I repeat, the housing crises WAS NOT a market a market failure, it was a policy failure. The market did exactly what markets do by correctly determining value. The same will happen with carbon trading too but here we go again trying to make nothing worth something. I’m sure when the carbon trading market collapses “market failure” will be blamed for that too.
Joey has come the closest to understanding this when he says: “Free market by definition needs regulations to remain a free market(see monopolies, oligopolies, etc..)”
I would only add that the regulations the markets require are not ON the markets at all, but rather are on individuals and institutions to keep them from interfering in the markets.
Jeff,
Did you read this blog before joining it? I am just curious if you think your tone fits this blog at all? You are a gifted writer who I can tell has spent a few hours in a public policy classroom. My question still has to go back to, “do you have any clue what this blog used to be about?” I agree with Don Johnson in that your pieces seem more fitting for MN Progressive Project or another academic blog, but as a reader I get really frustrated having to sift through your 3 policy pieces each day to find something interesting. Really it is like reading a grad paper synopsis every day. You have made it so that loyal readers who used to hang on every new post from MNPublius now have to sift through countless dry posts in order to find a post that somewhat resembles the true tone of this blog.
I don’t want to appear to be the illiterate who can’t handle a little public policy discussion, but my point is that’s not what people come to this blog for.
I also wonder what this is doing to the other bloggers on the site. Are they now tentative to write a post in fear that it will be drowned out by your 3 daily posts on cap and trade, mortgage rates, or Market Failures? I know it’s the off year, but a good writer crafts to the tone of the venue they are provided. Are you going to write on the Franken SC decision or are you going to drown them out on that news day with three more dry pieces that even public policy school students find boring?
You are a great writer. People (including my self) would follow you at MN Progressive Project or another venue. You just don’t fit the tone here. As George Costanza would say “It’s not you, it’s us.” We like MNPublius to be our quick snarky, gossipy blather Minnesota political blog; not a grad school synopsis proof reading site.
I hope people will post other similar replies but I have a feeling they have stopped reading these dry posts and can’t imagine them clicking on the comments box for more info on an article they didn’t come to this blog for in the first place.
Thoughts?
Sorry to disagree, but I find the wonky posts a nice relief from hyper-partisan sniping.
I prefer the informative posts and thoughtful comments to the namecalling that was often found here awhile ago. It seems to me the blog has room for more than one type of post,and that Jeff seems to be the only regular writer at present time. Besides that wonky terms like externalities are cool.
The housing crisis was primarily caused by government.
Lloyd said that, much more elloquently, above. Remarkably, he is just as incorrect as you are, but more thoroughly so.
By that, I mean that the government is to blame in part, but only inasmuch as it failed to REGULATE the market.
The problem with the free market is not only the pollution cost that is paid for by the public rather than the company paying for it(not just carbon, see superfund sites! Paid for by the people, so a business can go out of business).
Not to mention some businesses exist to pay the salaries of the owner/others and not to make a profit, so running the business to pull in capital and running it into the ground / not worrying if people vote with their feet/money. Yes, the free market works in it eventually runs out, but at what cost to the government(and thereby the people, again, see superfund) as well as to the credibility of the free market system as a whole?
Free market by definition needs regulations to remain a free market(see monopolies, oligopolies, etc..) and we don’t actually have free market in most places(GM never had to compete-compete, only had to “compete”).
You lost me at your first, oversimplified, generalized attack on conservatives.
You kinda got me back during the rest of your post.
I agree that there needs to be way to pay for market externalities. Right now, the externalities are being paid by our health and the future of many of our natural resources. I’d rather be paying for them with money.
I’m not totally opposed to cap-n-trade. I just think it should be honestly called an energy tax, rather than some time of green economy panacea.
Economics is a social science, one of many, and like the others, inexact. Capitalism is just one of many economic systems, and market theories do a pretty good job of explaining how money moves around. The problem in our current economic mess is that conservatives and libertarians (ala Greenspan) actually believe that an unfettered free market is the only social order necessary, and that because of its feedback mechanisms, everything will return to equalibrium (fancy term for ‘normal’) - and these people were making the laws and the regulations. The problem with their logic is that by the time markets correct, as they did last September, the people who raked in all the transaction fees from selling bad mortgages and dubious securities are rich beyond belief, leaving everyone else in relative tatters. A free market needs to be balanced by the regulation of a freely-elected government. The alternative will leave most of us in tatters indefinitiely.
Markets aren’t greedy, people are greedy. Guns don’t kill, people kill. Market require regulation to limit the risk that they will be abused by people; ditto for guns.
People on both the far left and the far right opposed the bailout of banks. The far left because they objected to rewarding greed and the far right because they wanted the market self correct. This is two ways of describing the same outcome.
Unfortunately, as Mr Tom pointed out, it was a moot point by that time since most of the ill gotten gains were already beyond reach.
It seems that people agree on one thing, some amount of regulation is necessary if markets are to function properly. Games without rules generally don’t work.
Agreed. I hope we can also eventually agree that policies that introduce moral hazard into the market should also be subject to regulation or avoided all together.
I think we all want a fair playing field where the have-nots can go toe-to-toe with the haves and have a fighting chance of winning. The left firmly believes it is the haves that are preventing that fair fight and they are absolutely correct. The part that they miss is that the haves in question get and pay for their advantage through government regulation which all too often raises the barrier to entry just out of their prospective competition’s reach. If we can shift the focus from left/right, rich/poor, republican/democrat and discuss regulations that can prevent people in power from preventing people out of power from getting power (or money, or whatever) I bet we’d surprise ourselves by what we agree on.
Our God Given Second Ammendment rights work in a world without rules.
I’m totally with Lloyd on this one. The goal here is not to assure some kind of outcome at the personal level — the goal is to give everyone a level playing field for trying to achieve their definition of success.