Wednesday, August 22, 2007

Market failure and government failure: which one do you prefer?

When social interest does not line up with private interest, we say the market fails. (The economist will say: It is when the social benefits curve lies below the demand curve; social optimum is at the crossing of social benefits curve and supply curve while market equilibrium is at the intersection of demand curve and supply curve. What drives the wedge? Negative externality).

Externality in the market invites government intervention: e.g. use tax to deal with negative externality and subsidy with positive externality. When there is an externality problem in the government we say the government fails.

When we have both market failure and government failure then we are really in trouble. What are the ways out? We can rely either on the market itself or on the government.

In cases like that of Indonesia, it is hard to believe that the government is efficient. The fact that we are still struggling with bureaucratic reform reveals otherwise. In other words, there are externality problems in the government. We do have government failure.

So it strikes me that some noted economists call for government provision of safety net as a prerequisite for removing the distortions in the market. That implicitly assumes that there is no problem with the existing government. Well, I don't buy that. After all, if the government can not solve its own problem, how come it even want to solve the problems in the market?


Yudo said...

Unfortunately, politics has corrupted these good people.

johnorford said...

strange, but i never really thought of the govt in that way, i always thought of them as a third party that shaped the market but didn't directly participate per se, so couldn't be accused of creating externalities...

unfortunately i can't understand the kompas article... but i reckon i agree with you.

what about this: the govt has monopsonies in the markets of power, every participant in an economy needs a specific "power" to be allowed do what they want to do. the more powers the govt has control over the more markets it undersupplies with power (because the indonesian govt officials are generally profit maximisers) resulting in an excess demand for power.

so i suppose the govt could be accused of causing costly externalities in the markets of power, and indirectly impacting multiple other markets (for example factors of production being undersupplied?).

interesting, if nothing really new...

in short, corrupt governments suck, and it's prob in their interest to try to maximise meddling, something indonesian politicians are world champs at!! :)

johnorford said...

sorry factors of prod should "under" demanded - or however u say it...

Aco said...

Hey, John, that is an interesting thought. Though public choice school will say it stronger: not only govt officials are in general profit maximizers, but they all do.

Thanks, John!

fau said...

I just read that article in Kompas. Kalla has a point, then.. :)

I don't know why are Indonesians so upset with the rising prices of sembako but keeping higher demand?

For me, if I think that one commodity is over priced, I will reduce the consumption and shift to other substitutions. Don't need to fry everything, I can eat healthier foods then :) And I don't need to eat rice 3 times daily.

I just can't understand why the poor choose to consume beras aking instead of singkong which is cheaper and healthier. Or do I have a strange mind?

Anonymous said...

fau :

I think, it is because the demand for rice is very un-elastic in Indonesia. May be it is because the Politics of rice during Suharto era. Thus, Indonesia people is not used to goods that substitute rice.

Moreover, the goods that substitute rice is not that cheap.

To Aco : If the government intervention in the market is removed, there must be some people who can not compete in the market (phisically diaable person, person with mental ill, cronic poor, old people, etc).

Usually, this kind of people is helped by the government through the social safety net ( even in the US i recall, they have all this program for disabled person). I agree that the government is sick, thus untrustworthy in handling this issue. So what is your suggestion such as this person do not "die" due to inability to compete in the market?


Aco said...

Budi, I wasn't saying that we want NO government at all. But we want some government that does not fail; so it has all the incentive to fix market failure(s). When the government is corrupt, I'd prefer market to heal itself. Of course, one way to reduce the likelihood of government failure is to shrink its role into where it is really needed in the first place (e.g. basic education, defense). Your example of physically disabled person, etc is for the government to take care only when his/her family gives up or abandon him. But let me ask you a hypothetical question. If one of your beloved ones is crippled, would you rather leave him/her to our government?