Posting on the Institute of Economic Affairs blog, Tom Papworth tries to clarify what the term “market failure” actually means, in comparison to how it’s commonly used by politicians and journalists:
Firstly, it seems to blur the distinction between ‘the market’ and ‘the markets’ — a very common error in current discourse. The market is an economic concept that describes the myriad of choices and exchanges that take place between people every day; the markets are the very real institutions created for handling major financial transactions. It is not clear to me that this article acknowledges that distinction. This manifests itself primarily in the title and main theme: indeed, as Jan (and at least one commentator) does tacitly acknowledge, the financial markets are so shaped by government intervention that it would be a surprise if they did correspond to a model market.
And that brings me to the second problem: the suggestion that markets don’t fail when they ‘respond rationally, quickly and often brutally to conditions as they find them’. While that description is true, it has little bearing on the concept of market failure. Market failure typically refers to situations where the effects one would expect to see in a theoretical market economy do not in fact manifest themselves in real life. As the great man himself would be — and perhaps was — the first to point out (though without using these terms) markets fail because of factors such as monopoly and externality — monopolies undermine competition and so markets do not clear; externalities enable costs to be passed onto third parties and prevent all beneficiaries contributing to the production of goods. Information asymmetry is often presented as another source of market failure.
Now, to be fair to Jan, that precision of language is hardly prevalent among the politicians he is criticising. When they speak of market failure, it seems almost as though market success is defined by a number of uneconomic measures such as social justice, or even (that ultimate weasel-word) fairness.
