Chapter 7: The Failure of Market Failure
7.1 INTRODUCTION The failure to include transactions costs when considering whether a rule or practice is efﬁcient is one of the most pernicious problems in economics. It has led to endless difﬁculties. This chapter delineates the role of transactions costs in considering efﬁciency. It shows that a proper consideration of transactions costs reveals the market failure approach – and the prescriptions for government intervention based upon it – to be incoherent. Axiom 7(a) states: ‘Transactions costs are to be included in evaluating an economic change or in determining economic efﬁciency.’ This simple axiom has powerful implications for the concept of market failure and the question of the proper role of government in the marketplace. This question is an old and fundamental one. Public ofﬁcials throughout the world grapple with this issue, deciding which public services to provide or how to regulate the activities of individuals and ﬁrms, a task made more urgent by recent efforts to privatize public responsibilities and ‘reinvent’ government. In the search for objective standards by which such decisions can be made, public ofﬁcials increasingly have turned to the concept of market failure. Use of the market failure concept is widespread, both in teaching curricula and in practicing government circles. This chapter demonstrates once again the limitations of the market failure concept. Its shortcomings have been known for some time, but with little consequence, since its use continues to be widespread. In this chapter I summarize the conceptual problems of the market...
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