Are there inherent problems with the idea of market failure?
The concept of market failure was first introduced to explain the need for government intervention into certain markets and, according to Carl Dahlman, market failure “constitutes a normative judgement about the role of government and the ability of markets to establish mutually beneficial exchanges” (Dahlman, 1979). The theory of market failure is now prevalent amongst both academics and policymakers alike. Indeed, an Executive Order was issued by Ronald Reagan in 1981 which required that proposed regulations were only issued if their benefits exceeded their costs. However, here lies one of the major problems with the use of market failure as a substitute for wider-ranging empirical analysis; many of the these costs and benefits cannot be quantified, such as the social impact of fairness or the environmental cost of pollution, and this therefore negates its use as a definitive benchmark to justify government intervention. The fundamental principal of cost-benefit analysis is that it “imposes mathematical discipline on agencies” (Posner, 2011). However, the element of subjectivity that is introduced, when these abstract factors are taken into account, means that the concept can be applied to almost any situation to justify intervention. This is shown when undertaking cost-benefit analysis where the choice of discount rate (although there is a methodology for calculating this) is largely arbitrary Market failure analysis has “developed into a quasi-scientific full-scale diagnostic test with the prescription of cures” (Zerbe & McCurdy, 1999).