Market Failure

Market Failure

If all Earth’s resources were marketed in the way described, then we
would have a fully automatic environmental protection system
already in place.We could all rest assured that there is no environmental
crisis. It has been argued consistently throughout this book,
however, that free markets frequently fail. The hand of government
is needed to adjust the price mechanism since markets do not factor
in to their signals all the many important influences that profoundly
concern people and the environment.
We have seen throughout this text a number of instances, where
markets fail to organise a society’s resources efficiently:
 Where there are substantial externalities – where any individual
consumption or production decision impacts significantly on
third parties (see Chapter 1 and further later).
 Where there is a lack of information for consumers to exercise
efficient choices.
 Where there is a need for pure public goods yet there is no
incentive for their private production (see earlier in this chapter).
© 2004 Tony Cleaver
 Where economies of scale lead to monopoly or oligopoly and the
erosion of the public’s interest (see Chapter 3).
 Where the sum of society’s choices add up to a level of aggregate
demand inconsistent with the level of aggregate supply (see
Chapter 4).
The first two points are particularly relevant to environmental
economics.
E X T E R N A L I T I E S
Certain basic resources we depend upon – like the air we breathe –
are free goods. They are not marketed, are commercially costless
to utilise and carry no price. Economics predicts, therefore, that
consumption will rise up to the point where the marginal utility
equals price. That is, we will consume as much air as we want with
no limit up to the point where the usefulness of an extra breath is
zero. (That happens when we die!)
Since there is no economic restriction on the consumption of the
atmosphere, so air and road traffic will burn its oxygen and spill out
poisonous emissions with no market penalty. Farmers, logging
companies and crazy arsonists will burn off natural vegetation as
they so wish. Levels of carbon dioxide in the atmosphere will
continue to rise. If the market cannot reign in such practice, government
must – or we will be condemned to live (and die) with the
consequences of global warming, acid rain, climate change and all
the other effects of atmospheric pollution.
Such external costs to society are not included in market prices.
Neither producers of cars, or food, nor consumers of these goods,
pay directly for the costs imposed on society of excessive oxygen
consumption-hence the argument for governments to impose a
carbon tax to restore a ‘market’ incentive to economise on this
otherwise free good.
It is a good idea in theory. The problem is trying to calculate the
appropriate level of tax. Exactly how much oxygen is consumed by
farmers, car drivers, everyone else who burns anything? And even
if you could calculate the damage done by each individual consumer
or producer, how then do you charge them? Governments must
struggle with this conundrum.
© 2004 Tony Cleaver
If we could get the answer right, it would internalise in the price
of each good, or service all the external costs (and benefits). Markets
can thus operate efficient price signals. Unfortunately, the task is
immense: externalities are everywhere. How do you account for all
the possible environmental impacts that may exist with every
production and consumption decision?
I M P E R F E C T I N F O R M AT I O N
This last point pervades all environmental concerns. Exactly how
much damage are we doing to the environment in the course of our
everyday choices? Discharging aerosol cans and disposing of old
refrigerators, we now learn, releases CFC gases that harm the ozone
layer. Had we known earlier we might not have done this. No doubt
all sorts of other practices carry environmental consequences too.
First, we need to know of the damage we are doing to the planet and
second, we must also be able to place a monetary value on this data
for comparative purposes.
We can only adjust our collective behaviour on the basis of reliable
information. This requires that those who speak out against the
wasteful excesses of economic growth do so with responsibility.
The essence of economics is opportunity cost: making intelligent
trade-offs where every option carries a price. For example, those
protesting about the construction of the Three Dams hydro-electric
power project in China ought to contrast the (undoubtedly serious)
environmental costs involved against the proposed benefits of
increased energy supplies to a poor population and the removal of
the threat of floods that have drowned millions in the past. Have
such protestors fully measured and valued the costs and benefits
concerned?
The Economist magazine reports that it comes as a shock to
discover just how little reliable information there is on the environment.
Look at almost any scientific investigation and you get a
different picture. One scare story follows another in the popular
press but a balanced overview is impossible since, especially for the
larger concerns such as global climate change, comprehensive data
is not available. Environmental audits at present underway on
numerous proposed ventures are undoubtedly steps in the right
direction, but the road is infinitely long.
© 2004 Tony Cleaver
COST-BENEFIT ANALYSIS is a form of educated guesswork at placing
monetary values on impacts that we know of. (It includes, in the
example earlier, attempting to measure the value of human life and
quantifying the reduced risk of drowning. There are sophisticated
procedures to follow; though they are not flawless.) But how do you
measure the value of environmental consequences that scientists
are at present only barely aware of?
Public officials designated to compile reports on these issues
must proceed with caution since in many cases environmental
impacts are long term, difficult to foresee but often irreversible, past
a certain crisis point. Issues are also frequently clouded by political
concerns. In the end, we have no choice other than to work with
uncertainty.