March 25, 2020 Reading Time: 4 minutes

The coronavirus pandemic has all the earmarks of a classic market failure: with every action, you create benefits or costs that spill over onto other people. When you get a flu shot, you make it less likely that people will get the flu. When you wash your hands carefully, you make it less likely that you will pass on illnesses like COVID-19. The people who benefit from your attention to your health and hygiene, however, don’t compensate you for your valuable service. 

This means there is a discrepancy between the private and social benefits from flu shots and careful hand washing, and according to the standard stories about externalities that we teach in introductory economics classes, we probably won’t do as much as would be socially optimal. 

Not enough people get flu shots. Not enough people wash their hands carefully. As I wrote over the summer, “just because an externality exists doesn’t mean the market has ‘failed’ enough for command-and-control regulation or even corrective taxation to be appropriate.” The stories we tell in introductory economics classes also tend to assume away the problem of government failure–and governments are failing mightily in response to the COVID-19 epidemic.

Consider just one example from the Food and Drug Administration. Before I proceed, I want to make something abundantly clear: I have no reason to think that the people who work for the FDA are anything other than fine, upstanding people who want nothing but what is best for the world. No doubt, many people working for the FDA are putting in a lot of extra hours in response to the pandemic. 

And yet they are, on many margins, actively making things worse. Consider this headline: “San Francisco startups have suspended sales of some coronavirus test kits after the FDA issued a warning.” The FDA has issued new rules governing testing procedures and products, but as Business Insider notes, “The new guidelines aim to speed up the approval process for labs in the US making COVID-19 tests, but the rules have caused confusion.” 

For a country that lags behind the rest of the developed world in coronavirus testing, this is simply remarkable. If the FDA is staffed top-to-bottom by competent and compassionate people, why are they making policies and issuing rules that are actively making it harder for people to get tested?

The fault is not in their stars or in themselves, but in their incentives.

As rule-makers, FDA officials do what rule-makers do best and, importantly, what rule-makers are rewarded for: they make rules. They have strong incentives to create vivid and intuitive fixes for easy-to-understand problems. In the case of the at-home COVID-19 tests, the possibility of fraudulent test providers is a pretty easy-to-understand problem. “Stop everyone from testing until we’ve sorted out the unscrupulous” is a vivid and intuitive fix for the problem. 

However, it’s a “fix” that ignores the often-ingenious ways people solve problems in commercial societies. It’s also a “fix” that denies people the right to make their own decisions about the risks they will bear. The world has gone into suspended animation in response to COVID-19; it seems unreasonable to throttle at-home testing–and in the process, likely make the problem worse–in order to prevent a few bad tests from getting through. If COVID-19 is the threat to global health everyone seems to think it is, then allowing and even encouraging at-home testing seems like it passes a cost-benefit test even if some people will peddle fraudulent tests.

Of course, if bad tests or bad drugs get through the screening process, then the regulators at the FDA would be blamed. There might be hearings. People might lose their jobs. Decent people at the FDA might hear “you could have prevented this” from other decent people suffering from loss and tragedy. No one wants that on their conscience–to say nothing of their resume.

What happens, though, when the FDA prevents a good test from getting through? People suffer and people might die, but the connection from the FDA’s action–or lack thereof–and the result isn’t quite as clear. Someone, somewhere would have gotten tested and gotten treatment earlier with an at-home COVID-19 test. Now they won’t. That person will suffer needlessly. Maybe he or she will die and be every bit as dead as someone who dies because of a bad COVID-19 test. 

The line connecting the FDA’s (in)action and the tragedy will be a lot harder to see. When a bad test gets through and someone gets hurt, it’s really easy to see the causal link between the FDA’s approval of the bad test and tragedy. Newspapers can interview the victim or take pictures of the body. That someone has been harmed by a fraudulent test is crystal clear. When a good test doesn’t get through, however, it will be harder to find someone to interview. There may not be a body a newspaper can photograph that can be connected with certainty to the FDA’s mistake.

This means, ultimately, that regulators have incentives to be too cautious. They will likely face serious professional and personal consequences for making one kind of mistake (approving a bad drug), but they likely will not face serious professional and personal consequences for making another kind of mistake (failing to approve a good drug). They are quite literally being set up to fail.

Market failure is a real and important phenomenon that shouldn’t be overlooked. We also shouldn’t overlook government failure, as well. Importantly, we need to be very clear about the problems that create government failure. 

It likely cannot be fixed by electing or appointing “better” people or by giving regulatory agencies like the FDA bigger budgets. Their failures are a product of their incentives, not their intentions–and until their incentives change, we can expect to see a recurring pattern of government failure.

I first learned about this from Alex Tabarrok at The Independent Institute, for whom I serve as a Research Fellow, maintains the very helpful website

Art Carden

Art Carden

Art Carden is a Senior Fellow at the American Institute for Economic Research. He is also an Associate Professor of Economics at Samford University in Birmingham, Alabama and a Research Fellow at the Independent Institute.

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