Guest columnist: critics of capitalism, beware

The notion of market failure is often labeled by critics of unfettered capitalism as a devastating example of the folly of leaving people free to trade with each other with no oversight from the state.

This phenomenon, the argument goes, is proof enough that people can’t be trusted to organize their own economic activities.

Those who employ this line of reasoning often cite examples that are actually not failures of free markets at all, but are the result either of government intrusion into private markets that has prevented their proper functioning or of a total lack of a market in the situation in question.

Occasionally, however, an example of market failure in a capitalist context is actually valid.

David Friedman, who is the son of renowned economists Milton and Rose Friedman, acknowledges that, while most critiques of capitalism that rely on market failure actually refer to problems not caused by markets, there are indeed some instances of actual market failure in the free enterprise system.

He acknowledges that the existence of such instances is a problem for laissez-faire capitalism, but — very importantly — he asserts that this argument applies both to free, private markets and what he calls “public markets,” or the political ways of allocating resources. He claims that “it’s a much more serious problem for the public markets.”

In other words, Friedman agrees that occasionally a private market situation will result in undesirable outcomes even when everyone involved acts in his own self-interest, but he is quick to point out that such situations are the exception in private markets and the rule in political markets.

In a talk delivered earlier this year, Friedman discussed market failure and the closely related “public good problem” at length. He made a convincing case that every criticism of free markets that relies on market failure applies tenfold to the political markets the purveyors of such arguments usually advocate.

He does so by dispelling the myth of what he calls the “civics class model of democracy,” in which all members of society are supposed to get what they want because politicians will be perfectly responsive to voters’ interests and voters will be fully informed about their representatives’ actions.

This model, he correctly notes, is deeply flawed because it actually makes sense for the typical voter to be ignorant of most political happenings. This is so because the cost of obtaining complete and accurate information is so much higher than the benefit to be gained from it when one goes to exert his extremely slight influence on the outcome of an election by voting.

He goes on to note, however, that even the more sophisticated special-interest model will generally fail to produce desirable outcomes because of the fact that some groups are concentrated — and thus more able to rally for a cause and lobby politicians successfully — and other groups are dispersed — and thus composed of many members who all correctly conclude that their personal involvement is unlikely to have much of an effect on the situation in question.

Numerous examples drive home his point that political mechanisms allocate resources inefficiently because of the existence of concentrated interest groups. For instance, he observes that in countries where farmers are a small fraction of the population, such as the United States, farm policy is tailored to benefit farmers at the expense of others, whereas the opposite is true in countries where the majority of the people farm.

Friedman also dispels the myth that private markets promote shortsightedness while political institutions foster long-term planning.

He uses the example of a man who is elderly and thinking of planting trees that will bear marketable produce some decades after his death. While some would claim the market gives the man no incentive to plant the trees and thus make society richer, Friedman notes that the man actually does have an incentive to do so because, while the man may not see the trees reach maturity, he will be able to sell the trees when they have had a few years to grow at a higher price than he paid to plant them.

He contrasts this example with that of a politician who is faced with the choice of advocating a policy that will benefit society years after he is out of office or advocating one that may harm society in the future but will benefit him politically between now and the next election.

As Friedman’s analysis makes clear, market failure can happen in a capitalist system, but replacing the marketplace with a bureaucracy or a legislature is precisely the wrong prescription for addressing that flaw.


E-mail: jarlower@indiana.edu