Misunderstanding Market Failure (Academic Agent)

Preface
I just want to say that this is a bunch of notes and is not meant to be a coherent work. I am mostly just providing video notes and stuff I wrote, but felt was largely off topic.

It is my intention to do some content covering the ideas of someone who has had a lot of influence on me, David Friedman. He is an anarchist thinker who leverages market failure arguments to make his points. Since market failure is assumed to be an anti-libertarian position, we should try to understand and clear up any bias we may have. In order to do this, I want to respond to a video by the Academic Agent, “On ‘Market Failure’ and ‘Public Goods’”.  He even responds to a lecture by David Friedman in this video making it perfect to take a look at. The Academic Agent is a classical liberal and Austrian economics oriented YouTuber. I think that he ultimately makes a few mistakes or at least I have a few disagreements with his understanding of the concepts at play. This is just a side project and a warm up video, the main content talking about David Friedman will come soon.

The Academic Agent provides an interesting critique of market failure; None of the examples you would learn in a classroom are markets: soldiers failing to maintain formation, people talking too loud in a restaurant, and cars jamming in an intersection. In all of the examples, what is occurring is a form of the prisoner’s dilemma. This is where people making a rational individual choice can lead to a bad outcome for everyone. But what is crucial here is that this is not a market. In a market they can attempt to cooperate inorder to increase their value. This presents us with the first important lesson to understanding a part of market failure. What is failing? We are failing to form a market, an efficient way of cooperating and trading.

What is a market? A market here is a cooperative system to incentivize parties to work together. The market is supposed to be a good way of distributing resources. If I have a jar of water and you have a jar of oil; We only trade these two objects, because we both see more value in having what the other has. The value of an object is not contained in the object, but what I personally can get out of it. I might use a jar of oil to cook fancy dishes at my restaurant and you might only cook a meal for yourself. In turn you might be really thirsty and have plenty of jars of oil. By trading we have actually increased value. Goods get to whomever can best use them. When these mutually beneficial relationships fail to materialize, then this is the crux of the market failure argument.

There are many ways markets can break  down but we should consider what market failure is responding to. Parties trading with each and the benefits that come are part of Pareto optimality; All interactions can only improve, nor hurt all parties involved. Another form of optimality that market failure is trying to solve is Kaldor-Hicks optimality; Here we want to look at interactions where some people are affected regardless if they consented to it. 

So the Academic Agent in his video presents us with a concept called revealed preference with the example of building a dam. Investors are asked whether they want to build a dam that they all may benefit from. The problem is that it fails to get enough funding. He uses this as a refutation to the idea that there could be room for market failure in interactions. Each participant can look at something and reveal their own preference for whether investing in the dam is a good idea. How can the market really fail if everyone sat down and weighed the options for whether it was a good idea or not? Wouldn’t this be assuming the value of something and knowing better than the people? I am here to assure you, that I am not assuming what a person values. I agree and think revealed preference is important to economics. 

Here is the reason why revealed preference is being abused by the Academic Agent here. Suppose that you need to make a choice for whether you want to drive your car a little bit more. Now you need to factor in the benefits and costs. It will help you get to where you want to go, but you need to pay for gas and you will create a very tiny amount of pollution. The pollution in the air from personally driving may hardly affect your health and might be a really good trade. The issue here starts if you live in a polluted society, because everyone drives too much. You might be willing to drive less if you can reduce the pollution, but the only preference that you are testing here is if the marginal pollution is worth driving the marginal distance. There is no obvious mechanism here to explore the value of changing others behavior for your own benefit.

In essence his use of revealed preference is irrelevant here, because we are talking about two different things. The marginal value of polluting and the value of policies on pollution for the town. Now the issue is that one of these can easily be tested with revealed preference and the other might be harder to test. The only issue I take is that just because something is hard to determine, doesn’t mean that it is irrelevant from discussion. The Academic Agent is far more pro-state than I am so at some level he would have to assert that there are certain private actions that need to be limited. There is a reasonable demand that other people have their behavior regulated in various ways. 

The real question we need to actually answer and contend with if you want to advocate for libertarianism: How do we handle this real demand for other people to change their behavior? 

The Academic Agent mostly focuses on how the market solves many issues and thus it is kind of silly to be a market skeptic even in the face of the market failure critique. Do we need a government to solve every apparent market failure? In many countries, the government controlled and publicly funded the broadcast of radio. It was argued that there would be no way to fund it. In other countries, they had a much more competitive market where radio stations could compete and bundle their services with advertisements. The radio station is able to sell beer, mattresses, beauty products, etc. to their listeners in order to fund its operation. This is how a lot of content works on the internet. This idea is just a bit of brilliant entrepreneurship, someone came along and figured out how to bundle this non excludable good with something that earns the provider money. A lot of market failures are just opportunities for entrepreneurs to come in and solve it to make money. 

So let us examine the issue of the lighthouse that The Academic Agent raised, the solution he provided is how it was actually solved. The public good of the lighthouse was bundled with docking fees to access the port. Ports funded their own lighthouses and didn’t receive government funding. I will even give that many economists have been fooled by market failure arguments. If you study welfare economics in university, you might come away too optimistic that the government can intervene to solve these problems. His argument however relies on the idea that people will buy up and monopolize some stretch of coast. This is not a bad thing, I mean you could solve the dam issue by just buying up all the property in the area and then building the dam to increase the value of the property. Yes, if we can all just privatize the external costs and benefits, then everything is fine. This just sidesteps the issue of trying to form cooperative efforts. 

A lot of market failures are solved with excellent entrepreneurship, but this doesn’t mean every market failure can be solved this way. Pollution was not solved by a market. Most pollution has been controlled with command and control standards, taxes, or tradable pollution permits. Now suppose we want to go to the austrian economics solution and avoid these statist schemes. A proposal is that of property rights, which is an alternative to direct government involvement. In essence, why don’t we just privatize the air around your house. If someone pollutes it, then you can just take them to court. The issue I take here is that this requires someone to craft a policy of property rights and air rights that is designed to be able to punish polluters. Technically competent property rights definitions are an example of the role of government. Setting up courts as an institution is also expensive. Trying to arbitrate every dispute with property rights is not necessarily the most desirable solution for all the parties involved. 

To go back to the issue of the state, The Academic Agent has even made arguments against immigration on the grounds that you can’t exclude them from public services and they impose an external cost on him. You can see his arguments in “The Economic Cost of Immigration” and I believe his economics bloodsport video on the same topic. Sadly, the Academic Agent has put this video behind a paywall. It is curious that he uses market failure arguments and asks for an explicit government involvement to limit immigration. From my memory, I do recall the Academic Agent making the argument that immigrants are like pollutants from a smoke stack. These arguments are curiously a market failure and almost a public good argument. This just goes to my point that most economic arguments about state action are in the tradition of correcting market failure and the Academic Agent engages in the same types of arguments.

Doing research for this video, I stumbled across a mises institute lecture that had many of the same examples that the Academic Agent used. So to close on here, I would like to recommend a video, ”Externalities, Public Goods, and the Role of Government” by Peter G. Klein. I assume the Academic Agent used this video in his research or at least had read other material from the mises institute. This is reasonable considering he has written for them and attends various lectures. 

I would recommend you go and take a look at this video, because the speaker goes into depth the issue with many of the standard theories and their implementation. He is far more expansive and cuts to core issues at play much better than the Academic Agent. This is not to knock any of the Academic Agent’s catalog of economic education; I only want to demonstrate that I think he really failed to defend his thesis. He didn’t really engage with any of the market failure arguments, just argue that government involvement is not always the answer. This was never the contention in the first place. If we remember from the start of this video, everyone was already arguing from the limited government framework. So I think he has done a disservice to his audience here and