Correcting market and government failures: generic policies
5 important questions on Correcting market and government failures: generic policies
Other values besides efficiency may lead us to rejects the market solution as a final policy choice. Nevertheless, letting markets work should be among the policies we consider if market failure does not appear inherent in the policy problem. We distinguish three general approaches for taking advantage of private exchange (or market-like exchange between private citizens and governments):
- Freeing markets
- Facilitating markets
- Simulating markets
Examples of framework rules are:
- Tort law: tort systems allow those who have suffered damages to seek compensation through the courts. The possibility of torts lowers the expected loss that consumers facd from collateral damage and deters some risky behavior by producers I situations involving information asymmetry.
- Contract law can also be formulated to reduce the consequences of information asymmetry.
- Antitrust law: can be desired to employ either criminal or civil procedures, seeks to prevent firms from realizing rents through collusive efforts to restrict competition.
Price regulation is frequently used as a method of preventing monopolies from charging rent-maximizing prices. Many regulatory regimes attempt to force natural monopolies to price at average cost by regulating prices. Historically, the usual approach has been rate-to-return regulation. There have been two major lines of criticism to the use of this type of price regulation to limit undersupply by natural monopolies:
- The regulators are quickly "captured" by the firms that they are supposed to be regulating, such that the outcome may be worse than no regulation at all.
- Such regulation induces inefficient and wasteful behavior. Two well-documented outcomes of such incentives are X-inefficiency and an overuse of capital under rate-of-return regulation.
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Single-purpose government entities, called special districts, are usually created to supply goods that are believed to have natural monopoly, public goods, or externality characteristics. A major disadvantage is the costs that consumers face in monitoring a whole series of "mini-governments" for different services. Three advantages are:
- They allow consumers to clearly observe the relationship between service provision and tax price.
- They can be designed to internalize externalities that spill across the historically evolved boundaries of local governments.
- Collections of special districts prevent logrolling across issue areas.
Because private firms could make an expected profit by buying low during normal markets and selling high during disruptions, we might ask why the government should stockpile. Two reasons:
- Government failure: based on past experience, firms might anticipate the possibility that the government will institute price controls, preventing them from realizing speculative profits.
- Market failure: acquisition and drawdown decisions by private firms have external effects on the economy.
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