The massive wildfires that have been rampaging across the American west this year are not purely natural disasters. They are partly products of the unnatural disaster of climate change – “unnatural”, in that the ultimate responsibility for global warming belongs not to physics but to our economic system. Nicholas Stern, the former chief economist of the World Bank, calls climate change the “greatest and widest-ranging market failure ever seen”. Sadly, climate change is only one – albeit a whopper – of the countless market failures that degrade our lives.
Though it sounds like a generic phrase, “market failure” is actually a technical term. It doesn’t refer to scams like insider trading or corporate fraud. A failure occurs when the marketplace allocates resources in a way that does not optimally deliver wellbeing. We understandably focus a lot of attention on the depredations of greedy tycoons and corporations, but many of the most consequential market failures stem from innate characteristics of our current market system.
Many of us probably already have a gut feeling that our current market system often fails. In order to build a more sustainable, just and prosperous economy, however, it’s vital that we better comprehend the shortcomings deep in the market’s DNA. Greater awareness would reduce blind faith in the market and enable people to see the market for what it is: a tool. It can be an excellent tool when used for the right job, but relying on the market to deal with something like climate change is like trying to pound nails with a saw.
One major inherent flaw involves communication. In an ideal version of the market, continuous indirect communication between consumers and producers leads to the best allocation of society’s resources. Consumers make their desires known by the prices they’re willing to pay, and producers convey their costs by the prices they charge.
However, producers only communicate a narrow range of costs. For example, an oil company will account for typical expenses, like payments to its employees, and then set its prices accordingly. Consumers will receive those price signals and decide whether to buy that company’s gasoline. But markets enable businesses to scrub most social and environmental costs from these signals, which garbles communication with consumers. For instance, the price of gas doesn’t reflect the cost of the revved-up wildfires we suffer due to the additional global warming caused by burning that oil company’s gasoline. Numerous studies estimate that the true cost of gas is two to four times higher than what we pay at the pump.
Incomplete communication misleads us consumers into buying products laden with hidden costs. Countless goods and services bear the stains of harms such as pollution, habitat destruction, floods, child labor, extinctions and disease. When we fill up at the gas station the price we are charged doesn’t tell us that our purchase increases the odds that a wildfire will burn down our community. Making such partially informed choices is like buying a house having seen only the kitchen.
Another characteristic of the market that leads to failure is its inability to provide incentives for businesses to produce or protect public goods, such as fire departments or city parks. Most important, the market doesn’t generate the public goods sometimes known as “ecosystem services”, such as nutrient cycling, soil formation, oxygen creation and a livable climate. Many of these essential services operate in the background; like plumbing and wiring, they go unnoticed and unappreciated unless they fail.
Take the flooding that drowned parts of coastal Louisiana and Mississippi in 2005 when Hurricane Katrina thrashed the Gulf coast. More than 1,800 people died, cherished communities disintegrated, and the price tag swelled to more than $100bn. Much of the devastation occurred because oil and gas development had decimated the coastal marshes that previously had tamed storm surges. The protection those marshes provide is an extremely valuable ecosystem service, yet no entrepreneurs hustle to produce that protection.
And why would they? The market doesn’t give private businesses a profit motive to produce public goods. For example, even if a company were to restore a marsh, they wouldn’t be able to sell that service because they couldn’t exclude anyone living on that coast from using that protection for free.
Private restoration companies exist, of course, and some make a profit by rehabilitating marshes. But market forces didn’t spawn these outfits. At some point somebody recognized the value of the marshes and made a conscious choice to try to preserve or restore them. Most likely a number of somebodies made that choice and pressed their government to hire a restoration company. More broadly, environmental and social projects happen when a great many somebodies vote for candidates who support such efforts. Such purposeful collective action is the overarching solution to market failures. Instead of passively counting on supply and demand to provide everything we need, we sometimes need to exert our judgment.
And there it is, the J-word: “judgment”. Free-enterprise disciples view most efforts to use our collective judgment to shape the economy as central planning that will foul the gears of the market. But banishing judgment about how to allocate our resources will result in a world with plenty of video game consoles and fashionable shoes and precious little biodiversity and climate stability – and, all too soon, biological poverty and climate chaos will also cripple the economy of stuff, and video game consoles and shoes will become scarce, as well.
Citizens who scorn judgment should note that we’ve exercised some collective judgment to help guide the economy since the advent of government. The problem is that we’re not exercising it enough. In recent decades we’ve gotten out of balance and are leaning too far toward an unrestrained market even when it’s the wrong tool for the job.
Consider your toaster. It’s loaded with hidden costs that the market doesn’t communicate and that individual consumers can’t be expected to discover. But government (well, good government that pays attention to science) has the expertise to evaluate your toaster. If we citizens decide that we want to address climate change and air pollution, then government can do our bidding by devising energy efficiency standards for our appliances.
In fact, they did, decades ago. According to the American Council for an Energy-Efficient Economy, those regulations have saved more than $1tn to date and have reduced greenhouse gas emissions by the equivalent of the annual emissions of 800m cars. And we don’t even know the standards are there – hardly the heavy hand of government that haunts free-marketeers’ fever dreams.
So let’s use our judgment to create an economy that better aligns with our values. Instead of surrendering our autonomy to the soulless mechanics of the market, we can freely choose to grow beyond being mere consumers and become forceful citizens.