Market Failure 8: Non-Efficiency policy goals (The right tool for the right job)

Policy analysis is client-oriented advice relevant to public decisions and informed by social values.

David L Weimer and Aidan R Vining, Policy Analysis: Concepts and Practice (3rd Edition)

Microeconomics as a discipline is focused on allocative efficiency as a goal. The entire structure of market failure economics is an attempt to answer the question of what kinds of government intervention will be allocatively efficient. But while allocative efficiency is very important, it is not the only goal policy-makers (or their constituents) value. These other goals do not fall neatly into the structure of microeconomics, but there are still some pieces of general advice I can give.

The sorts of non-efficiency policy goals I’m thinking of are:

1. Changing the distribution of incomes in society (e.g. welfare)
2. Providing of social services that are considered moral necessities (healthcare, public housing)
3. Supporting an industry for cultural or historical reasons (indigenous fishing rights, protecting traditional production of a good or service)
4. Economic policies enacted for national security reasons (18th Century Britain’s Navigation Act, or requirements that defence contractors produce their goods domestically)

Each of these policies has different rationales and effects, so rather than go through every possible intervention, I want to outline some points to bear in mind. Most of these are worth remembering no matter what kind of intervention you are planning.

The market has not failed. As I noted in Part One, the market’s function is to efficiently match demand and supply using the price mechanism. Market failures are phenomena that prevent the market from doing that properly. The market is not able to produce arbitrary income or wealth distributions, or promote certain industries out of proportion to market demand. This does not mean the market has failed, but merely that it is not capable of achieving every possible goal. Your car can’t fly, but that doesn’t make your car defective. What is does mean is that if you want to fly you won’t be able to use your car to do it. Similarly, if you want something other than allocative efficiency, you need to consider alternatives to market mechanisms. Your goal here is not to “fix” the market, but rather to get to your goal by working around the market as much as possible.

Efficiency is still important. Allocative efficiency isn’t everything, but it is very important. Efficiency is a measure of how well society is using limited resources to improve human well-being. No matter what you are trying to achieve, that matters. Be aware that any change you make to relative prices (the mechanism the market uses to convey information) will come at a cost to the well-being of consumers even if it is not immediately visible. That may be a price worth paying, but it is a price, and you should be aware of what you are sacrificing. You should also be aware of the welfare implications of your intervention. Know who your intervention is likely to harm.

Avoid distorting the market more than necessary. Since the market is doing what it is supposed to be doing you should endeavour to avoid messing with it more than you have to. There is a spectrum of intervention in the economy that looks something like this (from least intervention to most):

• Do Nothing
• Moral Suasion (asking people to do or not do something)
• Choice Architecture / Nudging
• Taxes or subsidies
• Regulations that don’t directly control prices and quantities (quality standards, disclosure requirements etc.)
• Regulations that do directly control prices and quantities (price floors or ceilings)
• Direct government control of production or consumption
• Outright ban of good or service

Think about how interventionist the government needs to be to achieve your goal. Can you support traditional industry with a subsidy of a handful of model producers rather than tariffs or price supports? If people can’t afford to purchase something essential, can you just give them a cash transfer (funded by relatively neutral methods such as income or consumption taxes) rather than having the government produce the good or service directly? Just because the price of intervening may be worth paying doesn’t mean that you shouldn’t try to make that price as low as you can.

There are also a few things that are worth bearing in mind for any policy intervention:

Simplify where possible. Complex interventions are harder for the public to understand and therefore it is harder for the public to hold the government to account over a complex intervention that doesn’t live up to its promises. Furthermore, the more things that have to go right for your intervention to work, the more likely it is that something will go wrong. Your interventions should have a clearly specified goal and ideally a reasonably straightforward intervention logic.

Separate out your interventions. On a related note, it’s a lot easier to understand several simple interventions rather than one complex one. The danger of trying to make the one intervention do several things is that it will probably do none of them very well, and it will insulate itself from criticism by pointing to its diverse mandate. I know you will want to protect your intervention from you political opponents. After all that’s a natural human response. But if you can’t admit when you are wrong, you can’t improve. And it is the people you are trying to help that will suffer for your failure to learn all the lessons you can.

Focus on your objective. Many people will suggest any number of policy options to achieve your objective. Few of them will have a good handle on how to craft a good policy intervention. Some people will naively suggest an intervention because it was the first thing that popped into their mind, or because some other country has implemented something like it. Other people will make suggestions that will be of advantage to them personally. The question you should always keep in mind is “Is this the most efficient method of achieving the goal?” You can’t let the perfect be the enemy of the good, but you should let the good be the enemy of the bad. It’s very easy to get caught up in partisan wrangling, but if you look for opportunities to advocate for good policy, you can make a positive difference.

Learn from experience. You will never know enough when you set your intervention up. Given the complexity of the market system, any policy intervention you implement will almost certainly have several important details wrong. If you wish to succeed, you need to monitor your intervention’s effects over time to make sure they are achieving what you set out to achieve. (This is one of the reasons defining your goal is so important.) Ideally, you should set up your interventions so they can be easily evaluated, but at the very least you should have a protocol set up in advance for evaluating your intervention, with clear criteria for what success and failure look like.

Listen to the experts. While these posts give you some of the basics, policy-making expertise requires more knowledge than a few blog posts can convey. Knowledgeable experts can help you design a policy to best achieve your goals. They can also help you figure out who is most likely to win or lose from a given intervention and by how much, and design a robust protocol for working out how well the intervention does against its goals. You don’t have to obey expert advice, your values may differ after all, but at least hear them out – you may be pleasantly surprised.

And that brings us to the end of this series. I hope you have found it interesting.