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When Markets Fail

By: Cielito F. Habito, PhD
Should government keep its hands off the economy? It’s often said that government has no business being in business, and that government should not be competing with the private sector in things that the latter can do better. Neither should it interfere in the working of the markets and allowing the law of supply and demand to work. Economists are often faulted for such advocacy for free markets and liberalized trade. But even the most zealous neo-liberal economists know that government intervention is warranted in certain situations because free markets do not always yield the best outcomes. There is such a thing as market failure, and it is incumbent on government to step in and correct them when and where they occur.
Economic theory postulates that leaving the markets alone usually (but not always) leads to outcomes that are efficient—that is, one where the economy’s limited resources are put to their best and most productive use. When the government tries to “play God” and decides what, how much, how, and for whom goods and services are to be produced—i.e., the basic resource allocation questions facing any economy—it invariably messes things up. China and the former Soviet Union tried it for many years, but eventually decided to give it up to rely more on market forces, even embracing the World Trade Organization. Only North Korea has persisted in that path of a command economy, with disastrous effects.
Adam Smith, considered the father of modern economics, argued in the 18th century that left to themselves (laissez-faire), markets would be guided by an “invisible hand” that ensures the most efficient outcomes. But perhaps Adam Smith failed to explain enough that markets are far from perfect. Markets often fail to yield efficient outcomes, and more often, fail to yield outcomes that are equitable or fair. Textbook economics identifies three instances, among others, when market failure occurs: public goods, externalities and economies of scale.
Read the full article at http://opinion.inquirer.net/100415/when-markets-fail