segunda-feira, abril 12, 2010

581) Markets Never Fail - Fred Foldvary

Markets Never Fail
Fred E. Foldvary
Dept. of Economics, Santa Clara University
Available here

Session 6.4: The State Versus the Market, I
APEE Conference, Las Vegas, April 4, 2006
"Private Solutions to Market Failures: Is Government Always the Answer?"

Mainstream allegations of market failure are based on misunderstandings of markets, governance, and ethics. This paper dissects the categories of alleged market failure: externalities, public goods, market structures, asymmetries, irrational behavior, injustice, and lack of sustainability. The analysis reveals that none of these phenomena contain any inherent market failures.

Almost all economists believe in the doctrine of market failure. Every widely-used textbook of economics presents the doctrine that markets fail. The mainstream view in economics is that an economy with "perfect competition" would be efficient, but the real world has no perfect competition, and market outcomes are inequitable, so market failure is ubiquitous. Markets always fail, and the only issue to be discussed is the degree of failure. That degree, it is said, is especially severe in the case of public goods, externalities, informational asymmetries, and economic justice.

The meaning of "market failure"

Market failure is distinct from entrepreneurial failure and human failure (such as due to bounded cognition). Market failure is a systemic inability of voluntary economic dynamics to provide the ends desired by the public, systemic meaning a failure which is economy-wide and persists over time due to the inherent structure of free markets. The three ends desired by the public can be categorized as efficiency, equity, and sustainability. Efficiency in this context means that the market provides the goods which people demand at prices that cover all the long-run marginal costs, with the costs borne by those using the good. Sustainability means that the global economy can be expected to provide at least the current standard of living indefinitely.

The full meaning of market failure requires a clear understanding of the meaning of the "market." The textbooks and academic literature seldom venture into what "market" means. A "market" is usually defined vaguely as a context in which there is buying and selling, or hiring and renting. The term "free market" is usually left undefined, and implicitly treated as a synonym for "market."

The concept of a market economy has meaning in contrast with a non-market economy. The logical contrast is with coercive harm. A pure free market is an economy in which all human action is voluntary. Any involuntary action, inflicting coercive harm, is therefore outside the market. The two sets of agents which apply coercive harm are private thieves and governmental officials.

Market failure is therefore the failure of a free market, rather than a market afflicted by governmental or private coercion. When slaves are bought and sold, or rented, there is a market, but not a free market, and the distress is not a "market" failure.

But it is not sufficient to say that a free market consists of voluntary production, exchange, and consumption. This brings the analysis to a deeper level, as we need to understand what it means for human action to be voluntary.

As Jack High has pointed out, "voluntary" action implies an ethical rule by which some acts are morally permitted and other acts, the involuntary ones, are morally evil and thus prohibited (High, 1985). To have a universal meaning of voluntary action, and thus of the market, this moral standard must itself be universally applicable to humanity. This universal ethic would be a natural moral law, based on human nature rather than any cultural practice or personal viewpoint.

John Locke (1690) described natural moral law as being derived from two premises, biological independence and human equality. Independence is the biological fact that human beings think and feel as individuals. Equality is the proposition that there is nothing in human biology that entitles one set of human beings to be masters over another set which has slaves.

A unique universal ethic can be derived from these premises (Foldvary, 1980). The universal ethic has three basic rules:

1. Acts which have welcomed benefits are good.
2. Acts which coercively harm others by initiating an invasion, are evil.
3. All other acts are neutral.

In this context, the term "harm" is distinguished from a mere offence. In an offence, the distress is due solely to the beliefs and values of the person affected. In contrast, coercive harm involves an invasion, an unwelcome penetration into the legitimate domain of the victim. So if a person is offended by what someone says, this is due to his beliefs and values; this act is not coercively harmful, and is designated as morally neutral by the universal ethic.

The universal ethic also provides a meaning for moral rights and liberty. A moral right to X means that the negation of X is morally evil. For example, a person has a moral right to possess a car because the negation of that possession, i.e. theft, is morally evil. Since the universal ethic is the expression of natural moral law, the moral rights based on the u.e. can be called "natural rights." Society then has complete liberty when its laws are based solely on the universal ethic, with legal rights congruent with natural rights.

The natural rights to property begin with one's own body and life. The right to one's person then endows the person with a right to his labor, which implies a right to the wages of his labor and the products of labor.

The universal ethic can now be applied to give meaning to the concepts "voluntary" and "intervention." An act is voluntary if it is either morally good or neutral. An "intervention" is defined here as an act which changes what voluntary action would otherwise do. Governance is morally proper when it acts as an agent of the universal ethic, prohibiting and penalizing evil acts, but not intervening into peaceful and honest action. The pure free market is defined as an economy in which there is no governmental intervention, and in which private coercive harm is effectively prohibited and penalized.

Negative externalities

Every economics textbook I have examined depicts negative externalities as a market failure. Markets allegedly fail because a social cost such as pollution or congestion is imposed on persons and not on those who buy or rent the product. But by the universal ethic, pollution which invades the property of others is an act which is morally wrong and outside the market. The pollution of other people's property is a trespass which, in a free market, requires compensation. This compensation internalizes the cost, eliminating the externality.

The optimal amount of pollution is not zero, but that amount for which the marginal cost of eliminating pollution equals the marginal benefit of less pollution. Normally, the cost of reducing more pollution rises as more pollution is reduced, and the social benefit of eliminating more pollution declines with greater reduction. When polluters compensate others for the damage, then the optimal amount of pollution will tend to take place, as a polluter will weigh the cost of compensation with the cost of pollution reduction. If the transaction costs are low, the affected parties can negotiate an efficient outcome. If there are too many persons affected for negotiations to be effective, then government, acting as an agent for the people, can levy a pollution charge equal, so far as can be measured, to the social cost. Such a charge does not correct a market failure, but rather enhances the market by preventing trespass. Excessive pollution is therefore not a market failure, but a government failure, the failure by government to enforce the property rights of the victims of pollution.

The same analysis applies to congestion externalities. If a large store opens in a neighborhood and there is increased traffic and more congestion, the market has not failed. If the streets were privately owned, the owners would see a profit opportunity and charge higher tolls. If the streets are owned by the government, then congestion implies a failure to charge a toll sufficient to eliminate the congestion. In a congested highway or street, each car imposes a negative externality on the other drivers by increasing the crowding. A toll just high enough to eliminate the congestion is therefore like a pollution charge, and prevents rather than corrects an externality. If a private owner of a highway fails to apply a congestion charge, this is an entrepreneurial failure, since there is no systemic reason to not apply the charge.

Positive externalities

Market failure is also alleged when the externalities are positive, people receiving benefits which they do not pay for. The allegation is that there are fewer beautiful front-yard gardens because the owner is not compensated for benefitting his neighborhood, when folks would pay to have more of this beauty, but don't because they can be free riders.

The retort that government correction would be worse does not eliminate the proposition of market failure. Clearly, this is a systemic situation, and can be non-trivial. Also, the fact that some benefits are provided even when they receive no compensation does not eliminate the proposition that if people could be made to pay for additional benefits, they would pay, but they cannot be made to pay in a market context, and so the market fails to provide goods for which there is a demand.

Suppose the government could determine what each neighbor would pay to have more beauty, and charges them for that. The charge would not be an intervention, since that is what the person is willing to pay. But in fact there is no way to find out the subjective values people have for more beauty, and to also charge them that amount. It is possible to reveal the amounts people would pay if the actual payment is determined independently of their stated values, a process called "demand revelation" by which a person whose stated value changes the outcome pays the social costs of doing so (Tideman and Tullock, 1976). But people can lie if the amount they pay depends on their stated values. Since the externality cannot possibly be eliminated, then the market cannot fail, since failure needs to be defined in a real-world context. The inability to do what is impossible cannot be designated a "failure." One can only fail if it is hypothetically possible to succeed.

Moreover, one cannot ascribe market failure to today's significant positive externalities, because no economy today is a pure free market. Governance in a pure free market would be contractual rather than imposed on people who are not harming others (Foldvary, 1994). Contractual governance would be both greater and lesser than government is today. It would be lesser, because it would not impose taxes and restrictions on peaceful and honest human action. It would be greater, because a contractual agreement would provide rules that would be considered discriminatory by democratic government today. For example, today there are retirement communities that require minimum age limits for residency, something no government today could require. A marriage is a type of contractual governance in which the parties agree to provide each other with positive effects, which governmental law would not require.

The covenants, bylaws, and deeds of private communities can and do deal with positive and negative externalities. They can require people to have well-kept front lawns. Likewise, a night club can have a dress-code, enhancing the positive externality of nicely-attired attendees and avoiding the negative externality of having to look at slobs. Thus, when a potential externality (such as the color of the exterior of a house) is regarded by the community as significant, it can be mandated in its covenants. People can then move into communities with the covenants they prefer. Contractual governance can thus provide for positive externalities, and if people consider them important enough, there will be communities that require these.

The voluntariness of such communities exits at the level of choosing to join it. Once one is a member, then there may be rules which they may not like, but they accept them as part of a package that provides for greater benefits than if they were not members.

There is therefore no systemic failure by markets to provide positive externalities. Some external benefits are provided even without compensation. Others are compensated or provided by contract. The fact that would be more positive externalities if we could determine all subjective values is not a market failure if this determination is biologically impossible.

Excludable public goods

The next allegation of market failure concerns collective goods. Almost all textbooks and economists claim that markets fail to provide sufficient public goods because of free riders who cannot be made to pay.

Public or collective goods are nonrival, in contrast to "private" goods for which the greater use by one person implies less for others. With collective goods, each person uses the entire good, and is not affected by others who use it, such as watching a movie in an uncongested and quiet theater. Some economists define "public goods" as also being nonexcludable. However, Paul Samuelson's (1954) landmark paper on public goods defined only two classes of goods, public and private, the latter occurring when the total amount equals the sum of the individually consumed quantities, as with rival goods. Good which are both excludable and nonrival are called "club goods."

Markets do not fail to provide club goods, because exclusion implies the ability to charge for entry and for continuing use. Almost all goods and services provided by government are excludable. A highway is excludable, as reckless drivers are stopped and expelled. Many governmental services are excludable by proximity; a neighborhood park is used mostly by the residents of the neighborhood, others being excluded by the transportation cost. Even national defense is excludable, as those outside the country are excluded from the protection, and those who enter illegally can be deported.

Most public goods provided by government are territorial, and to the extent these are wanted services, they become capitalized into higher land values and land rentals. This extra rent provides the means to finance the goods, the optimal quantity being the amounts for which the marginal rent generated equals the marginal cost of the public good. The rent is a private good, the total rent being the sum of the individual rents. Thus when a private agent can collect the rent, the rent provides the means for private-sector provision (Foldvary, 1994).

Nonexcludable collective goods

Market-failure advocates seem to have a stronger case for non-excludable public goods. For example, basic research can benefit society as a whole, and once the knowledge becomes public, it becomes non-excludable. One can well argue that education and the alleviation of poverty benefits society overall, not just those immediately affected, and these benefits are non-excludable. These benefits also fall into the class of positive externalities. Being non-excludable, the public benefits are greater than those obtained by the contracting parties.

The market-failure argument for non-excludable public goods and positive externalities presumes that people are narrowly self-interested, so they will choose to be free riders. But in fact, human beings have two basic motivations: self-interest, and sympathy.

In The Theory of Moral Sentiments (1790), Adam Smith wrote: "How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure in seeing it" (p. 9). These principles are manifested in "sympathy," a feeling of affinity, solidarity, accord, generosity, and empathy with a person, group, culture, organization, or other entity. "Nature, therefore, exhorts mankind to acts of beneficence, by the pleasing consciousness of deserved reward" (p. 86). Sympathy can apply to an idea or project, like a religion, wildlife conservation, or helping the needy.

Henry George (1879, 462) stated similarly, "If you would move men to action, to what shall you appeal? Not to their pockets, but to their patriotism; not to selfishness, but to sympathy. Self-interest is, as it were, a mechanical force - potent, it is true; capable of large and wide results. But there is in human nature what may be likened to a chemical force; which melts and fuses and overwhelms; to which nothing seems impossible. 'All that a man hath will he give for his life' [Job 2:4] - that is self-interest. But in loyalty to higher impulses men will give even life."
There are also of course self-interested motivations for donating benefits. A donor may seek the prestige that comes from being recognized as a philanthropist. Another motivation is a sense of moral duty. The dutiful and prestige-seeking motivations are complementary to the sympathetic motives, so the self-interested motivations are also worth cultivating. Benevolent sympathy overcomes the problem of free riders unable to cooperate in the provision of a non-excludable public good. If a person has benevolent sympathy for a community and its goods, he will not wish to free ride; the act of contributing itself provides satisfaction, or even joy.

Sympathy is generated by social entrepreneurship. A philanthropist might not only provide charity but also stimulate others to give. He creates institutions - traditions, festivals, symbols, organizations, - that elicit greater sympathy from a commmunity. Benevolent giving is also promoted by mutual-aid fraternal societies, many of which flourished during the 1800s and early 1900s, before they became preempted by governmental programs (Beito, 2002).

If such sympathy is lacking, this implies that the public does not value the activity that highly. The lack of provision is not a market failure if people do not value the provision. Moreover, a lack of private-sector provision today may be due to interventions that prevent firms from acting jointly. For example, joint basic research may be inhibited if not explicitly prevented by anti-trust laws, and there are in fact trade associations which promote mutually beneficial activities, to the extent permissible without violating anti-monopoly laws. The benefits of belonging to trade associations can induce the members to avoid being free riders.

The argument for market failure for non-excludable public goods and positive externalities therefore has to explain why mutual aid and sympathy would fail to provide the public goods wanted by the public. It is not sufficient to merely assume that the only motivation is narrow self-interest, because there is in fact abundant charitable and philanthropic giving. Would anyone argue that there the amount of churches is insufficient? There are numerous churches of many denominations in all American cities, where the financing is private.

The case for market failure in the provision of non-excludable public goods itself fails by assuming deficient amounts of sympathetic provision, when it is that very sympathy that implies public demand.

Market failure for imperfect competition and monopoly

The neoclassical-economics benchmark for market efficiency is perfect competition, with many tiny firms producing an identical product. The efficiency comes from each firm being a price taker, selling all its output at the market price, and therefore the profit-maximizing quantity is that for which price equal the marginal cost. Ease of entry and exit induce zero economic profits, so the price is also the minimum average cost. Government can do nothing to improve this outcome.

The market-failure doctrine alleges that when competition is imperfect or non-existent, the price is above marginal cost, and the market fails to be maximally efficient. But economics analysts seldom explain the meaning of "perfect" and "competition." The term "competition" in this context does not mean "rivalry," but rather "the absence of pricing power." "Perfect" does not mean ideal or desirable, but rather "complete." "Perfect competition" thus means nothing more than the complete absence of pricing power. In "imperfect competition," there is some pricing power; there is no inherent implication that such a market structure is bad.

In monopolistic competition, there are many small firms, but they produce differentiated products, so each firm confronts a declining demand curve. Even though making no economic profit in the long run, the firm produces at a price greater than its marginal cost, a situation with excess capacity, as each firm could produce more at a lower average cost, but at a quantity greater than that which maximizes profit. Moreover, product variety induces competition by advertising, adding to the costs of production, cost which often merely induce customers to switch brands.

However, the greater cost of goods relative to if the industry had one identical product is offset by the value people place on product variety. Since product variety has a benefit, its absence has a social cost. Including the marginal social cost of eliminating differentiated products, the price of a good in monopolistic competition is not necessarily above its social marginal cost. Moreover, the advertising finances public-goods media such as television.

An oligopoly being an industry with a few firms, not only is the price above marginal cost, but there can be lasting economic profits not to due entrepreneurial innovation but to the cost of entry. Economic profit as such is not a social cost and thus not an indication of market failure. The social cost is the reduction in quantity relative to a greater number of firms.

But an industry with a few firms implies economies of scale that lower average cost with increasing size. The public would not benefit from splitting up the firms, as this would increase average cost. But market-failure advocates could argue in favor of government intervention to set the price at marginal cost, increasing quantity relative to the profit-maximizing quantity.

But such a policy would need to consider the market as global rather than national. For example, the U.S. automobile industry has only a few firms, but the planet has many car makers. Moreover, with technological products, competitive advantage requires continuous innovation, which requires investment. Price fixing and lower profits can lead to the social cost of less technological and marketing progress. Only when the oligopoly involves the value of natural resources such as oil is there a case for the price and the profit not being a result of entrepreneurship. (Natural resources are examined below). Thus the mere existence of oligopoly is therefore not necessarily a market failure, when all social costs are taken into account.

In the case of monopoly, the case for market failure depends on the cause of the monopoly. Clearly, monopolies due to governmental restrictions on competition are not market failures. Copyrights and patents confer monopoly privileges which may be justified by inducing creation and discovery; a consideration of such intellectual property is beyond the scope of this paper. Franchises such as local cable services are monopolies whose failures are due to the governmental protection from competition.

Another source of monopoly is collusion among oligopolists. Such collusion is illegal in the United States. Would such collusion be a market failure? Economic theory as well as historical evidence tells us that such collusion often breaks down as there is an incentive to cheat by providing more at a lower price, until the others also lower their prices.

But suppose the cartel does not break down or there is a dominant firm. If the product is not a natural resource, then an economic profit is an inducement for competitors to enter, if the fixed cost is not prohibitive. It may take some time, but eventually, for example, alternative products will appear if users are not satisfied with the dominant product such as a computer operating system.
Moreover, as technology advances, the new versions compete with the prior versions, and high prices prevent users from buying the new versions. Thus overall, the mere existence of dominant firms does not necessarily indicate that the public is worse off.

If there is a large fixed cost and a small marginal cost, then the firm is a natural monopoly, and there may not be any actual or potential competition. Advancing technology is making industries such as electricity and even water provision less naturally monopolistic (Foldvary and Klein, 2003). At any rate, if a resource such as water is a natural monopoly, the market does not necessarily involve a monopoly exploiting the users by charging more than average cost. Another possibility is that homeowner associations and other private communities would jointly own the water company.

As analyzed by Oliver Williamson (1985), asset specificity, the specialized use of assets not easily transferable to other uses, determines the contracting process. If there is little asset specificity, competitive market contracting is effective. With high asset specificity, governance within an organization is efficacious as agents economize on bounded cognition while protecting themselves against opportunism. If a community is dependent on a particular natural monopoly, its incentive will be to own it. Vertical and horizontal integration prevent the problem of natural monopoly, which is why residential associations own their own streets and transit services. House owners also own their back yards rather than rent them, to prevent paying monopoly prices. Therefore, the mere potential of monopoly does not inherently imply market failure.

Finally, some have pointed to network externalities as a possible market failure, as an inferior product can become established and then becomes difficult to replace. This is the strongest argument in favor of market failure, but it is much stronger in social and cultural spheres than in the commercial realm. As Israel Kirzner has argued, in the commercial context, there is a profit opportunity for entrepreneurs to innovate and market better products, overcoming or adapting to the older networks. For example, Apple computer has made its computer compatible with the PC format.

But, as Kirzner also argues, in the social and cultural sphere, less efficient patterns can persist, such as the irregularity of English-language spelling, when considered narrowly. The English language would be even more efficient if everybody spoke Esperanto, a constructed language with no irregularities. But giving up traditional language and spelling would amount to losing part of our cultural heritage, so even there, it is not clear that there is a market failure to replace the network. Measurement would be more efficient in the metric system, yet the USA persists in using traditional inches and pounds; but these traditional measures could be more fitted to usual human usages. Swimming would be less costly if people swam nude, but it would cause distress to most people. Thus there are social costs in cultural change.

There is, however, one area where the market does fail. When there is a dictator, the market will usually fail to overthrow him. Those who are brave enough to oppose him will be killed, or suffer terribly. So the proposition is not that markets always succeed in everything, but that markets do not fail to provide wanted services in the context of a pure free market. When there are interventions, then markets may not succeed in eliminating them.

Informational asymmetry

Another allegation of market failure invokes asymmetries of information, where one party is much better informed than the other, such as when someone has his car repaired. The first line of defense against market failure from this source is the prohibition of fraud, since fraud is a type of theft, and is outside the market. In a proper contract, all parties are competent and informed about the terms. Caveat emptor should apply when the buyer has more knowledge of his usage, but caveat venditor should apply when the seller has better information.

Moreover, reputation is an effective antidote to lack of knowledge. One may not know much about cars, but one can have confidence the company providing the services. The market also provides sources of information, from publications such as Consumers Reports to organizations such as the Better Business Bureau, to the Internet.

Thus the ability to sue for fraud or damages, the incentive of firms to have a good reputation, and the availability of information from many sources, undermine the allegation that the mere existence of informational asymmetry is necessarily a market failure.

Irrationality as market failure

A more radical challenge to market success is the literature on economic psychology, which posits that cognition is bounded and that people fail to maximize possible gains. (The allegation of "bounded rationality" is better termed "bounded cognition," since it is the processing of information that is bounded rather than rationality itself.)

The existence of human character flaws such as excessive confidence, bias towards recent and readily available data, and anchoring on some past event, does not make human action irrational. Human action is rational when human beings economize in the pursuit of the ends, and when preferences are consistent (thus transitive, as when A is preferred to B and B to C, then A should be preferred to C).

When a person is overconfident and trades stocks in the mistaken belief that he can do better than average, this is a human failure rather than failure of the overall market. When the owner of a stock is anchored on the price he paid, and refuses to sell as the price declines, this is also a human failure, or entrepreneurial failure. There are winners and losers in financial markets, and the winners are those with better knowledge about economics, finances, and personal and mass psychology. So human foibles do not constitute market failure.

Distributional injustice as a market failure

Finally, the market-failure doctrine claims that even if markets are efficient in providing goods, they fail to provide equity. Critics of markets often point to today's inequalities of income and wealth as outcomes that should be corrected by government.

Neoclassical economics, as expressed in textbooks and the academic literature, claims that there is a necessary trade-off between equity (justice or fairness) and efficiency. If the rich are taxed and the wealth is redistributed to the poor, the rich will have less incentive to produce and invest, resulting in a lower amount of wealth, which may make the poor less well off. Nevertheless, some limited redistribution is advocated in the name of social justice.

But the ethic that tells us the meaning of the market is the same ethic that tells us the morally proper laws and policies. Therefore, a pure free market cannot possibly be unjust.

By the universal ethic, doing good does not absolve evil. The universal ethic makes it morally wrong to tax wages no matter what the funds are used for. Theft does not become proper if the thief transfers the money to the poor. Thus, social justice cannot be enhanced by immoral means.

Moreover, the outcomes of today are not free-market outcomes. One cannot point to any actual distribution as a flaw of the market, since intervention has affected the outcome. Governments throughout the world are engaged in massive redistribution, including subsidies and grants to the wealthy.

Economic justice therefore cannot predetermine any particular outcome, but must examine the initial distribution of resources and the process of exchange, and then accept whatever outcomes result. A voluntary process of exchange is morally neutral, so what remains is to examine the initial distribution of resources.

The ultimate and original factors or inputs into production are land and labor. We have already concluded that self-ownership endows a person with a complete right to his wages and the products of labor. But land, defined as all natural resources, exclusive of any improvements, is not a product of human action, and so self-ownership cannot apply to the ownership of land.

Natural resources and rent

We have to begin, as did John Locke (1690), with the premise of human equality, which entitles every person to an equal access to unclaimed natural resources. As labor must necessarily be applied to natural resources, private possession is justified and may be claimed. But Locke included the proviso that one could fully own features of nature only if there were also quantities of similar quality freely available to others.

If that situation does not hold, as indeed it does not in much of the world, then the implication is that the title holder does not properly own the total rights to the land. He should be entitled to the rights of possession, to have an effective market, but that does not entitle him to the yield, or rent, of that land.

To examine this issue more deeply, we need to recognize two sources of land rental. One source of rental from land is the presence of civic infrastructure. The presence of streets, parks, public transit, and other territorial amenities increases the demand to be located then and pumps up the rentals and site values. If the provider is a private firm, then it has the moral right to the generated rental, subject to contracts with the local residents. This provider could be a proprietary community, owned by a corporation, or a civic association.

If the provider of the public works is government, then government may properly collect the rental, as it has generated that rental. If the funds instead come from taxes on wages (including sales taxes paid from wages), then a worker-tenant is double billed, as he pays a higher rent and also higher taxes. Also, if the funds come from non-land sources, the landowner is effectively subsidized, obtaining rental and site value paid for by others.

The tapping of site rentals or site value to finance civic works such as mass transit relates to the issue of natural monopolies, goods for which there is a declining average cost, and where the marginal cost is below the average cost. In a free market, the provide can charge the user the marginal cost (which can be zero if the marginal cost is trivial, as with elevators), and pay for the fixed costs from the site rentals generated by the service, such as hotels financing elevator costs from the room rentals.

Thus one source of income inequality is land rent which is generated by civic infrastructure paid for by taxes on wages and business profits. Landowners become wealthier at the expense of workers. Attempts at redistribution are largely futile, since much of the taxation is on those having higher wages, rather than landowners, and the transfers received by lower-income folk then enable them to afford higher rents, and some significant portion of the welfare ends up with the landlord.

This inequality is caused by intervention, not the market. When the infrastructure is provided privately, then this redistribution does not take place, as the residents are not taxed, but instead pay for the civic goods from their rentals or assessments on their units of property.

The other source of land rental is the natural features of the area: the climate, proximity and access to waterways, soil quality, forests, etc. New York City and San Francisco, for example, are located places suitable to harbors. Las Vegas could not function without the availability of natural sources of water. The natural rent of such land can be tapped for public revenue without hampering the market or intruding into self-ownership. Such taps would also eliminate a source of inequality to the extent that land value is held unequally. If, on the other hand, all communities are contractual, then the natural rent would be collected by contract along with the rentals generated by civic goods.

The option of using land rent for public revenue creates an opportunity to increase the efficiency of the economy by shifting taxation from wages and capital to land rent or site values. This shift would also reduce the inequality of income distribution. Thus, the tradeoff between equity and efficiency is an unnecessary one; it is possible to have more of both, relative to current outcomes.

Therefore, the allegation that markets fail achieve justice is doubly false. It is false because the criterion for justice uses the same ethic that determines the market in the first place, making true free markets inherently just. It is also false because government today creates more inequality than necessary, and so inequality today is logically a government failure, not the failure of a non-existent free market.


The use of fixed natural resources such as oil and copper necessarily uses up the available sources, so it cannot be a "market" failure to use them up. A market can efficiently allocate use, since as the good gets used up and reserves diminish, the price rises, and users economize by substituting other goods or using the resource more efficiently.

For renewable natural resources, if the universal ethic requires that wildlife and the habitat of the earth be preserved, then that is what a free market does. Market failure implies that markets within their ethical constraints are failing to be sustainable, but that is not the case if the ethic that gives the market its meaning also prohibits the destruction of the commons, the atmosphere, oceans, rivers, underground waters, the soil, and the wildlife of the planet.


The claim of mainstream economic thought that markets fail is not justified. The failures ascribed to externalities, public goods, market structures, asymmetries, injustice, and lack of sustainability, are due to misunderstanding or ignorance of the ethics, governance, and economics of markets. There is plenty of entrepreneurial and human failure, but no inherent systemic market failure.

Free markets never fail.


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