Montreal, April 15, 2008 • No 255




Jean-Louis Caccomo is an economist at l'Université de Perpignan and is the author of L’épopée de l’innovation. Innovation technologique et évolution économique (L’Harmattan, Paris 2005).




by Jean-Louis Caccomo


          The most recent evolution in economic theory aims to rehabilitate government intervention by hiding behind a pseudoscientific approach that portrays market failures in highly mathematical terms – the better to forestall any potential challenges. The theory of market failures relies on two types of arguments: market imperfections on the one hand, and the existence of externalities on the other.


          Although these two arguments take on the semblance of mathematical demonstration, they are based on deliberate confusions that completely undermine their impact. They have nevertheless become the arguments of choice for those socialists who appear resigned to market economics but consider that the market cannot function without the crutch of a state whose regulatory nature is never really called into question.

          First of all, what is usually called a "market imperfection" is not really a market imperfection at all, but simply the imperfection of human action itself. Human action being based on learning and discovery, it is always perfectible, a fact which is well encapsulated by the popular saying, "To err is human." The imperfections that effect the decentralized decisions of economic agents will also characterize the centralized decisions of planned organizations like the state and its administrations. In both cases, whether we're talking about civil servants or stockholders, it is always human beings who make decisions. In addition, the imperfections inherent in public choices will be amplified as the decision maker is further and further removed from the field where his decisions are applied.

          From this point of view, it is unclear how governments can correct the imperfections contained in economic choices. This corrective capacity is simply assumed to exist in the models' hypotheses, but it is never demonstrated. I have discussed at length in other articles the question of information asymmetry that constitutes an example of imperfection. But the presence of information asymmetry in human choices is probably exactly what makes the market irreplaceable, if we acknowledge the Hayekian principle according to which competition is a process of discovery. The market makes comparison possible, and therefore encourages the emergence of new information allowing individuals to compensate for – if not correct – the initial asymmetry.

          A central planner never escapes the information asymmetry he pretends to correct, since he will make decisions based on information provided to him by the rank and file. Thus, the state never has the right information, but remains unaware of this fact. From this perspective, we can even consider the market to be the lesser evil, since when economic actors are free to act, the imperfections inherent in human decisions are compensated for at the microeconomic level.

“To pretend that state action can correct externalities generated by the market is to posit once again that this government intervention does not itself generate externalities. By what miracle? Nobody knows.”

          Second of all, invoking "externalities" verges on intellectual fraud insofar as, in human societies, practically everything generates externalities. If I am in good health, I can work, so I call on society to finance my health. But if I have children and educate them well, there will be workers in the future, which is useful for society, so I call on society to subsidize my parenthood and I ask for all sorts of parental allocations. At this rate, I can get everything subsidized, since it is always possible to invoke some positive externality, which is to say, some result of my private decision that benefits others. In effect, if I am happy and fulfilled, I will not attack my fellows and I will be fully productive in my work. It is therefore society's responsibility to see to my happiness… We're talking here of positive externalities, but the existence of negative externalities is used to justify the regulation of behaviour, and notably the multiplication of prohibitions to the extent that my private decisions have side effects that harm others.

          It is not a matter of questioning the existence of externalities, even if their precise measurement poses real problems, severely limiting the applicability of this type of theory. But we must realize here too that the existence of externalities is not specifically a market phenomenon. We can even suggest that the market itself exists in part to take advantage of this phenomenon, since competition can be seen as a positive externality issuing from the division of labour. Furthermore, to pretend that government action can correct externalities generated by the market is to posit once again that this state intervention does not itself generate externalities. By what miracle? Nobody knows.

          Government intervention implies public financing and the establishment of a technocracy, which entails an increase in the tax burden, which in turn sets off a whole series of negative externalities (tax evasion, corruption, the development of an underground economy, the modification of the way people think, the crowding out effect…). How can we know whether the sum of these negative externalities is not more costly and more serious than the initial problem that motivated and justified the state's intervention?

          In practice, it can be observed that in a growing number of areas, market mechanisms are being reintroduced to compensate for the accumulated failures of public management, in flagrant opposition to the official dogma that posits the need to call on the government to correct for market failures.


* This article was first published in French in QL no 254 – March 15, 2008. It was translated by Bradley Doucet.