Fix Highlighted + Conclusion

This paper examines the failure of markets and policies in the USA and tries to identify which one of the two is the cause and which one is the effect by analyzing existing literature on this issue. The aim of this paper is to narrow the debate between those that blame policies for market failures and those that blame markets for policy failures by identifying any core underlying aspects that might be contributing to both! The paper takes the stance that policy failures spur market failures by primarily focusing on articles that discuss market failure in the context of policy failures.

The purpose of this paper is to examine the failure of markets and policies especially in the USA. This essay attempts to see the reasons of market failures caused by the policy failures and policy structures. It is important to remember that there are many ways of going around this issue and the current literature tends to take both sides of the issue very clearly. There is a group of academics who tend to believe that market failures cause policy failures and not vice versa. The other group tends to support what is the thesis of this paper that policy failures cause market failures.

The discussion of market efficiency and its policy implications is introduced as a start-up point for market and non-market failures. The explanations provided by some authors on this issue is both, interesting and disturbing because the majority of economists believe that policy formulation and implementation has a significant role in policy failure, thereby causing market failures. Most economists tend to ignore or confuse non-market failures with market failures and thereby blame the policies for all kinds of failure in the market.

The basic flaw in this analysis lies in the explanation of the structure, scope and goals of a policy and their respective definitions. Another flaw in this analysis is the lack of clear distinction between policy ineffectiveness and policy failure. However, this topic is beyond the scope of our current analysis and hence is not discussed in detail. The third flaw that is noticeable is that the policies taken into consideration vary from environmental to trade, and hence are not entirely comparable.

In spite of these flaws, this paper tries to give support to the argument that policy failures spur market failures rather than vice versa, the case study being the USA in almost all the articles reviewed. The basic premise for the articles is market failure, explanation for its existence and its dependence on policy failure.

Economists originally presented the concept of market failure as a normative explanation of why the need for government expenditures might arise. It has taken on the form of a full-scale diagnostic tool frequently employed by policy analysts to determine the exact scope and nature of government intervention. The concept of market failure is basically flawed, argue Zerbe and McCurdy in their paper on “The Failure of Market Failure” (1999). From the perspective of transaction costs, market failure diagnostic leads analysts to make generalizations that are not necessarily supported by facts, but mere empirical evidence. The transaction cost analysis helps to explain the underlying processes involved.

White (1976), in his article on “The Anatomy of Market Failure” synthesizes the work of Francis Bator, thereby distinguishes the modes of market failure, and subsequently identifies the main causes for these failures. His basic premise is that public policy analysts need to make an effort to generalize about the circumstances under which public policies fail. This framework has then been applied to environmental policy. It is interesting because typically environmental policies have a higher chance of failure as they are necessarily interfering with the market and thereby cannot be completely excluded from being the cause for market failure. Academic work has gone on for years to describe the circumstances in which markets fail in the distribution of goods and incomes and developing these models. Nevertheless, there is not enough analysis of circumstances in which public programs and policies fail. The problem is not that analysts have failed to find fault with various public programs. Instead, these criticisms have never been systematically synthesized and used as an alternative to the “market failure” approach. White tries to pose an important question for policy makers and policy analysts that how does existing non-market decision-making compare with an idealized non-market system. White insists that environmental policy is a non-market failure, but in my opinion, this article has many flaws that need to be overcome.

Keck (1987) makes another interesting case for market failures in his article “The Information Dilemma”. He says that private information is the cause of transaction failure in markets, regulation, hierarchy and politics. Information asymmetries persist because in certain situations the one who has it cannot appropriate the value of information. He uses a game-theoretic model for information asymmetries and shows that under certain conditions a typical prisoner’s dilemma exists. His model clarifies the failure of markets to transmit certain types of information and explains policy failure in regulation without recourse to government failure. He also identifies new types of transaction failure in hierarchy and politics. Thus, Keck believes that at the root of both, market and policy failures, is the failure of information transactions.

Townley (1990) talks about life-insured annuities and says that private annuity markets fail because of adverse selection. His premise is that retirees would benefit if they could spend at least some of their accumulated, non-social security wealth on publicly provided annuities. Governments do not operate such plans and optimal plans may not be feasible because of informational constraints. However, if ranked on both economic and political criteria, potentially welfare-enhancing compulsory and voluntary annuity plans that are feasible are not very dominant. The dilemma between market failure and policy is explained as the main reason for government inertia in this area.

Amsberg (1995) talks about intergenerational market failure in the environmental perspective and explains that markets do not work efficiently transmitting across generations. He uses overlapping-generations models to show that the incompleteness of intergenerational insurance markets constitutes a market failure that leads to inefficient intergenerational investment decisions under risk. Early generations over-diversify if they face risks that are larger than those of the following generation and could, therefore, be shared with them. On the other hand, if risks were increasing from generation to generation, the current generation would under-insure against those risks. The direction of the inefficiency depends on the nature of the risk assumed, the policy implications depend on the empirical assessment of the risks that current, and future generations are facing. Amsberg’s paper provides applications of the general result to environmental problems such as global warming, reduction of bio-diversity and inefficient depletion of natural resource. Though his paper does not directly deal with policymaking process, it is significant to our study because it provides an insight into some market failures that are not policy based, but entirely risk-based. Since environmental policy is the one that is most likely to fail because of high start-up external costs, it is important to remember that policy implementation is valued more than policy formulation. In addition, policy makers need to consider the risks to the past, current and future generations in terms of business before establishing hard-to-achieve standards for the current generation.

Gupta, Miranda and Parry (1995) talk about public expenditure policy and the environment and commonly cited environmental instruments in the legal, regulatory and fiscal domains that primarily address market failures to ensure that environmental degradation and resource use is contained to appropriate levels. They argue that in many instances, environmental degradation is rooted in policy failure rather than market failure. This paper argues that a reform of certain types of subsidies, increased operations and maintenance expenditures and thorough environmental assessment of capital projects will benefit the environment and move the economy towards a “sustainable” development. They argue that public expenditure policy will directly influence the market for environmental protection, which is an externality in itself. Now we go on to discuss the literature that talks about policy failure and reforms required to avoid it.

Mesquita et al (1999) advance in their paper on policy failure and political survival, a theory of the effects of political institution on state policy. It explains how political institutions affect the ability of leaders to maintain themselves in office and why some systems are more prone to policy failure than others are. It also explains why some autocrats create mass political systems. The three main results of their statistical study are that large winning coalitions are associated with enhanced economic growth, tenure is shortened by large winning coalition but lengthened by a large electorate and in the face of policy failure, leaders with large electorate are more likely to survive than those in systems with a large winning coalition. This paper is directly related to our study because in order to understand policy failure, it is important to keep track of the political influence on the policymaking process. This is a theoretical approach and is therefore just an introductory point in our analysis.

May P. (1992) in his article on policy learning and failure conceptualizes two forms of policy learning – instrumental and social. This includes lessons about the viability of policy instruments and implementation designs and the social construction of policy problems, scope of policy or policy goals. Policy learning is distinguished from political learning with which policy advocates become more sophisticated in advancing problems and ideas. Sets of United States policies that have been revised in response to widespread perceptions of policy failure are discussed in this paper. In principle, policy failure presents opportunities for policy learning. However, several features of American politics constrain each form of policy learning and foster political learning instead. This article is useful for our study because it deals with yet another cause of policy failure that is not market based. However, it would be interesting to pursue this line of discussion (beyond the scope for this paper) by considering the political arena as a market in itself and considering its success and failure with respect to policy.

Robertson (1989) talks about three most common interpretations of the war on poverty and the comprehensive employment and training act in his paper because of the failure to distinguish between ineffectiveness and political failure. He says that failure owing to central government incompetence, pluralism and “hidden” success is often misconstrued as policy failure, which is not the case evidently. The reasons he talks about cannot adequately account for the gap between the ambiguous performance of policies and their clear political failure. He adds further that for social policies, resources constraints and large degree of policy discretion in our current system, states tend to retain the historic resistance to social policies that would increase short-term expenditures and reduce the attractiveness of their business climate. Representatives from the states tend to oppose fully nationalized initiatives and insist on policy designs that promise fiscal relief while protecting state and local policy control. He says that social policy programs generally tend to yield ambiguous overall results and provide unambiguous examples of waste, fraud and abuse. This paper is relevant again because it blames political failure as the root cause rather than market failure for policy failures. Typically, market failures do not seem to be playing a major role for policymaking, but the fear of market failure causes inaccurate analysis of the policy and thereby becomes a self-fulfilling prophecy.

Scarpff (1986) talks about policy failure and institutional reform and reviews relevant literature for the same. He questions the proposition that form should follow function in institutional reform. Institutions may be important determinants of policy performance, but the author does not share the optimistic expectation that institutional or organizational factors could be treated as design variables, that can be manipulated.

Another relevant paper for our discussion is the paper by Seroka and McNitt (1984) that talks about program design and central focus of policy. They claim that these factors need to be thoroughly understood to analyze policy failures. Implementation scholars often cite “creaming” as an example of failure of policy design to determine policy execution. Creaming is the practice of selecting the least disadvantaged for social benefits. The authors trace the origin of creaming in two revealing programs – US Employment Service and Manpower Development and Training Act. These programs were legitimated on the basis that they would serve large segments of the American labor force; they were designed to server employers. The authors conclude that program design and implementation are closely linked. If the design is aimed at a different set of people than it is supposed to be, the policy is doomed to be insufficient and, in some cases, even fail. The growing literature on policy implementation reflects a decade of skepticism, reduced expectations and conservative renewal. This is but “a thread in a larger fabric of research exploring the overwhelming social complexity, fiscal and political overload in government, futility of planning and failure of the great society.” This paper is supporting the evidence that policy failure is caused by policy makers and improper information transit rather than the markets per se.

Foreign policy of the United States is often criticized as being invasive and inextensive. Vasquez (1985), in his paper talks about the different periods or cycles in which public and congressional involvement and interest in foreign policy increases and then wanes. Dynamics of domestic contention on foreign policy are discussed with respect to changing times. He goes on to talk about the contention over foreign policy as having an important impact on world politics. He also suggests that the reverse has been neglected and needs to be looked into. The relevance of this paper for our study lies in the fact that it gives yet another reason for policy interest and failure – circumstance! Since foreign policy has a definite impact on the markets, both local and foreign, its failure has many implications. He has talked about the Vietnam War, but even today post 9/11 the foreign policy has become a very important part of people’s everyday lives. Thus, market does not influence policy to the same extent that policy affects the market.

Atkinson and Coleman (1987) talk about micro, meso, and macro levels at which the state confronts the economy and a disaggregated view of the state. The article uses the concepts of state capacity and societal mobilization to identify the six ideal typical policy networks at the sectoral level. It elaborates on the organizational logic associated with these policy networks by examining them in conjunction with industrial policy. After the distinction between two approaches to industrial policy – anticipatory and reactive, the article shows how different policy networks emerge to support alternative approaches and how a disjunction between networks and approaches can produce policy failure. Again, this is reminiscent of the cause of market failure – network and information exchange. Thus, the debate between market failure and policy failure affecting each other is justified, as we have found that there are some common reasons to the failure of both, and we need to remove causality for further research in this field (beyond the scope of this paper).

The paper by Rodrik (1996) on understanding economic policy reform is relevant because it also brings together market and policy. Economic recovery and success is the focus of almost all governments as it assures political success. Reform requires austere policies, which respect budget constraints. It also precludes compromising with the narrow, special interest groups that have been the beneficiaries of the deleterious policies of the past. Policy makers take on such groups and pursue market-oriented policies. The main question considered by the author is why reforms should be unpopular. Reforms arouse opposition, Rodrik explains, if they are viewed as applying the wrong fix or if they are perceived as being primarily redistributive. Economic strategy emphasizes fiscal rectitude, competitive exchange rates, free trade, privatization, undistorted market prices and limited intervention. Since these issues directly link with the development of the nation, political leaders have a duty and desire to have a good economic strategy.

Cooke (1985) talks about determinants and policy implications in his study on why unions fail to secure agreements in twenty-five percent of their negotiations in spite of winning certification rights. Chamberlain’s theory of relative power of negotiating parties as a function of the costs, shaped by economic, legal and organizational factors, of agreeing and disagreeing is brought to the front in this paper by statistical analysis. He concludes that when national union representatives participate in negotiations, and bargaining units are relatively large and cohesive, unions are more likely to obtain first contracts when firms pay wages well above the industry average. Though this paper at first glance seems to be irrelevant to our study, with scrutiny we can realize that it is. The reason for saying this is that when collective bargaining can sort and clarify things at a micro level (going back to Atkinson), would some such system not be affecting policy. Interest groups, those are representatives of industry pretty much do the same thing for congressmen and thereby influence policy. The more cohesive ones are likely to get what they want even if it is not entirely efficient from the market perspective.

Thus, we have seen that policy failure has similar causes for failure as does market failure. Since policymaking is dependent on political factors, markets tend to follow the trend rather than set it. In a bipartisan system like ours, it becomes increasingly difficult with time to distinguish between markets and policies over time. Though the ideology of the parties is very different, the policy impact created in the end is not.

Political factors are closely entwined with the market because of policymaking strategy and ideology. The scope of this paper was very limited but further research and empirical analysis of this issue is likely to bring up many interesting points and causalities, which could help reduce the debate on market and policy failures.

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