Market Failure and Government Failure

Markets sometimes fail. I say that as someone who tends to think market solutions should be more ubiquitous than they currently are. Yet I feel no shame in admitting that markets can  fail – indeed, they sometimes fail in spectacular ways. When markets appear to fail, the question becomes: should we automatically turn to the government for solutions? 

Market failures are one of the key rationales people give to argue in favor of government intervention. What people often fail to realize is that government solutions aren’t failsafe. This isn’t necessarily an indictment of people in government. Though the standard caricature of bureaucrats is less than flattering, many bureaucrats I’ve met are people who are genuinely interested in advancing the mission of their organization. Yet people in government are no different from people in markets – they’re all just people, with the same sorts of flaws and shortcomings. People in governments – just like people in markets – often lack either the knowledge or the incentives to know how to solve these complex  problems. 

Take the Endangered Species Act (ESA) as an example. The ESA was passed in 1973, with the explicit goal of countering species destruction attributed to markets. Indeed, the very first sentence of the act says that its intent is to protect “various species of fish, wildlife, and plants in the United States have been rendered extinct as a consequence of economic growth and development untempered by adequate concern and conservation”. Translation: markets are to blame for the destruction of these plants and animals. 

The dirty little secret of the ESA is that since its passage nearly half a century ago, fewer than 2% of the animals that have ever been put on the list have been removed due to population rebound. I have no doubt that the people at the US Fish and Wildlife Service (FWS) and the National Marine Fisheries Service (NMFS), the two agencies tasked with carrying out the provisions of the ESA, are genuinely well-intentioned and want to ensure that no further species decimation occurs. At the same time, I can think of no better example of clear government failure. 

There are two big problems with the ESA approach. One is a knowledge problem. The people at the FWS and NMFS simply don’t have the local knowledge required to adequately protect all 1618 US species on the endangered list. They’re forced to use the same one-size-fits-all tools to try and protect all species. Which leads to the second problem: their usual approach creates some really perverse incentives for those who find endangered species on their land. 

Essentially, landowners who find protected species on their land lose some of their rights to use the land in the way they want. In order to avoid the destruction of a species’ habitat, for example, the FWS will generally not allow development to take place on land on which a known endangered species resides. What are the incentives for landowners? As sad as it may be, many have been known to “shoot, shovel, and shut-up”. That is to say, they get rid of the species before the FWS can discover it’s on their land. This is the very opposite of what the ESA is intended to accomplish. 

For years, the Property and Environment Research Center (PERC) has been championing an approach that treats endangered species as assets instead of liabilities. In Botswana and Zimbabwe, for example, villages have had private ownership over endangered African elephants for many years. Because these endangered species have been treated as an asset, the incentives for their preservation have been robust. This has led to a revitalization of elephant populations in those countries, even as herds have been declining throughout the rest of the African continent. 

This shows that while markets sometimes fail, markets are also amazingly innovative at coming up with solutions to those failures. Economist James Buchanan described the tendency to automatically turn to government solutions when markets appear to fail as being akin to participating in a big pretty pig contest. These are contests in which the competing pigs must both be big and pretty. In Buchanan’s parable, assume there are two swine participating in the contest. Upon seeing the first pig, and noting that he looks relatively small and not particularly attractive, the judge automatically declares the second pig to be the winner of the contest. 

What’s the problem here? The problem is that the judge didn’t even look at the second pig! This is essentially what happens when we automatically turn to governments when we encounter problems in markets. A true comparison would require us to evaluate both alternative sets of institutions on their merits, then decide whether markets or governments are better suited to solve this particular problem. Sure, markets fail – but so do governments. The big difference is that markets are nimble, and market actors are regularly coming up with solutions to the problems that markets create. As much as we might wish it, government solutions just aren’t that nimble.