The End of Market Failure

Originally, the market failure concept was used only as a normative concept to define appropriate situations for government intervention in markets. As it matured, the market failure concept took on an additional characteristic— that of a diagnostic tool by which policymakers learned how to objectively determine the exact scope and type of intervention. Joseph Farrell suggests: “The welfare theorem lets [us] classify inefficiencies as due to monopoly externalities, and so on. This helps us to understand and perhaps to solve such inefficiencies just as a doctor’s diagnosis ... is part of treatment” (p. 116). To employ the diagnostic approach, analysts attempt to identify both the precise type of problem that gives rise to the market failure and the different types of nonmarket failures (bureaucratic malfunctions) likely to occur if public officials attempt a cure. Advocates of the approach present use of this “double market failure test” as an essential part of the diagnostic process. Like doctors attempting a cure, policy analysts render a diagnosis of the underlying disease and consider the dangers of treatment, including side effects. Some textbooks even present tables that allow students to identify appropriate interventions for different types of market and government failures. In keeping with the diagnostic model, policy analysts are taught to apply the least intrusive intervention. If a market failure can be resolved by the creation of an incentive that will allow the market to correct itself, such as a tax expenditure, such a measure is to be favored over more aggressive treatments, such as the creation of a government monopoly. What began as a simple attempt to provide a normative rationale for the existence of government expenditures has A N A L Y T I C A L F O U N D A T I O N S