The concept of market failure exists within the neoclassical lassiez-faire framework, in that the economists who use it think of failed markets as exceptions to the rule that regulation of markets is undesirable. In other words, free markets are desirable in all contexts except those where market failure is likely or inevitable. Thus, our understanding of market failure defines the rightful place of government regulation of the economy. A new book, How Markets Fail, by longtime economics journalist John Cassidy, introduces this important concept.
The book is divided into three sections, the first of which is devoted to the development and evolution of the free market academic theory and the related political ideology. This analysis begins on the wrong foot with a serious mischaracterization of Adam Smith’s understanding of markets and their potential flaws. However, discussion of the 20th century theorists, such as Friedrick von Hayek and Thomas Friedman, is more or less fair. Though Cassidy’s discussion of this history is somewhat simplistic, the amount of depth is appropriate in the context of the book’s argument; one need not know the history in such great detail to understand the nature of market failure, and Cassidy finds the right balance.
The second of the book’s three sections identifies a handful of actual ways in which markets fail. In this portion, Cassidy’s underestimation of Smith is especially apparent, in that Cassidy gives 20th century economists credit for ideas in large part drawn from Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations. For example, Smith identified many of the conditions necessary for a market to function ideally, like excellent information and many small firms, which Cassidy credits to Joseph Stiglitz and Francis Bator, respectively.
Still, the issue of giving proper credit aside, Cassidy does summarize the findings of modern economists well. For example, in discussing externalities, Cassidy does an excellent job of tracing the history of the idea from Arthur Pigou through Ronald Coase to the present. Externalities are positive or negative effects of production and consumption that are not reflected or accounted for in the market price. The classic example of an externality relates to the purity of the air; all unfettered markets that might do damage to air quality have done so, since the damage did not affect the bottom line of the company until the government stepped in.
Another interesting mechanism of market failure that Cassidy explores is the one related to so-called public goods. Public goods are those that, according to Adam Smith, are extremely important to a society, but cannot be provided by private industry without losing important qualities. The ultimate example of a public good is the military, which is never a directly profitable enterprise, but is necessary for national security. Public goods can be abused through externalities, which can lead to market failure.
The third and final section of How Markets Fail applies the reasoning from the second chapter to the most recent financial crisis. To people who have kept up with the discussion among experts about the crash, this section may not be all that interesting, since virtually all Cassidy has to say has already been said multiple times by more prestigious journalists and economists. On the other hand, it may be helpful to see the theory of market failure applied to a detailed example.
Cassidy is a journalist, not an economist, and this is a mixed blessing for readers. An advantage is that Cassidy’s writing skills make How Markets Fail a breeze to read. The disadvantages are more numerous. Cassidy gets some minor things wrong, draws conclusions too easily and with too much certainty in them, and above all, does not organize his ideas into an easily applicable logical framework. This is especially problematic since it’s already been determined that market failure is easy to organize into assumptions and guidelines; numerous economists have already done so.
On the whole, How Markets Fail will be a very valuable book to anyone who has not learned about the history of economics or market failure before. To those with more background, Cassidy may not have so much to offer except in the middle section. Despite its flaws, How Markets Fail is still highly readable and has many important conclusions that deserve far better consideration than they are currently given in our political system.