market failure and government intervention

UNIVERSITI SAINS MALAYSIASCHOOL OF SOCIAL SCIENCESMASTER OF PUBLIC ADMINISTRATION

SPA504 : ECONOMICS FOR THE PUBLIC SECTOR

DR. SAIDATULAKMAL MOHD

MARKET FAILURE ANDGOVERNMENT INTERVENTION

By :SARJANUDDIN (P-SM0123/09)

MUHAMAD IZZWANDY BIN MAMAT (P-SM0081/09)

BACKGROUND

Economists of different political philosophies argue about the extent

to which governments need to intervene in the workings of the free market. Free

market economists argue that government intervention should be kept to a

minimum whilst socialist economists, in favor of more state ownership and

control, argue that there is greater need for intervention. One argument where

there is considerable debate is concerned with the environment and its

sustainability. It is when the protection of the environment is considered that the

free market appears to fail on several counts.

Market Failure and Government Failure

Market failure refers to those situation in which the conditions

necessary to achieve the market-efficient solution fail to exist or are contravened

in one way or another. (C. V. Brown and P. M. Jackson, page 28).

Market failure exists when the production or use of goods and services

by the market is not efficient. That is, there exists another outcome where market

participants' total gains from the new outcome outweigh their losses (even if some

participants lose under the new arrangement). Market failures can be viewed as

scenarios where individuals' pursuit of pure self-interest leads to results that are

not efficient – that can be improved upon from the societal point-of-view. The

first known use of the term by economists was in 1958, but the concept has been

traced back to the Victorian philosopher Henry Sidgwick. (Wikipedia).

Market failures are often associated with non-competitive markets,

externalities or public goods. The existence of a market failure is often used as a

justification for government intervention in a particular market. Economists,

especially micro-economists, are often concerned with the causes of market

failure, and possible means to correct such a failure when it occurs. Such analysis

plays an important role in many types of public policy decisions and studies.

However, some types of government policy interventions, such as taxes,

subsidies, bail outs, wage and price controls, and regulations, including attempts

to correct market failure, may also lead to an inefficient allocation of resources,

(sometimes called government failures). Thus, there is often a choice between

imperfect outcomes, i.e. imperfect market outcomes with or without government

interventions.


THE FALL OF WALL STREET, MARKET FAILURE?

Free Market Economy was Fault. That was everybody’s comment on

respond the fall of Wall Street as result of financial companies’s bankrupt. Big

names like Lehman Brothers, American International Group (AIG), Merril Lynch,

Goldman Sach was gave up. The Wall Street which the world knowas a capitalist

economy power symbol and the success of free market, now have no power.

Without government bail out, financial crisis which bear down upon

Wall Street not only disabling United States economy, but also dragging world

economy to the recession. United States’ economy condition marked as high

inflation now, economy growth slowing down, unemployment increasing, budget

deficit and balance of payment swollen up. Subprime Mortgage crisis effected

liquidity tight, the bankrupt of financial sector companies; stock market price and

debenture fall down in Wall Street. This was a momentous financial crisis after

the Great Depression in 1929. At that time, capital market fall down, investment

bank and commercial bank was bankrupt. Costumer can only draw out 50% of

their money on the bank. Financial company other than bank was bangkrupt.

Non-financial companies was hard to stand. Economy growth was

minus, inflation was flown away, amount of rich and middle people descended,

unemployment swollen up. Because of wrong policy, this depreciation was going

on until 1938. To prevent from Great Depression II plummet, the United States’

government and central bank planned the bailout. Giant financial companies’

obligation which was role as Wall Street’s motor, axpropriated by government

and injected with fresh fund in order that it can be re-operated. This policy judged

as contended with free market ideology which was the United States’ direction in


tens of years. The bail out policy indicated that free market economy was fault to

gave prosperity and to convoyed American Dream. United States as a super power

country which is have the respect of others, will be lost it’s power if bangkrupt.

Presidentt Barack Obama clearly announced that United States in danger and will

be fall in to economy recession if not saved as soon as possible. That was why

President Barack Obama gave countenance to save The Wall Street. He was

convinced the people that bail out is important to save United States’ economy.

That bail out is a part of safe the nation.

FREE MARKET FAILURE

The Wall Street destruction indicated that glorious free market

economy can’t increase and maintain economy growth and prosperity. The Wall

Street destruction hint that how important government role even government

intervention is. In this situation, bail out become a non-evasive solution. Because

of investment bank bangkrupt, commercial bank, insurance companies and most

of listed companies on New York Stock Exchange (NYSE) will drag United

States’ economy into recession.

If this recession occur, it will also impact to low level people. The

Wall Street bangkruptcy was one from so much many examples of this imperfect

free market economy. In fact, invisible hand which made market work efficient

such as Adam Smith mentioned, free market economy organiser in The Wealth of

Nation, not proven. When asymmetry information happened as a result of

imperfect information spread, market will not efficient. Lucky only for a few

people who got first true information. The Wall Street organizer group and in

every capital market, generally get first information material than investor they


server. Double attic - as broker and trader - make securities industry give priority

to it’s portofolio than to serve costumer order.

Share price movement benefit enjoyed firstly by securities company.

Information never spread perfectly, and also market not always going perfect.

Without government intervention, without good regulation or law and tight

supervision, market will be inefficiency. Stiglitz (2003), criticize accountant and

investment bank CEO who did not work efficient. Apart from doing offence

allocation, they also inflate asset. Fast or late, the bubble will break and occur

economy recession. Financial bubble now breach. What was Stiglitz’s reminder is

proven now. Excessive investment at derivative product made financial

companies collapse. Oil, mines and gardening commodity price fluctuation caused

by financial companies. Market price not reference to physical goods value

anymore, but it reference to future price speculation. Because of asset

enhancement and their ability to convincing costumer, investment companies can

gather large number of fund.

With large fund, CEOs and professionals in Wall Street profits very

high salary. The situation made the rescue packet of US$ 700 billions not get

Congress approval in short time. People of the United States unwilling their tax

used to subsidize CEO in Wall Street, who was rich and fashionable high lifestyle.

One of the conditions is proposed by Congress on government proposal is CEO

salary’s high cutting. The fund which injected by the government is used to pay

national debt and to add more capital. Government sent FBI to ensure that a dead

los of the companies which the governments want to save are not due to moral of

its CEOs and professionals. The Wall Street unstable starts from subprime


mortgage loan crisis, which is home ownership credit to all middle and lower

debtors who are living dependent on low fixed income. When inflation increases,

they can not pay the interest and account payable. This situation which already

begun since around five year ago finally burst on middle 2007. The value of

securities with underlying asset subprime mortgage is going down, whit the result

that can not being sold at fair price. In fact, fair price was difficult to be known

because there was so many kind and variation of securities derivation with

subprime mortgage basis. Total investment loss in subprime mortgage achieves is

more than US$ 800 billions, even there was a guessed above US$ 1 trillion. The

estimate that subprime mortgage crisis will end immediately had not proven. One

by one, financial companies announced their loss as a result on variety investment

derivation subprime mortgage worth trillions of US dollar. When subprime

mortgage price collapse, the obligation increase highly, exceeded its asset. That

loss that is which should help by all tax payers now, including those all who lives

by the sweat of their brow. Around last five years, United States economy actually

no more healthy. Purchasing capacity of middle and lower people relative fixed,

and some reduced.

GOVERNMENT VS FREE MARKET

The Berlin Wall collapsed 9 November 1989 expressed a new

economic system era. Centralized economic system or commando economic

system molded by communist country or totalitarian country not manner sold

anymore. Two years later, 1991, glasnost and perestroika demolish Russia. Those

countries whit by economic system command have broken in pieces. Another

centralized economy country, China, already start exposes its country on free


market economic system since 1978. Prime Minister Deng Xiao Ping, China open

for foreign capital. China’s economy was growth very good even though their still

ruled the communist system. Whit economic growth 9 - 10% for last ten years,

China wants to point out to the world that socialist economy system also able to

make their people prosperous. After centralized economy collapse, there are only

two systems which became referenced now, that are liberal economy which carry

free market economy and economic system which gave countenance to

importance government intervention. Free market ideology loyalist require the

minimum government intervention in economic. The minimum government

intervention, the maximum for economic advancement. Free market ideology

again promoted since 1960’s, and the economists extremely influenced Milton

Friedman and Anna Schwartz (1963) with Chicago University, Friedman was

earthed market economic theory. Milton and Anna have a conclusion that 1929

Great Depression was not a market economic failure, but it is a Federal Reserve

Board Failure.

Suppose if the Economic Nobel Price Winner 1976 still alive, we can

ask him, “This Wall Street's ruins arising out of market failure or government

policy failure”? By Friedman hand, free market economy is an outcome from

ivory tower and popular among economy students. In his book, he was stresses

how importances are the individual freedom in improving welfare. In same book,

Friedman explains the importance of floating exchange rate, negative side from

income tax, etc. Friedman masterwork, which entered non fiction best category is

Free to Choose, 1980. He was stressed, free market economy is very important for

people sovereign. By giving freedom for every individual to have production


resource and if government does not intervene directly in economic activity,

People participation in economy will increase. The condition also will establish

spirit and people creativity to produce high quality products. Free market

economy will make competition to supply the best thing and all those will benefit

the consumers. Profit motive will forced the producers to be more efficient, and

the consumers will get high quality products and services with reasonable price.

Free market economy afterwards got labeled as neoliberals since Washington

Consensus. According to the consensus produced by World Bank, IMF, and

United States economist, to broke economic crisis in the Latin America, economy,

should be pushed by surplus budget, financial liberalization, trade liberalization,

invests liberalization, deregulation, and privatizes. This recipe is incompatible for

all countries. The evidence is, many of the countries that increasingly bankrupt

precisely. What is the compatible economic system? Seem, extreme free market

economic system and extreme government intervene market useless. Friedman

also stated, Free market not eliminate government intervention. Government

intervention is very important to role the market and also as a fair referee for all

actors. US histories show so many government’ intervenes to save the economy.

After WTC twin towers collapsed in 2001, United States government also extends

more funds to capital and money markets to increase market liquidities. Famous

investor, George Soros, in his latest book, admits, free market have failed. Free

market ideology that states the market mechanism will correct its own fault, not

proved. Market failure not completely means that free market not needed

anymore. Free market should be applicable, but the space for government

intervene must there so that the market can be run in order, fair, and not distorted.


CONCLUSION

Governments having an active role in markets, particularly setting

prices. The best way to understand market failure is first to understand market

success, the ability of a collection of idealized competitive markets to achieve an

equilibrium allocation of resources which is Pareto optimal. For the free rider

phenomenon problem, government also can provide the public good if the total

benefits exceed the costs and government can make everyone better off by

providing the public good and paying for it with tax revenue. Also everyone has

to cooperate together in paying the taxes and get benefits from the public good.

There are many instances of market failure. Someone may possess

information that others do not, as in insider trading, and thereby gain an

illegitimate leg up. There may be too few players in a given market, which allows

them to manipulate, hoard, and toy with prices. Capricious government

intervention in cases where it is neither required nor appropriate constitutes

another condition that may create a market failure.

There are also cases of market failure in which some people get a free

ride while others bear a disproportionate burden. This is the case in national

defense, for example. Consequently, a government subsidy for national defense is

necessary for the maintenance of security and power, and the overwhelming


majority of citizens acknowledges it and does not complain about it. National

defense is a public good, perhaps the original public good.

REFFERENCES

Charles Victor Brown and Peter McLeod Jackson, Public Sector

Economics, Blackwell Publishers, Oxford UK & Cambride USA, 1994.

Mrinal Datta-Chaudhuri, Market Failure and Government Failure, The

Journal of Economic Perspectives, American Economic Association Vol. 4, No. 3,

1990 (http://www.jstor.org/action/showPublication?journalCode=jeconpers)

John H. Makin, A Government Failure, Not a Market Failure, August

2009 (http://www.commentarymagazine.com/viewarticle.cfm/a-government-

failure-not-a-market-failure-15191).

Milton Friedman and Anna Schwartz, Monetary History of United States,

Chicago University, Chicago, 1963.

http://www.environment.nsw.gov.au/salinity/glossary.htm


market failure and government intervention

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