Markets Specialize in Finding and Fixing Failure

By Veronique de Rugy

I love this quote by Nobel Prize–winning economist F.A. Hayek:

We are only beginning to understand on how subtle a communication system the functioning of an advanced industrial society is based — a communications system which we call the market and which turns out to be a more efficient mechanism for digesting dispersed information than any that man has deliberately designed.

It echoes nicely this beautiful quote by Ronald Coase and Ning Wang in the conclusion of their 2012 book, How China Became Capitalist. They write:

The stupendous loss in the depth and richness of human nature is a noticeable part of the price we have to pay in transforming economics from a moral science of man creating wealth to the cold logic of choice in resource allocation. No longer a study of man as he is, modern economics has lost its anchor and drifted away from economic reality. As a result, economists are hard pressed to say much that is coherent and insightful, although their counsel is badly needed in this time of crisis and uncertainty.

I think about these two quotes when I hear people complain that the market is not producing what they think it should produce. Here are a few of these complaints that we hear on a regular basis: “Everyone should have more access to low-cost health care at low cost!” “All small businesses should be better able to find low-interest loans!” “Wages aren’t growing fast enough!” “College shouldn’t cost so much!” In view of these problems, the market must be failing, and we need the government to fix the problems.

People who issue these and similar complaints don’t understand the truth to which these quotes allude — namely, that the market is a process of exchange through which order emerges rather than a static snapshot or outcome of exchange. A well-functioning market is one in which order emerges out of the peaceful and voluntary interactions of many strangers guided by the information carried by prices. A well-functioning market can’t be judged by the outcomes of exchange at a certain point in time and by comparing that outcome against the desires of policy makers or pundits.

In other words, the fact that everyone doesn’t have paid leave, or that wages aren’t growing as fast as people would like them to, or that college is pricey, doesn’t mean there is a market failure. In most cases, it simply means that there is a gap between what people think the world should look like and what it really looks like.

Unfortunately, this misunderstanding leads to another problem. Once people start saying that markets have failed they often mean that government intervention is required to improve on the outcome. Nothing is further from the truth.

Take allegations that trade with China causes net job losses in the U.S. People who make these complaints fail to ask relevant questions about what barriers to employment exist today.

Instead of asking what the government can do to remedy these potential adjustment issues, we must first and foremost study how much net job loss there really is and, if we find some, identify the reasons for its existence.

Trade and automation of course have impacts in certain labor markets. But what role is played by government policies — such as minimum-wage legislation, occupational licensing, zoning, housing policies, disability insurance, and others — that prevent workers from finding new jobs? A lot, I bet. Until we understand the role played by government policies, we won’t have a full picture of what is happening.

Unfortunately, too few people take the time to look at the role of government in outcomes they dislike. The president looks at adjustment issues triggered by import competition and demands protectionist policies. Others demand wage subsidies, trade-adjustment benefits, and other government handouts that will create further distortions.

That brings us to the last reason why we must first and foremost examine government failures rather than constantly cry wolf about market failures. When any particular outcome emerges from the market process that is not suitable for market participants, the market will adjust and, sooner or later, produce another, better outcome. By contrast, government failures are rarely improved with adjustments. Steve Horwitz explains the issue this way:

So why then do we think markets are better? To answer that question, we must ask: Which process has better built-in mechanisms to provide the knowledge and incentives necessary to notice imperfections and improve on them? It is here that the Austrian argument for markets comes to the fore. Markets are desirable not because they don’t fail, but because they are better able than government to respond when they do fail. Thus the charge of “market failure” itself fails to address the main issue. Rather than worrying about when and why markets supposedly fail, we should be concerned with how well they, and the political process, respond to imperfections.

Think about these issues in the next few months as politicians on the campaign trail rail against markets and offer government solutions to address them. So many of the problems they complain about are either non-issues or in most cases are created by government interventions.

 

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Veronique de Rugy

AIER Senior Fellow Veronique de Rugy is also a Senior Research Fellow at the Mercatus Center at George Mason University and a nationally syndicated columnist. Her primary research interests include the US economy, the federal budget, homeland security, taxation, tax competition, and financial privacy.