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Why not let the market provide second generation rights and an equitable distribution of resources? Because it cannot. There is little doubt that the market is the greatest tool humanity has found for the allocation of resources to date. Introductory economics textbooks tell students how efficiently the market can muster the complex task of adjusting the allocation of resources without any central management. Yet, these textbooks also tell students that "there is no question that government must be involved" (Case & Fair, 2007, p. 350). The market only distributes goods efficiently under certain conditions. As Stiglitz noted in his 1998 Lecture on Economics in Government, "Today, many of us look at the fundamental theorem not as a description of the world, but as an explication of the conditions under which a market equilibrium will be Pareto efficient... The importance of some of the more explicit assumptions-like the lack of externalities and the completeness of markets-has long been known... In particular, it has been shown that in the presence of imperfect information or incomplete markets, the economy will not be Pareto efficient; in other words, there will always be some intervention by which the government can make everyone better off" (pp. 3-4). Barr (2004) identifies the conditions under which markets function efficiently as follows (pp. 73-81): - Perfect information. Consumers and suppliers must be well-informed about the nature of the product and prices. Information must be easily accessible and comprehensible. Furthermore, the time horizon must not be too long, as individuals need to have adequate information about the future in order to make efficient decisions about the future.
- Perfect competition in product, factor and capital markets. Individuals must be price-takers with equal power.
- Complete markets. Markets that "would provide all the goods and services for which individuals are prepared to pay a price that covers their production cost." Missing markets arise when the market does not provide a certain good or service. For example the market cannot insure against the risk of inflation.
- Absence of market failures, which result from externalities, increasing returns to scale which cause firms to exit an industry and leave a monopoly in place, and the nature of public goods. "Pure public goods exhibit three technical characteristics, non-rivalness in consumption, non-excludability, and non-rejectablity, which together imply that the market is likely to produce inefficiently."
In the face of inadequate information, public goods, externalities, increasing returns to scale, missing markets and imperfect competition, government intervention is warranted on the grounds of efficiency. In some cases, such intervention will be small, in others public production of a given good may be warranted (Barr, 2004, p. 72). Even in the case of food - a privately produced and funded good, the government must impose labeling laws to alleviate the problem of inadequate information, enforce anti-trust policies and grant income transfers to the poor, so no one is denied their right to adequate nutrition. References: Barr, N. (2004). Economics of the welfare state. New York: Oxford University Press (USA). Stiglitz, J. (1998). Distinguished lecture on economics in government: The private uses of public interests: Incentives and institutions. The Journal of Economic Perspectives, 12(2), 3-22.
Joseph Stiglitz is a Nobel Prize Laureate and professor of economics at Columbia University. Nicholas Barr is professor of public economics at the London School of Economics.
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