The idea for the Theoretical Foundations work programme topic came from reading John Kay.
John Kay is a British economist and writer. He has been director of the Institute for Fiscal Studies and a columnist for the Financial Times. His most famous book is probably The Truth about Markets (2003), which I haven’t yet read.
But I have read “Market Failure”, a chapter in a book called Beyond New Labour: The future of social democracy in Britain edited by our old friends Patrick Diamond and Roger Liddle, that covers some of the same ground.
In this chapter, Kay discusses how modern progressives – he is focussing on New Labour in the UK but the lessons go wider – have embraced the doctrine of ‘market failure’ as a way of squaring an acceptance of a market economy with a continued desire to address inequality. This, he says, has been a mistake.
Under the market failure doctrine, effective market outcomes rely upon the following four conditions, and there is an ‘efficiency justification’ for state intervention if any of them are breached:
- A competitive environment
- Consumers have good information about their needs and the services available
- No ‘externalities’ (the good or service affects only the producer and the consumer, not any third parties)
- No ‘public goods’ (producers can identify the consumers of the service, and can quantify the consumption and charge for it).
We can probably all think of instances where such breaches occur. A number of environmental issues for instance, including the climate challenge, are situations where condition 3 does not hold.
The market failure doctrine therefore seems to offer plenty of scope for progressive action, while also feeling quite prudent and economically literate. It is understandable that it would have seemed an attractive approach for modernising progressive parties.
But, according to Kay, market failure is a bad argument for progressives to buy into. “By conceding too much to market fundamentalists it loses both intellectual coherence and political resonance.” (p. 74)
Kay mounts a comprehensive critique of the market failure doctrine thoughout his chapter, but the theoretical core of his argument can be found in the following paragraph (p. 76):
The basic philosophical differences that divide left and right concern the priority that should be given to claims of individual rights and private property relative to those of solidarity and social justice. The left insists, and the right denies, that the public interest is more than an aggregation of private interests. The model that underpins the market failure doctrine answers these questions, and others, in the right’s favour. A particular philosophy is inherent in the mathematics. The model takes individual preferences as given, along with personal resources and property rights, and sees social welfare as an aggregation of individual preferences. The primacy of material incentives as determinants of economic behaviour is not a prediction of the model, but an assumption.
Moreover, because the modern left has invested so much in market failure as its rationale for action, there is a temptation to frame everything they want to do as a response to market failure, however tenuous the basis for this may be. Kay cites the example of health, where Gordon Brown insisted on explaining his commitment to a tax-financed National Health Service by reference to market failures that, while real, did not actually justify the particular model he supports.
“More importantly, they have nothing to do with the real reasons why most people – including Brown – support a publicly funded NHS. These reasons begin from ethical concepts such as compassion and fairness rather than economic concepts such as information asymmetry.” (p. 76)
And this is the crux of the problem. “The notion that some economic choices are essentially collective, and cannot be described as a summation of personal of personal preferences, strikes at the heart of the market failure doctrine.” (p. 77)
I can relate to this. Back when I worked for NZUSA in the late 1990s there was a lot of debate about the extent to which tertiary education was a private good and should be privately funded through student fees. The students wanted to maintain that tertiary education was a public good and should be fully publicly funded. I was keen to dissuade them from this – while they had good arguments against particular claims about the private benefits from tertiary study, by buying into the public/private benefit argument, they undermined their own position. There is clearly some private benefit from study so you couldn’t argue for free education on public/private benefit terms.
Instead, I argued, they should seek to frame tertiary education as a collective good, i.e. one which society should agree to fund collectively as it does for school education.
John Kay makes a similar point: “The majority of contested economic policy issues reflect disputes about the nature of entitlements, or they occur when parties look to the government to fill in the implicit terms of imperfectly specified contracts.” (p. 81)
And, indeed, first amongst his list of illustrative recent policy issues is tertiary fees, framed not as public/private benefit or as (market failure) barriers to participation, but as “What rights of access do individuals have to higher education, and on what terms?”
Progressives in New Zealand have not made as extensive or explicit use of market failure as a theoretical framework as appears to have been the case in the UK. Nevertheless, these and other market-oriented economic concepts have permeated policy discussion pretty thoroughly in this country for the last twenty-five years, and to a large extent progressive policy thinking has accommodated itself within that discourse.
In the Theoretical Foundations work programme topic, I want to take a step back from that and have a look at the theoretical arguments we progressives rely upon to justify our actions and initiatives. Are they fit for purpose, or, like the market failure doctrine, do we end up either making tenuous linkages and/or conceding significant intellectual terrain to our opponents?
In Tuesday’s post, I’ll survey Kay’s proposed alternative to the market failure doctrine.
Tags: John Kay, market failure, New Labour, Policy Network
While I know you’re moving away from market failure, you still present a pretty light characterisation of that issue at the start. A gap on one of those four criteria does not give an efficiency justification in itself as you have to weigh up the benefits and costs of that intervention. No comment on your alternative approach.
I agree that I did skimp a bit on the characterisation of market failure, in order to keep the wordcount from being even longer. So thanks for the opportunity/excuse to expand upon that!
Kay does cover the point you’re making, noting that “market failure must be measured against ‘regulatory failure’ – the difficulty a government may encounter in its achieving its own objectives.”
And in fact this makes market failure an even more disappointing and dangerous idea for progressives to buy into. Disappointing, because the opportunities for justified action that those four conditions initially seem to offer will often prove illusory once these countervailing ‘regulatory failure’ costs are factored in. And dangerous, because the temptation to make tenuous linkages so ‘market failure’ can be used as the basis for an initiative means that a properly-grounded analysis that actually works through the costs and benefits may often not be undertaken.
David,
Like you, I think our buying into the public/private debate in tertiary education was a loss of vision as to where that would take us. We didn’t argue outside the box and bought into fighting on the wrong field of battle. The ground has long been lost, and there’s no signs of education as a collective public good being argued these days. We will have a user pays tertiary education system until that ground is reclaimed, which is tremendously hard.
That’s interesting, Kyle – I hadn’t really clicked that students had slipped back into using the ‘public good’ frame for their arguments. Not surprising I guess since it was a pretty prominent and superficially-attractive one. Not that there aren’t challenges with mounting a collective good argument, of course – it works for school education, but the school experience is much more uniform in form, duration and resources used from one person to the next than tertiary is. Still, particularly if you want to argue for free education, it provides a stronger basis that public/private benefit.
David
1. Long time reader and fan, first time commenter. This site has some great stuff.
2. I agree that mounting a progressive argument **completely** based around an alleged market failure is a bit narrow. But it doesn’t follow from that statement that market failure arguments should be avoided.
3. Using the language of economics to defeat the right is, when possible, more powerful that rejecting the traditional economic paradigm entirely. Why? Two initial reasons:
a. In a country like NZ, if you get saddled with the reputation for being “anti-economics,” then I conjecture that you almost certainly lose. The population has already bought into a broadly traditional economic paradigm. Sure, you get some support and some votes, but not enough to actually make any changes.
b. In adopting economics language but not right-leaning conclusions, you limit the number of places your rhetorical opponent can hide. They no longer have grounds for saying “she just doesn’t understand the way the economic world works” etc. Sure, sometimes they’ll say it anyway, but they won’t get as much purchase.
4. I think there are other very good ways to use concepts form economics to advance a progressive agenda. We can use then either in addition to or instead of market failure rationales. One currently in vogue is to take the concept of “utility” seriously. For many even serious thinkers “utility” = “money,” that is why all the economic models based around utility end up getting estimated using market income as a proxy. But utility is in fact much more than that – as all the econ texts tell us. There is a very fruitful progressive argument to be made that we are about maximizing the total utility throughout the land. This is happiness economics. Utility, it transpires, is mutually reinforcing – our own happiness is partly a product of our neighours’ happiness. This, I think, is an empirically verifiable demonstration of the progressive argument that social welfare is more than just the sum of all individuals’ atomistic welfare.
5. It seems Kay would likely reject the happiness economics approach as ceding too much theoretical ground. I disagree.
- Rob
1. Thanks, and welcome!
2. I think that’s probably true. In particular, I think the concept of ‘externalities’ is almost certainly useful when thinking about environmental policy issues. Kay’s objection was to progressive using market failure as the rationale for intervention (apparently the New Labour policy bible Microeconomic Reform did more or less say that state action was only justified where one of the four conditions were breached). On the other hand, two points to consider: if you’re not going to use market failure as your rationale, what are you going to use, and might it not be better to use that alternative rationale consistently instead? And it also assumes you accept all of the premises underpinning the market failure rationale.
3. I see what you’re saying but I think this blurs communication and analytical considerations in a way that could get a bit messy. To quote Kay again, “what politicians do is not always the same as what they say they do. But what they say they do frequently as substantial influence, direct or indirect, on what they do.” When we are deciding what we want to achieve and what policies are most likely to allow us to achieve that, we need to have our own theory of state action to guide us. Whether we make use of some other bits of ‘conventional wisdom’ when it comes to marketing those policies is a separate consideration.
And also, isn’t it partly because progressives don’t have an alternative theory of society and collective action that’s compelling and has strong explanatory power that populations have “bought into a broadly traditional economic paradigm”?
4. I think these points you make about utility and happiness are a useful avenue for further work. I’d be particularly interested (in the context of this topic) as to whether using this broader definition of utility changes the (rather pessimistic) conclusions that conventional economics comes to about the efficacy of public action.
5. Actually, I don’t think so: http://www.johnkay.com/2005/03/15/winners-and-losers-in-happiness-stakes/. More about what John Kay thinks on Tuesday.
David
Thanks for the constructive and helpful reply. I don’t think our positions on this question are very far apart, and I’m looking forward to learning more about Kay’s views on Tuesday.
Having said that, I was interested in your comment “isn’t it partly because progressives don’t have an alternative theory of society and collective action that’s compelling and has strong explanatory power that populations have “bought into a broadly traditional economic paradigm”?” I think what you say here is possibly true, but not necessarily a good reason for scraping around for an alternative theory *at this point.* It is a little like building a fancy new barn while watching the horse run halfway to the horizon. Step one should be to go get the horse, which in this instance we do by speakng the language the horse *is* listenng to, rather than the language we think the horse *should be* listening to.
And in answer to your (4), yes I think broader happiness-based conceptions of utility to change many of the policy conclusions from economic analysis. See almost any happiness ranking within the OECD for a quick illustration – the higher tax more equity-oriented populations are often happier than more market-oriented societies like the US and UK. I think this a significant part of the argument in The Spirit Level, too (although I concede I have yet to read it.)
Yes, I’ve got to get around to The Spirit Level, too. I heard an interview with one of the authors a while back, and I’ve gotta confess I’m a little sceptical. It just seems too convenient. I keep hearing “correlation does not equal causation” in my head – but maybe they can convince me.
And, incidently, that same objection can be advanced against some of those happiness ranking findings. That’s why [cue broken record] we need a convincing theoretical argument to use to interpret those sort of findings. Still, I definitely intend to look at ‘happiness economics’ over the course of this topic – cheers for the suggestion!
Re your second para – I think it comes down to who you mean by “we”. Figuring out the best political communications strategy to win the 2011 election is important but if I thought the Theoretical Foundations topic was likely to make a difference in that sort of immediate way, I’d be trying to fast-track it a bit more than I am!
Your ‘use their language’ approach might well be the best way to proceed for that purpose. But that purpose is not the primary purpose of this ‘think-site’ – see for instance my initial post: http://www.policyprogress.org.nz/2010/02/first-post/.
I would note, though, that a person who gets very good at figuring out how to mount a horse, without knowing how or where to ride it, might be getting themselves into no end of trouble . . .
Ha – I like the running barns and horses thing. To wit: a man who has mounted a horse and then has to figure out where to ride it has more agency than a man who sits alone in a flash, shiny, empty barn.
More seriously, I’m not sure I agree with the bifurcation you propose here between analysis and communications. The “speak the same language as the populace” position s not solely a communications strategy. You can also think of it as analytic pragmatism. Remember, for every person who thought differently and changed the world, there are untold thousands who thought differently and changed nothing.
Not if the horse bucks him off and he breaks his neck! Aren’t metaphors fun?
Less flippantly: at the risk of being one of the untold thousands, I’m gonna keep exploring some different theoretical perspectives here for a little while. Will be interested to see whether this project comes up with anything you find useful, as it progresses.
I have found this a very challenging post – and you have found way of making the abstract sounding topic of ‘theoretical foundations’ something ‘graspable’ in more practical and concrete terms.
I would like you to expand more on the notion of ‘collective goods’ – and elaborate that argument – it obviously needs to get beyond ‘we assert this to be a collective good ergo it must be provided collectively’.
So far (and you have only had an opportunity to get warmed up!) it sounds like you are just talking about the distribution and redistribution of opportunity and income. If that is all it is, then I see it as complementary to the market failure argument – in fact a lot of us actually include that as an aspect of market failure.
I have tended to view health care in this way – the equity/justice/redistributive argument is why the government funds healthcare for everyone (there is also an efficiency argument i.e. healthy people = productive people). However you also need to justify why the government should also be the dominant supplier of healthcare services and why we shouldn’t just give everyone a voucher – in my view that has to do with organisational efficiency and also countering the market power of potential private sector providers who will add in a big fat rent seeking super profit margin.
Thanks for the kind words Achela – I was fairly pleased with this post, myself. I found the Kay chapter a very stimulating one, and feel I did reasonable justice to it. Nevertheless, it’s certainly worth hunting out the original – you may be particularly interested in the part where Kay talks about market failure as a rationale for health policy (which addresses your last point at least in part).
Interesting that you see income/wealth/opportunity distribution as an element of market failure – I guess that rather transforms the concept, and probably makes it more attractive. But I don’t think that’d be part of the standard definition – it’s certainly not part of the one Gordon Brown was putting forward.
Re collective goods, yes there’d be a need to theorise it some more. I was able to cheat on this with tertiary fees back in the ’90’s by just (as I noted in my response to Kyle) extending the logic from school education, where there is a pretty well-established consensus that we provide it collectively (even though there’s a clear private return from learning to read etc etc). But I think an element of this probably probably would be by assertion/negotiation (cf Kay “The majority of contested economic policy issues reflect disputes about the nature of entitlements) – you can also see this in the social democratic concept of “the social wage”.
Tuesday’s post may (or may not) help to illuminate matters some more, at least in terms of Kay’s thinking. It may not be what people are expecting . . .
1. Yeah you are probably right that ‘market failure’ is traditionally defined in terms of failure to reach economic efficiency. I agree it is useful to ring fence those particular failures (externalities, imperfect competition etc) into one group. Though I do wonder whether the coining of the word needs to be challenged and updated as the market’s failure to distribute income and opportunity according to human need, and the market’s failure to be just would be its biggest failures in my book. But let’s not put too much focus on rhetoric and semantics!
2. Now that I have had time to sleep on it I begin to see your/Kay’s point as being quite obvious – the reason governments began to intervene in the welfare area (health, education etc) was first and foremost motivated by income distribution – a lot of people could not afford the essential services they needed. I suspect we lost sight of that during the 80s when the health of public finances became the central obsession and the alleged efficiency impacts of taxation were used to curtail govt spending – in that context I can see why some advocates may well have turned to economic efficiency arguments (i.e. market failure) to shore up the defence of the welfare state.
3. Having said that I want to make a small plug for the ‘Material Welfare School’ (see Robert Cooper and Peter Rappoport – ‘Were the ordinalists wrong about welfare economics?’ – J Econ Lit June 1984 – yes I know sounds terribly obscure;-) As I recall (and it’s been even longer since I read Kay’s book) they were arguing in the early 20C for a welfare state on grounds of economic growth i.e. health = productivity. I think Alfred Marshall and AC Pigou were the main exponents of this line of thinking.
4. OK now it sounds like I am contradicting myself. I guess I don’t see why we should argue about which rationale for govt is the one that should be emphasised the most – we need to be aware of the whole kit of rationales at our disposal and deploy them as the issue or political situation demands it.
5. There does seem to be an important issue about the government budget constraint – which is where things went wrong for us in the discourse of the 80s. There are all sorts of issues there – e.g. the myth that NZ is a high tax country when we are in fact one of the lowest. The myth that high tax = low growth and productivity &c &c.
6. This is where the Material Welfare School, revised and updated for the early 21C may come into it – if you can argue that there is actually a positive feedback into economic performance you get a virtuous circle of improved welfare leading to improved economic output leading to improved tax revenue leading to improved govt spend on welfare leading to improved welfare…
7. And now for something completely different. One aspect of theoretical foundations that I would like to see mentioned is the idea that ultimately nations, can’t solve all of our problems by ourselves – most of our problems are global or at least universal in nature and ultimately will require the international community to come together and rework our international trade and monetary institutions. I raise this because I won’t to see this recognised as an important aspect of NZ’s foreign policy – that we should make diplomatic efforts on this front. If NZ can put diplomatic efforts into something as ambitious of ridding the world of nuclear weapons we can do the same on this front. The world started to have this conversation 30 years ago around the issues between North and South (ie developed and developing countries) which culminated in the Brandt Report. Unfortunately Thatcher and Reagan were elected and the international conversation went off in a different direction. Last year during the ‘peak’ of the economic crisis I started to see the signs of a similar conversation beginning. As I believe the crisis is going to come back with a vengeance then a window will open to pick up where the Brandt Report left off 30 years ago – http://www.brandt21forum.info/
Hi,
really interesting stuff. I would love to see the shiny new barn. That’s what I come here for, I guess. But while that’s being built, I think there is still such enormous mileage to be gotten out of the externalities argument here in NZ. Just look at dairying – runoff – algae bloom – drinking water … It’s so obvious, and pertinent, and important, and a powerful argument without needing to convince anyone of a completely new political worldview. I don’t think this argument should be abandoned because it buys into market economics in the first place. So let’s do both – work on the barn and catch that horse. Because there are enough of us. Cheers!
Fair enough!
[...] « The Failure of Market Failure [...]
Just my 2 cents to note that I’m really elated to see that you’ve started to comment Rob, and say that you’ve pretty much managed to nail all the points I’d want to make in a conversation with David.
I agree you two aren’t that far apart but the distance still matters. And on the issue of language – it matters very much. Yes we need to be clear on our own language (in the metaphor, we need to think carefully about the barn we want to build) but we also need to understand and be fluent in the language currently in vogue (we need to go and get the horse – and I’d suggest that the first place to use our agency and take it is back to the ranch where we hobble it and start building our barn).
Hobble it, eh? Wonder what that translates to in real-world policy terms . . .
Dude, what good is lame horse? You don’t even need a barn to keep that bad boy in place.
it is now official: I have entirely lost track of this metaphor.