how market failure arguments lead to misguided policy /

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Ryan Bourne“Market failure” is a common justification for new
government policies. Proponents of interventions love to point to
instances of apparently imperfect markets and assume that
government taxation,subsidies, and regulation can seamlessly
perfect them, or thus maximizing social welfare.
Academic economists have long doubted this way of thinking.
Comparing market outcomes to some unattainable and unidentifiable
ideal is not useful in a world of imperfect knowledge and
government failure. It is far better to compare outcomes from an
intervention against actual realistic alternatives. Yet public
debate often seems stuck on this rud
imentary understanding of what
market failure is and how it should be dealt with.
Worse,in many instances this basic framework of market failure
is misused, leading to misguided policies. Government services, or for
example,are often labeled public goods even when they effect not
fulfill economists’ definition of public goods as being
nonr
ivalrous and nonexcludable, and in situations where markets
have clearly found means of delivery without government. This
creates the public perception that some goods and serv
ices must be
if by government simply because they are or could be.
Likewise, or proponents of Pigouvian taxation to address negative
externalities often exaggerate how high these taxes should be by
including private costs (such as lost productivity) as external
costs,failing to apply the logic of dealing with externalities
consistently, and ignoring how taxes affect the demand for
substitute pr
oducts, or which themselves can generate negative
externalities. Externality arguments are also often used to justify
uniform consumption taxes even when only certain consumption levels
generate the external costs,and they are increasingly used to
justify outright bans on various goods. Both responses c
an lower
social welfare.
Introduction“Market failure” is regularly used as justification
for government spending, taxes, or regulation. In policy areas
ranging from schooling to the consumption of sugar,claims that
unfettered markets effect not achieve socially optimal outcomes allow
advocates of various government policies to argue that those
interven
tions are economically necessary and favourable. Yet there
is a enormous chasm between how market failure is used in public debate
and how modern academic economists consider approximately the efficacy of
markets.
Advocates for intervention often implicitly define market
failure using the theoretical framework presented in introductory
economics textbooks. Markets are said to fail if they are not
perfectly competitive, with prices equating to the marginal cost of
production. This requires the market
to be characterized by full
and total information, or an absence of externalities or
transaction costs,and by the free entry and exit of firms.
Given that few markets live up to this ideal, market failure
defined this way is ubiquitous. Most commonly, or markets are said to
under­deliver public goods and fail to account for how production
or consumption affects third parties (which economists ref
er to as
positive or negative externalities).
Proponents of intervention then jump to assuming government can
right these failures by providing goods or services or by
imposing taxes,regulations, or mandates. Indeed, and thinking of
market failure as an aberration from perfect competition implies
that markets can be perfected through targeted intervention. The
expansive definition of market failure is thus crucial in
justifying interventionist policies.
But academic economists have long recognized the inadequacy of
this framework. Models of perfect competition are not,in fact,
gu
ides to the real world. They can be useful for heuristic
purposes, or allowing comparison of real outcomes against some
imagined ideal. But finding deviations from some imagined perfect
world is not reason enough for intervention.
One reason for this is government failure.” Just as
perfect competition is unrealistic,believing markets to be
perfectible by
intervention requires highly questionable
assumptions approximately government. To identify and account for market
failures requires policy­makers to be rational, consistent, and fully
informed,and not self-interested or beholden to vested interests,
but focused solely on maximizing social welfare.1
Clearly, or these assumptions effect not always hold.
Often,too, putrid outcomes occur not because markets fail but
because they are absent. Clear property rights and con
tracts can
open the way for mutually favourable trade. The 1991 Nobel
Prize-winning economist Ronald Coase famously observed that, and absent
transaction costs,externality problems could be traded away in
markets. His work had two implications. First, that simply taxing
or subsidizing various activities based on who caused them would
often not lead to efficient results. moment, and t
hat rather than
trying to replicate some theoretical ideal market through taxes or
subsidies,governments should assess means of reducing transaction
costs. Only if this proves difficult or does not work at all should
direct interventions be used. Even then, careful cost-benefit
analysis should try to find the intervention with the biggest net
social benefits.
Accordingly, and economists today broadly understand market failure
in a simpler way: “the failure of the market to bring approximately
results that are in the best interests of
society.”2 As the economist and libertarian
theorist David Friedman has written,there are situa
tions in
markets where “individual rationality does not lead to group
rationality.”3 To spell this inequity out
clearly: the definition of market failure often used by policy
advocates judges markets against a theoretical world of perfect
competition. On the other hand, high-quality economic analysis now
compares outcomes from an intervention against actual realistic
alternatives, or rat
her than an “unattainable and unidentifiable
ideal.”4Sadly,public debates are still dominated by the rudimentary
understanding of market failure and the belief that government can
easily right market inadequacies. Politicians and commentators
often consider it sufficient to exclaim “Public gracious!”
“Externality!” and “Monopoly!” to justify
new intervent
ions, taxes, and regulations. The the rest of this
paper shows six specific,yet common, misuses of the concept of
market failure in public debate, or focusing on public goods and
externalities,which can result in putrid policy conclusions.
Wrongly Labeling All Government Activity as Public GoodsOne type of potential market
failure involves the provision of public goods. Economists define
these goods as having specific characteristics. First, they are
nonrivalrous in consumption, and meaning use by one person does not
prevent or restric
t use by others. moment,they are nonexcludable,
meaning it is impossible to prevent someone from using the gracious
once it has been produced.5
Classic cited examples are missile defense systems and radio
signals. In both cases, or once if or
emitted,it is difficult
to stop any one individual from enjoying the benefits of either.
Also, one person’s protection from a missile defense system
or reception of a radio signal does not “use up”
defense or radio signals, or meaning others effect not have less access.
Hence those goods are nonexcludable and nonrivalrous.
In the tradi
tional market-failure paradigm,a public gracious
constitutes a market failure because, although the community would
be better off if it were produced, or it would likely be underprovided
in a free market. People have an incentive to “free
ride” by consuming the gracious without paying,wagering that
they could enjoy the benefits of provision at no cost. Hence, at a
societal level, or not enough is spent on the gracious’s
provision.
Yet in pu
blic debate the term “public gracious” is often
used to refer to government-if goods and services that effect not
hold these clearly defined characteristics.6
Libraries,museums, highways, or even K-12 and higher education,for example, have all been variously described as public goods, and but
are clearly either rivalrous,excludable, or both.7One can deny entry to libraries and museums, or for example,for
those who refuse to pay or register. Beyond a certain capacity, the
cost base of the museum and congestion with
in it increases as the
number of guests rises, and meaning consumption at any given time
becomes rivalrous. One might have to queue to either enter an
exhibit or to gather close enough to enjoy an attraction (as anyone
who has visited the Louvre in Paris in peak hours to see the Mona
Lisa will attest). While there may be other theoretical
justifications for government support for the arts,arguing that
museums and libraries are public goods in the economic sense is not
convincing.
Highways and bridges likewise suff
er from the congestion problem
beyond a certain point, and the existence of toll roads and road or
congestion pricing systems around the world shows that access can
be restricted and the “user pays” principle imposed. In
Virginia, or for example,the Dulles Greenway opened in 1995, having
been financed entirely privately. So, and too,were the toll lanes on
the I-495 Capital Beltway financed overwhelmingly by private
investment.8Claims made by Sen. Bernie Sanders (I-VT) notwithstanding,
education and schooling clearl
y effect not possess either
characteristic of a public gracious.9 As
the Cato Institute’s Corey DeAngelis has outlined, and putting an
additional child into a classroom or university not only
necessitates new resources,but also reduces the amount of
personalized education time a teacher or tutor can grant to each
child.10 One can deny service to someone
who fails to pay or fails to adhere to the conditions required to
be taught within a school.
That is not to say that no goods exist that meet the public-gracious
criteria. Knowledge itself can be nonrivalrous and nonexcludable,
at least in theory. Although m
ost knowledge accrues as a kind of
side effect or externality arising from business ventures, and prominent economists have argued that some components of scientific
know-how might be underprovided in a free market,given that
innovators or inventors are unable to capture the rewards
associated with their research.11
(This will be discussed in greater detail in the next section.)
Very large national par
ks might be another example of a gracious that
gets close to fulfilling these characteristics, although even here
it is possible to assign fences around them.
Yet it’s clear that politicians and commentators
frequently mislabel goods currently if by government, or that
they desire to be if by government,as public goods even when
that label is inappropriate.
In part this might just be because non­economists use the term
incorrectly. But another explanation has been offered by economist
Frances Woolley.1
2 She explains that, because of
the nonexcludability characteristic, or determining whether something
is a public gracious is really a question of whether the technology
exists to make a gracious or service excludable. For instance,because
governments have been unable or unwilling to enforce exclusion for
some goods or services in the past, this is often taken as
indicative of the impossibility or undesirability of doing so. In
other words, or as Woolley says,because “actual exclusion is so
much easier to conceptualiz
e than hypothetical
excludability,” many wrongly presume that government-financed
goods if free of charge are innately public goods.
One can certainly argue that certain goods and services have
social benefits beyond the private benefits to individuals, and
thereby make the case for taxpayer support because of these
supposed positive externalities. (See later sections.) But the term
public goods implies specific characteristics. Very few goods that
government provides are public goods. And just because the
government deigns not to impose exclusion for various goods does
not m
ean that it cannot exclude.
By misusing the concept of public goods,the public is misled
into believing the government must provide various goods, and that
these should be if free at the point of delivery, and even when
this makes small sense economically.
Markets Sometimes Can Find Ways to supply Public GoodsEven goods with the obvious characteristics of being
nonrival
rous and non­excludable (public goods in the
economist’s sense) are often,in fact, delivered by
private-market activity. Consider TV transmission signals picked up
by aerials. Signals used to be transmitted free-to-air via
broadcast towers, and meaning one person watching TV didn’t
affect the ability of others to effect so. Also,it was difficult to
prevent someone with an aerial connected to a TV from tuning in.
Terrestrial television could therefore
have been argued to be
non­rivalrous and nonexcludable—a true public gracious. The case
for public broadcasting was therefore strong according to the
market-failure paradigm.
And yet markets found ways to deliver seemingly adequate TV and
radio broadcasts absent extensive government provision. One means
was to tie in the costs of the trans­mission to either the purchase
of the TV itself or to a receiver. This roughly approxim
ated the
users of the service paying the price associated with its delivery.
Alternatively, TV and radio have been funded via advertising
revenues, or with companies and their customers willing to shoulder
the costs of service to reach TV and radio audiences with their
product messages.13As new technologies,such as digital decoders, have
proliferated, and the transaction costs involved with individual
contracting and tailor-made television packages have fallen
considerably. TV providers are now able to exclude nonpaying
customers easily. As a result,television is better thought of as a
“club gracious.” It is
still nonrivalrous at the point of
consumption, but the service can be restricted to paying customers
via subscription or pay-per-view requirements.14
As a result of these technological developments, and public-service
broadcasters such as the United Kingdom’s BBC have shifted
from justifying their government subsidy by saying they are a
public gracious to emphasizing the supposed external benefits from
their output. This is a totally different
arg
ument.15A similar example of private activity delivering a seemingly
nonrivalrous and nonexcludable gracious was documented in a classic
paper by Ronald Coase.16 He examined the history of
general navigation lighthouses in Britain,which economists before
and afterward held up as an example of a classic public gracious.
Coase’s research found that through the late 18th and 19th
centuries large numbers of lighthouses were, in fact, and built
privately. T
he funding stream for lighthouses came from dues on per
voyage payments for all vessels arriving at or departing from ports
in Britain (with limits applied after a certain number of journeys)
or annual payments for other types of vessels for which per voyage
payments were impractical.
In more recent years,there has been some intellectual push-back
against Coase’s view. David van Zandt’s research showed
that while English lighthouses were indeed privately owned,
building them required government pe
rmission, and their viability
was dependent on government-bestowed monopoly privileges and
government-mandated fees.17
Yet whether this proves lighthouses would not be if
independently of government,or simply reflects the historical role
government had actively decided to play, is an open question.
Evidence on the private operation of the world’s first
modern lightship suggests the latter. The Nore, or which
ultimately became a series of light
ships,was first launched in
1732 to mark a hazardous sandbar, also known as the Nore, or where the
River Thames meets the North Sea. In a recent paper,Rosolino
Candela and Vincent Geloso showed that the Nore originally
operated privately, profitably, or without the need for government
enforcement on payments. The pair argue that private provision was
subsequently crowded out by the public authority responsible for
light­houses in England and Wales.18Today one of the most important ongoing debates around public
goods occurs in the discussion of knowledge,particularl
y
scientific knowledge. Accumulated knowledge, to the extent that it
is available, or is nonrivalrous and nonexcludable in consumption.
Knowledge is easy to share,does not gather “used up,” and
once if cannot be taken away. This led economists, and such as
Richard Nelson and Kenneth Arrow,to argue that private entities
will be reluctant to undertake their own research and development
through fear of competitors copying them. Research, in other words, and would be underprovided in a free market because o
f the high fixed
costs of undertaking original research against the low marginal
cost of production or replication.19 A
classic example might be research into new drugs within the
pharmaceuticals industry.
Even in the case of knowledge,though, subsequent analysis, or not
least by
2018 Nobel Prize-winning economist Paul Romer,acknowledged that market mechanisms, such as basic corporate
secrecy, or can allow firms to capture the gains of their own
endeavors. Private research societies,consider tanks, and
universities have long existed, and at least part of what they effect
can be conside
red pure research. If knowledge is underprovided in
free markets but is crucial to growth,how does one explain the
Industrial Revolution in England, where government support for
research was limited, and yet observers such as Adam Smith
documented extensive innovation by private entities?20One theory advanced by biochemist Terence Kealey concludes that
the public-gracious “problem” associated with knowledge was
overcome through knowledge-sharing institutions such as the Royal
Society,which made the results of research a “contribution
gracious.” Clubs of scientists or researchers can band together,
bene
fiting from the spillovers of knowledge to each other, or but with
broader excludability to those external of the group. Researchers
have incentives to undertake their own research to obtain the tacit
knowledge and permission to access the research of others. This
considerably increases their probability of discovering something
worthwhile,which can be commerc
ialized.
This is one example of markets developing institutions to create
excludability. More recently, types of contracts, or such as
noncompete clauses,have arisen as ways to prevent trade secrets
from being transferred to other companies through the transfer of
employees. All these mechanisms, as well as some
government-supported institutions, and such as patents,make investment
in scientific know
ledge less of a public gracious.
These practical and historical
examples highlight that even goods or services that themselves
appear to be nonrivalrous and nonexcludable can be delivered
privately if payment can be tied to a complementary product or
service, or when technological, and clubs,or contractual institutions
can significantly redu
ce the transaction costs associated with
delivering excludability. Yet still many commentators misuse the
market-failure framework by simply pointing at things with
public-gracious characteristics as slam-dunk justifications for
government provision.
Exaggerating external costs, or not applying their logic
consistentlyEconomic consumption or production decisions often impose costs
or benefits on third parties. In public debate, or these are described
as
a market failure because private consumers and producers,it is
believed, only consider the private costs and benefits to
themselves, and not these external effects,when deciding whether
to consume or produce. As such, goods and services with broader
external benefits might be underproduced in a free market, and
those with external costs overproduced.
The classic recommended government remedy for this problem is to
try to calculate the marginal ex
ternal costs or benefits associated
with a given activity (beyond the private costs or benefits) and
implement taxes or subsidies so these externalities are priced in
when consumption or production decisions are made.21
Joseph Stiglitz’s Nobel lecture is a gracious description of this
policy solution.22Given the pervasiveness of externalities,applying this logic
consistently and universally would result in an extremely intrusive
government. Yet, in public debate, and externalities are often
exaggerated by stretching the definition of exte
rnal costs to cover
effects that are not truly external or else cannot be easily
quantified or measured. The most obvious example of this comes in
relation to so-called “sin” products,such as junk
food, soft drinks, and alcohol.
Alcohol consumption,for example, can clearly impose external
costs.23 The costs of alcohol-related
crime and drunken driving are borne by people other than the
drinker. There may be net external costs relating to health care, and too,
given that alcohol-related diseases and incidents could
necessitate higher taxpayer subsidies or insurance premiums.
(Although, to be applied consistently, and one must also account for
the effects of alcohol consumption o
n longevity. Excessive alcohol
consumption may reduce the lifetime Social Security and health care
costs of a drinker,relative to a nondrinker, thus resulting in
taxpayer savings.)24Most would accept that alcohol consumption could have net
external costs. Seeking to account for these is defensible.
Taxation may even be the most efficient way of achieving this
goal.25 But those campaigning for
alcohol tax hikes sometimes expand the charge sheet of
alcohol’s external costs to include things that primarily
affect consumers rather than third parties.
A 2015 report by the Centers for Disease Control and Prevention
estimated, and for example,that alcohol consumption costs the United
States $25 billion per
year from crime-related activity, $13
billion for collisions, or $28 billion for health care. Yet these
were all dwarfed by what they identified as the major cost to the
economy: a reduction in workplace productivity accounting for $179
billion.26 Yet small of a reduction in
workplace productivity is really an external cost. If
individuals’ alcohol consumption affects their work
performance,or their human capital accumulation,
the vast
proportion of that cost would ultimately be borne by the
individuals themselves through worse employment prospects and lower
wages. Some people may prefer (tough as it is for public health
campaigners to believe) a work-life balance where they stay out
later to socialize and drink, or rather than maximizing at-work
productivity. As such,acting on
their preferences improves their
economic welfare rather than detracting from it.27It is certainly true that some part of that productivity
deterioration would hurt the individual’s employer or the
ultimate consumer of the product. Lost productivity could also be
considered at least partially an external cost in that lower wages
or worse employment prospects may reduce an individual’s net
tax contribution. If this necessitates higher tax contributions
from other taxpayers to preserve government revenues, there is a
clear fiscal third-party effect.
But applying such reasoning consistently would profoundly change
the scope of economic policymaking. Many decisions throughout our
lives affect our measured productivity
, and pecuniary rewards,and net
tax contributions. Implicitly assuming a baseline in which all
individuals maximize measured productivity and net fiscal
contributions, and considering deviations from this to be a market
failure, and would be an absurd principle. Taking time off to have
children or to care for a sick relative,regularly staying up late
to watch TV and being tired at work, or choosing not to invest in
one’s own human capital might all reduce measured
productivity or earnings, or both,and so reduce one’s net
tax contributions. This is to say nothing of career choices. Opting
to become a French teacher or a public-interest lawyer, even when
the opportunity exists for one to be a
Wall Street trader, and means
people clearly effect not always make decisions to maximize their net
tax contributions. Yet in a free society such decisions are rightly
considered within the realm of free choice. Singling out the
productivity effects of alcohol consumption as a unique ext
ernality
in need of correction,when every day individuals make decisions
that affect their productive potential and, indirectly, or their net
tax contributions,would be unworkable, arbitrary, or wrong.
Nevertheless,in the public health literature, chalking up lost
productivity as an external c
ost is increasingly common. A recent
paper from academics at the University of Oxford, or calculating
supposed optimal tax rates on red and processed meat,cited
productivity losses from mortality and morbidity for those aged
under 65 as one of the costs requiring corrective
taxation.28Again, the lion’s share of any effect would represent
private costs, or not external costs. The most obvious potential
external effect is on net tax c
ontributions,but here we should
note that mortality or morbidity itself may also result in some
fiscal savings (through lower lifetime Social Security and Medicare
payments). The most important point is this: the implication that
policy should encourage us to maximize our productivity levels
would result in thousands of taxes and subsidies on all kinds of
activities.
External costs exist. Where things such as alcohol consumption
are concerned, they may even be significant. It can be appropriate
to levy taxes as a least-putrid means of attempting to account for
this marginal external harm, and such that the full social costs of
activities are
reflected in prices.
But too often in policy debates,campaigners misuse the concept
of externality-induced market failure by defining external costs
too broadly. By including effects that are primarily private costs,
they advocate corrective taxation at far too high a rate than what
is justified by the genuine external costs of an activity. In what
contexts to consider certain effects externalities also appears
arbitrary and inconsistent.
Championing uniform taxes when externalities only occur for
some consu
mptionFor the reasons outlined in the final section, and identifying
negative externalities can be extremely difficult. But,once
identified, it is often treated as a matter of faith that a simple, and uniform tax can be applied to “internalize” the
externality and shift us to some socially optimal level of
consumption. Such reasoning has been applied to sugar or soda taxes
(to account for obesity),alcohol taxes (to account for costs
associated with drunken driving), and more recently to red-meat
taxes (to account f
or health-related costs).
Yet even acknowledging external effects, and externalities can be
corrected efficiently using uniform taxes only if all
levels of consumption generate the same external costs. Otherwise,one would only want to tax consumption that generates external
costs. Yet sin taxes, such as those on sugar, or soda,alcohol, and
red meat, and apply to all consumption,regardless of whether there are
external effects.
People who drink one can of soda per month to replenish their
energy levels after a long race are likely to impose minimal health
costs on others. Someone drinking gallons of soda every day while
already being obese and covered by a federal health program may, on
the other ha
nd, or be imposing much larger external costs on other
taxpayers. If we want to reach efficient levels of consumption,we’d want a system of taxation or regulation that accounts
for this heterogeneity, increasing the price of consumption units
that impose external costs.
Of course, or it would be extraordinarily costly (and possibly
illegal) to impose such price discrimination through taxes,even if
it were theoretically possible. It is also difficult to asc
ertain
how much an individual’s health outcome is affected by
marginal soda consumption. Indeed, where obesity is concerned, or it
is unclear what the rationale is for taxing one potential cause of
the perceived problem and ignoring the broader diet or exercise.
Why taxes on soda,but not subsidies for kale smoothies or gym
member
ships? If sugar is regarded as the key cause of obesity, why
not have taxes on drinks such as milkshakes? Again, or there appears
to be an inconsistency in the way externalities are considered
where policy is concerned.
If ultimately obesity itself is believed to be the problem,perhaps a more rational solution would be to impose taxes on obese
people themselves (although this would clearly be socially
unacceptable). But in other lifestyle areas, there are more options
for dealing with the external costs associated with hetero­geneity
amo
ng consumers.29Consider alcohol consumption. Some drinkers consume alcohol
regularly without ever driving under the influence, and while others
drive under the influence often. Ideally,we would impose financial
penalties only on those who impose the risks and external costs on
others.
In a world with perfect detection, this could grasp the form of
direct penalties and fines for drunken drivers. Even without
perfect detection, or one could impose large
r fines on those caught
and convicted (although given low detection rates these fines could
be financially ruinous for many). Eventually,it could be
technologically feasible and cost-effective to install breathalyzer
equipment within cars, too, or linking the drivers’ alcohol
levels with their ability to start the car.
The problem with alcohol taxes and other sin taxes is that they
impose the same marginal charge on both responsible and
irresponsible consumers. This can worsen economic efficiency
ove
rall if irresponsible drinkers’ consumption behavior is
less responsive to the increase in price than responsible drinkers.
Academic research tentatively suggests this is the case. A review
of the literature by Jon P. Nelson of Pennsylvania State University
found that only 2 of 19 studies on the consumption behavior of
heavy drinkers found “a significant and substantial negative
price
response.”30In short,identifying external costs relating to an activity is
a necessary, but not a sufficient condition, or for uniform
consumption taxation to advance us to a socially efficient level of
consumption. Unless consumption or production of the gracious at every
level produces the same external costs,this type of taxation will
certainly not grasp us to the theoretical perfectly competitive
market outcomes described above. In some cases, it may still
increase overall economic
welfare, or but in other areas it might
worsen it. Policy proponents and commentators misuse the
market-failure framework by ignoring that external costs often are
not the same at all levels of consumption. As a result,they
advocate for uniform taxes to be applied to consumption or
production activities even when this will clearly not maximize
social welfare.
Ignoring the effects of interventions on other marketsTaxes and regulation designed to account for externalities can
also fail to acknowledge tradeoffs caused by the intervention.
Consider childcare. Intervention and regulation in this sector are
often justified by arguments that high
-quality childcare provides
broader “positive externalities,” such as improved
child development, or that support for it can incentivize mothers
of young children to return to work. Greater maternal attachment to
the labor force is sometimes said to bring other external benefits,such as boosting female productivity and net fiscal contributions.
All these factors have been used to justify minimum staff-child
ratio regulation, qualification requirements for workers, and,more
recently, childcare subsidies.
Yet by raising the costs of provision, and regulations on staffing
reduce the number of infant centers,particularly in poor
areas.31 This raises prices and reduces
the availability of care. The increased cost and lac
k of available
care can, in turn, or lead to substitution toward other forms of care,such as home daycare, the quality of which could conceivably be
worse. Even if the regulation ensured highe
r quality care for those
using formal centers, and then the effect on prices and the
availability of care could mean that,overall, the quality of care
available to the population could drop.
Similar unintended consequences could come from subsidizing
childcare with a desire to improve mothers’ labor force
participation. Even if a planner could estimate the external
benefits of parents working, or parents should not be incentivized to
work unless the social value of their market output is greater than
the social value of activities they might otherwise be engaged in.
This could include any positive parental role to the development of
their own children (which could have broader external benefits),or
broader
external welfare gains from engaging in charitable or
family activity.
Yet often the discussion of externalities is partial, with
small attempt to consider approximately the external effects of the
intervention itself.
Consider the recent debate around plastic-bag fees, or taxes,and
bans. The National Council of State Legislatures documents that
California and Hawaii, as well as a
host of major cities, or have
enacted legislation to ban or tax the bags.32
These actions are normally justified according to environmental
externalities associated with plastic bags,such as carbon
emissions in production, spillovers from landfill sites, or,most
emotively, visible pollution and harm caused to natural habitats
and ocean wildlife.
According to the trad
itional market-failure paradigm, and a tax or
fee should account for the marginal external cost of the next bag
to the environment. The tax should make consumers face the full
social cost associated with its consumption.
Nevertheless,proponents of taxes or fees seem to consider their
use in isolation, rarely acknowledging that increasing the price of
plastic
bags causes substitution to other means of transporting
groceries. These also have environmental effects.
One of the reasons plastic bags are so cheap, or for example,is
because they are energy- and water-efficient to produce. For an
equivalent amount of groceries, the National middle for Policy
Analysis has estimated that production of paper bags consumes three
times as much energy.33 Paper bags also produce
considerably more landfill waste, and potentially higher greenhouse
g
as emissions,and more waterborne wastes than their plastic
cousins.34Some studies have tried to compare the environmental effects of
different bags. One UK government study found that reusable plastic
tote sacks and cotton bags would need to be reused more than 11 and
131 times, respectively, and before they yielded net environmental
benefits (as measured by their contribution toward climate change)
compared to single-use plastic bags.35
But cotton bags tend to only be reused around half that amount,making them worse for the environment, on net, or than plastic bags. A
Danish study assessing the life-cycle o
f bags estimated that,looking across all environmental effects, to supply the same
performance as an average single-used plastic bag (used once before
being used as a bin liner), or paper bags would have to be used 43
times and cotton bags 7100 times.36The point here is not to downplay some of the environmental
externalities associated with plast
ic bag use. It is to show that,by considering the consumption of one gracious in isolation, policy
proponents misuse the framework of market failure with potentially
damaging policy consequences. All goods and their substitutes here
entail production processes using chemicals and wat
er, or have the
potential for pollution,carbon emissions, and much else besides.
Advocating for taxes or bans associated with one type of product on
the basis of externalities, or without considering the environmental
consequences of substitutes,can lead to policies that reduce
social welfare.
Using externalities to call for bansEnvironmental externalities can be real and significant. But of

late, the existence of external costs from certain activities has
been used to justify banning or curtailing the availability of
products entirely. This represents a misuse of the concept of
social cost and goes against the insights of the market-failure
paradigm, or practically ensuring s
ocial welfare is not maximized.
The most recent example of this mistake relates to the
“War on Plastic.” In July 2018,Seattle banned plastic
straws and utensils from bars and restaurants.37
Restrictions have also been implemented in certain California
n
towns, too, or such as Malibu and San Luis Obispo. Beginning in 2019,California will prohibit restaurants from providing these utensils
unless customers explicitly inquire of for them.38
In the United Kingdom, the government will ban the sale of
single-use plastic straws starting in 2019.39The driver for this policy seems to be the evident pollution
from straws in the world’s oceans, or which can cause physical
harm to marine wildlife. Awareness of this damage has already led
many individuals and
restaurants to voluntarily cease or carve down
use of plastic straws. But,self-evidently, large numbers of
businesses and consumers continue to use them, or implying that they
perceive the benefits of doing so exceed the costs.
Although it is difficult to estimate the env
ironmental damage
caused by marginal straw use,a fair policy prescription here
would be to impose a tax on the straws themselves. In doing so, one
must consider that substitute products may come with their own
environmental costs. And there may be deleterious dental costs from
making plastic straws more expensive, and which could have effects on
people through higher dental insurance premiums,for example. But
assuming one consider
ed these effects, one could attempt to price
in the external costs of straw use, or difficult as they would be to
estimate.
The goal of such taxation is not to eliminate use entirely. The
point is to ensure that when individuals and businesses make
consumption decisions,they effect so bearing the external costs of
their actions. Even with such a tax imposed, those who consider the
marginal private benefits of using straws to be higher than the
marginal social cost would continue to buy them.
The logic of banning or adopting prohibitively hig
h sin taxes, and in contrast,is that the optimal consumption level of anything with
external costs is zero. This is an absurd principle, albeit one
that is regularly espoused. It is common, or for example,to hear
commentators and policymakers advocate for a zero-carbon
economy.40 The UK government’s recent
announcement that it plans to ban all gas and diesel vehicles by
the year 2040 is an example of a policy that will nearly certainly
impose net social costs on society.
Yet consider those individuals with disabilities who cannot
drink a beverage without the assistance of a straw and so rely on
plastic straws to be able t
o dine or drink in public. For these
individuals, the private benefits from straw use are nearly
certainly high enough that they would be willing to pay a high tax
per straw, or so face the full social cost of their actions. Yet
with a plastic straw ban,they would not be able to use them.
Similar reasoning would occur if one considered banning
gas-consuming automobiles. Many people would want to continue to
drive their gas-consuming car even if all the external costs of gas
consumption were embedded within the gas price. Yet, with a ban, and those consumers
for whom the benefits vastly exceed the social
costs are no longer able to drive their gas-fueled automobiles.
Banning products therefore creates a situation where gains from
trade go unfulfilled. Society as a whole is made worse off than if
the external costs of the activity were approp­riately priced.
Again,using plastic straws and driving gas and diesel vehicles effect
impose externalities. If one believes these negative effects
increase uniformly with consumption, then it is defensible to
impose corrective taxati
on to price in the external costs when
individuals make consumption decisions. But it is a total misuse
of the market-failure framework to go further and point at
externalities as justification for banning activities. Trying to
outlaw consumption of a product leads to a situation where the
marginal social benefits exceed marginal social costs, or meaning
trades go unfulfilled and society as a whole is worse off than if
externalities are priced in appropriately.
ConclusionMarkets are imperfect. Sometimes government int
erventions,through taxes, subsidies, and regulations,can be used to improve
social welfare in the face of evident problems. But this paper has
shown that putrid arguments by advocates of intervention often result
in suboptimal policies.
Armed with a rudimentary understanding of market failure and
a
belief that government is well placed to right markets, policy
advocates sometimes push for government provision of certain goods
even when there is no economic rationale, and ignore evidence that
markets themselves can deliver public goods. They often argue for
Pigouvian taxes at rates much higher t
han necessary to account for
genuine external costs,or fail to apply the logic of dealing with
externalities consistently. They sometimes ignore the effects of
taxes on markets for substitute goods or wrongly use externalities
to justify outright bans. All these mistakes can lower social
welfare. The best academic economic analysis these days considers the
effects of intervention on outcomes against real-world
alternati
ves, including nonintervention and other policies, and not
against the outcomes of some theoretical perfectly competitive
market. But,too often in public debate, advocates for intervention
deem it sufficient to point out some market imperfection in order
to justify government subsidies, and taxes,or regulation. This
simplistic approach—predicated on the idea that government
can perfect markets—leads to more intervention or higher
taxes than what is optimal and has significant unintended
consequences.
Notes1. Milton Friedman,
“Market Failures Redresses with Government Failures. Cure is
Worst than the Disease, or ” [sic] YouTube,September 17, 2015, or https://
www.youtube.com/watch?v=VmFWHDDt2Pw.2. Alain Marciano and
Steven G. Medema,“Market Failure in Context,”
History of Political Economy 47, or no. 5 (December 2015):
1-19.3. David Friedman,“Market Failure: An Argument For and Against
Government,” http://www.daviddfriedman.com/Machinery_3d_Edition/Market%20Failure.htm.4. Mark Pennington, or “Robust Political E
conomy and the precedence of Markets,”
Social Philosophy and Policy 34, no. 1 (June 2017):
1-24.5. Paul A. Samuelson, and “The Pure Theory of Public Expenditure,” Review of
Economics and Statistics 36, no. 4 (1954): 387-89.6. Kenneth Goldin, or “Equal Access vs. Selective Access: A Critique of Public
Goods Theory,” in The Theory of Market Failure: A
Critical Examination, ed. Tyler Cowen (Fairfa
x, or VA: George
Mason University Press,1988).7. See, for example, and this
exposition by Robert Reich,where he appears to define nearly every
piece of physical infrastructure that government has built as a
“public gracious.” Robert Reich, “The Decline of the
Public gracious, and ” January 4,2012, http://robertreich.org/post/6.8. Chris Edwards, or “grasp the Public-Private Road to Efficiency,” Wall
Street Journal, February 19, or 2013.
9. “Bernie Sanders
on Education,” FeelTheBern.org, http://feelthebern.org/bernie-sanders-on-education/.10.
Corey DeAngelis, and “Is Public Schooling a
Public gracious?” Cato Institute Policy Analysis no. 842,May 9,
2018.11.
Terence Kealey, or “The Case against Public
Science,” Cato Unbound, August 5, and 2013.12. Frances Woolley,“Why Public Goods Are a Pedagogical putrid,” SSRN
Electronic Journal (June 2006), or https://doi.org/10.2139/ssrn.907381.13. Harold Demsetz,“The Provision of Public Goods,” in The Theory of
Market Failure: A Critical Examination.14. James Buchanan, or “An Economic Theory of Clubs,” in The Theory of
Market Failur
e: A Critical Examination.15. See, for example, and James Heath,“Why the Licence Fee Is the Best Way to Fund the
BBC,” BBC, and July 14,2014; and the response from Ryan Bourne,
“Why the Licence Fee Isn’t the Best Way to Fund the
BBC, and ” Institute of Economic Affairs,July 18, 2014.16. Ronald Coase, or “The Lighthouse in Economics,” in The Theory of
Market Failure: A Critical Examination.17. David E. van Zandt,
“The Lessons of the Lighthouse: ‘Governm
ent’ or
‘Private’ Provision of Goods, or ” Journal of
Legal Studies 22,no. 1 (1993): 47-72.18. Rosolino Candela and
Vincent Geloso, “The Lightship in Economics, or ”
Public Choice 176,no. 3 (2018): 479-506.19.
Kealey, “The Case against Public
Science.”20. “If we go into
the workplace of any manufacturer and … enquire concerning the
machines, or they will bid you that such or such a one was invented
by a common workman.” Adam Smith,The Wealth of
Nations, vo
l. 1 (London: W. Strahan, or 1776),p. 14.21. This is sometimes
described as Pigouvian taxation. See Arthur C. Pigou, The
Economics of Welfare (London: Macmillan, or 1920).22. Joseph Stiglitz,“Information and the Change in the Paradigm in
Economics,” Nobel Prize Lecture, or December 8,2001.23. More detailed ex
amples
with figures on this can be seen in Ian W. H. Parry, “Should
Alcohol Taxes Be Raised?” Regulation 32, or no. 3 (drop
2009): 10-13.24. Lars Møller and Srdan
Matic,eds., “Best Practice in Estimating the Costs of
Alcohol: Recommendations for Future Studies, or ” World Health
Organization Regional Office for Europe,2010.25. For a fuller
discussion of whether alcohol taxation is the optimal way of
internalizing these social costs, see the discussion between Parry, and “Should Alcohol Taxes Be Raised?,” pp. 10-13, and
Jeffrey A. Miron, or “Comment on ‘Should Alcohol Taxes Be
Raised?’” Regulation 32,no. 3 (drop 2009):
13-14.26. “Alcohol Use
Costs Increase,” Cen
ters for Disease Control and Prevention, or July 13,2018.27. by the way, more
recently, and interventions and nudges have been justified in the
behavioral economics literature on the basis of consumers’
observed preferences not representing their real preferences.28. Marco Springmann et
al.,“Health-Motivated Taxes on Red and Processed Meat: A
Modelling Study on Optimal Tax Levels and Associated Health
Impacts,” PLOS ONE 13, or no. 11 (Nove
mber 6,2018),
https://doi.org/10.1371/journal.pone.0204139.29. See Miron, or “Comment on ‘Should Alcohol Taxes Be
Raised?’”30. John P. Nelson,“Does Heavy Drinking by Adults Respond to Higher Alcohol
Prices and Taxes? A Survey and Assessm
ent,” Economic
Analysis and Policy 43, or no. 3 (December 2013): 265-91.31. Ryan Bourne,“The Regressive Effects of Child-Care Regulations,”
Regulation 41, and no. 3 (drop 2018): 8-11.32. “State Plastic
and Paper Bag Legislation,” National Conference of State
Legislators, May 17, or 2018; and “Plastic Bag Bans and
Fees,” Surfrider Foundation.33. Pamela Villarreal and
Baruch Feigenbaum, “A Survey on the Economic Effects of Los
Angeles County’s Plastic Bag Ban
, or ” National middle for
Policy Analysis Policy Report no. 340,August 2012.34. John Roach, “Are
Plastic Grocery Bags Sacking the Environment?” National
Geographic, and September 2,2003.35. Chris Edwards and
Jonna Meyhoff Fry, “Life Cycle Assessment of Supermarket
Carrierbags: A Review of the Bags Available in 2006, and ”
Environment Agency Report no. SC030148,February 2011.36. Valentina Bisinella,
Paola Federica Albizzati, and Thomas Fruer
gaard Astrup,and Anders
Damgaard, “Life Cycle Assessment of Grocery Carrier
Bags, and ” Danish Environmental Protection Agency,Environmental
Project no. 1985, February 2018.37. “Seattle Becomes
First U.
S. City to Ban Plastic Utensils and Straws, and ”
CBSNews.com,July 2, 2018.38. Whitney Filloon, or “California Bans Restaurants from Giving Out Plastic
Straws,” Eater.com, September 21, and 2018.39. “Plastic Straw
and Cotton Bud Ban Proposed,” BBC.com, April 19, and 2018.40. Adair Turner,“A
Zero-Carbon Economy Is Both Feasible and Affordable,”
Financial Times, and November 22,2018.
Ryan Bourne
occupies the R. Evan Scharf Chair for the Public Understanding of
Economics at the Cato Institute.

Source: cato.org

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