Why must government policy be justified by market failure?

Robin Hanson writes:

In ordinary talk, you often hear arguments like:

  • There aren’t enough Jazz stations – government should subsidize them.
  • Too many kids today let their pants hanging low – that should be illegal.
  • Not enough kids want to be scientists – schools should push that earlier.

But to an economist, it is not enough to note that you do or don’t like something, to justify a policy to encourage or discourage it. We instead hold ourselves to a higher analysis standard – is there a net market failure sufficient to justify an intervention?

Except, alas, on (national at-a-time between-family) income and wealth inequality. There, most economists think it sufficient to just note that a policy influences inequality – they rarely feel a need to identity an associated market failure…

As Obama has decided to make reducing inequality a central issue in his reelection campaign, we are going to hear a lot about it between now and November, including from economists. Could economists who support policies to reduce inequality please identify their market failure arguments?!  Why lower our usual standards for this topic?

This strikes me as utterly bizarre. I’m not going to worry here about the “official” meaning of “market failure,” since I strongly suspect that economists don’t use the term totally consistently. Instead, let’s just think about what well-functioning markets do. Well, what they do is if I have money and would like to spend it on something, they give people an incentive to provide that thing to me at a reasonable price. Similarly, if I have something I want to sell (including, say, my labor) markets give people an incentive to give me a reasonable price for it.

And in general, I think free markets are awesome! When the government tries to say things like, “you can’t charge more than $X for such-and-such,” the result tends to be not that such-and-such gets sold for $X, but that it doesn’t get sold at all (that is to say, you get a such-and-such shortage). And protectionist policies may benefit a few groups in the short-run, but in the long run we’re all better off without protectionism.

But markets aren’t much of a help if you don’t have any money to spend in them. I’m agnostic on whether inequality in and of itself causes problems, but it’s pretty clear that being poor does: it gets in the way of having access to things like health care and education, even food and shelter in extreme cases (extreme by USian standareds, that is.) And there’s a pretty simple government intervention to fix that: tax the rich to pay for things like health care, education, and food stamps.

The reason this makes sense is that, in terms of actual human welfare, the difference between a $2 million house/yacht/whatever and a $2.01 million house/yacht/whatever is a lot smaller than the difference between, say, no health care and $10,000 in health care. The issue isn’t market failure, but diminishing marginal utility and people’s tendency to not care much about strangers.

Now, in an update Robin claims that he isn’t necessarily objecting to this kind of argument:

In case it is not clear, this post is directed to economists, in their role as economists. I’m not saying market failure is the only consideration anyone uses to decide policy, but I am suggesting that it is the main consideration that economists use in their role as holders of economic expertise. Economists don’t have much expert to say about whether we have too much or too little inequality, outside of their expert ability to discern and fix market failures.

But even accepting the premise here, so what? Why shouldn’t economists comment on things outside their main area of expertise, as long they’re at least as well-informed as other kinds of commentators, like journalists? And the premise seems implausible: why should economists be restricted to knowing how to fix one kind of problem? Whatever you think about how much economists actually understand or are able to predict, wouldn’t an economist who was good at making predictions be able to understand a range of effects that policies affecting the economy can have?

I’ve been reading Overcoming Bias since the days when Eliezer Yudkowsky was blogging there, and find some of Robin’s stuff hugely insightful. But posts like these read like a case study in how knowing about biases can hurt you–a case of being way to quick to insinuate that the other side must be under the effect of some kind of irrationality.

  • http://motherwell.livejournal.com/ Raging Bee

    Here’s my market-failure argument, FWIW: ever-widening income inequality means more and more people simply don’t have enough money to buy much of anything, which means demand for goods and services declines, which means fewer opportunities — particularly for smaller businesses — to create jobs and growth by meeting that demand.

    And here’s a deeper moral/political argument: ever-widening income inequality ultimately means that larger numbers of people are simply excluded from participation in the economy; therefore that economic system is less legitimate because it no longer serves its purpose, which is to organize people to do useful work and meet the people’s material needs. We prefer capitalism over communism, not because of some abstract doctrine or reasoning, but because the former is observably better at meeting the people’s material needs effeciently. So if a capitalist system becomes observably less efficient in achieving this goal, we are required to modify it so it works better.

  • Kevin

    I think his approach is fine. The appropriate level of poverty is a social preference not lead out by facts. An economist can suggest ways to lower the percentage of people in poverty, but they can’t set the acceptable number because that number is different for everyone so it then becomes a matter of public discussion. They can contribute to this discussion, but they should make it clear that it is simply their opinion. However, I would not fault someone from not discussing that issue for fear of being misconstrued, especially if they are giving economic advice in the same discussion.


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