August 20, 2015

Government Intervention Is Becoming Obsolete

Fred E. Foldvary

Lecturer of Economics, San Jose State University
Summary

Much government intervention has no economic rationale and is due instead to pressure from special interests. However, some interventions have a public-welfare justification, backed by conventional economic theory. Textbooks in the field normally present four such rationales: asymmetric information, external effects, public goods, and monopoly. Advances in technology are fast rendering these arguments obsolete.

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Much government intervention has no economic rationale and is due instead to pressure from special interests. However, some interventions have a public-welfare justification, backed by conventional economic theory. Textbooks in the field normally present four such rationales: asymmetric information, external effects, public goods, and monopoly.

Advances in technology are fast rendering these arguments obsolete.

"Asymmetric information" means that in an exchange, one party has much more knowledge than the other. When one buys a used car or computer, the seller could take advantage of the buyer's ignorance. Therefore, says standard theory, the market fails.

But ignorance creates a demand for both information and assurance. The economy provides consumers information through such channels as Consumer Reports, Angie's List, and Yelp reviews. Advancing technology provides greater and cheaper information. The websites of consumer publications enable users to computer-search, rather than having to go to libraries and look up printed articles. Markets also provide assurance through warranties, guarantees, and sellers' desire to preserve a good reputation.

"External effects" are uncompensated effects on others; the standard example is pollution. In a pure market, pollution constitutes trespass and invasion of another's property, and is subject to a liability rule that makes the producer pay for the damage, making the cost internal.

But some property rights, such as for fish in the oceans, have not historically been feasible.

Here too, advancing technology, like electronic fencing and tagging, is providing a solution. Even when government is involved in reducing pollution, better technology can replace regulations (such as on gasoline, engines, and smog) with pricing when remote sensors measure actual pollution and photograph the license plates. Private associations and firms can also use such technology to get polluting car owners to compensate for their emissions and help pay for the roads.

"Public goods" are items that are non-rival, meaning that their use by one person does not diminish the use of others. One more person viewing a city fireworks show does not prevent others from viewing it. Standard economic theory posits market failure due to free riders: An entrepreneur cannot privately build a dam to protect a city from floods, because some people will refuse to pay, figuring that the dam will protect them whether they contribute or not.

Already, private contractual communities such as homeowners' associations can and do provide such collective goods. And better technology such as electronic tolling now makes private provision more feasible, as private roads and parking can more easily collect the needed fees, while also eliminating congestion with prices just high enough to enable traffic flow and parking.

Monopoly can indeed result in higher prices, but there can be benefits to large firms, such as providing standard formats for software. Also, even dominant firms need to innovate in order to maintain market share, and excessively high prices induce competition. Here too, better technology helps to address the problem. Examples include cheaper generation of electricity on a small scale, including solar generators, and the recycling of water. Both of these examples reduce the need for regulated "natural monopolies" that have high fixed costs.

The effects of advancing technology on the rationales for governmental programs were presented in the 2003 book "The Half Life of Policy Rationales," edited by Daniel Klein and myself. Eric Hammer and I recently updated this research in 2015 in a working paper published by the Mercatus Center at George Mason University, "How Advancing Technology Keeps Reducing Interventionist Policy Rationales."

The prevailing market-failure theory and the government programs that claim justification from such theory are increasingly obsolete, and both theorists and practitioners need to take note.