Inefficiencies in Markets and Government
Apr 6, 2011

Inefficiencies in Markets and Government

When discussing the relative roles of the market versus the government at providing a service, among the standard criticisms of government is that it is inefficient. This comes from a more limited accountability mechanism - voting - than the pricing mechanism of the market.  However, there are several aspects of a market provided service which ought to be considered inefficiencies yet are infrequently termed as such.

Perhaps the most important neglected inefficiency is profit itself. If x% of the revenue for providing a service ends up as profit then this is an inefficiency of x%. For a company, the goal is to maximize profit and hence profit is never considered an inefficiency (something one wants to minimize) but instead a good thing to be maximized. However, if the goal is providing a service like, say, garbage collection or health care to the people than dollars going to profit are inefficiencies at providing this service cost effectively and a smaller profit - all else being equal - is better for the people than a large one.

Secondly, we have the issue of many smaller companies doing overlapping tasks that a larger company or government program could eliminate. This is the basis for the general heuristic that larger is more efficient because commonalities and redundancies can be eliminated. Two individual small companies may each be maximally efficient with respect to itself but if combined could be made more efficient.

Thirdly, efficiency is typically referred to exclusively as financial efficiencies and the monetary cost of providing a service or product. However, one often wishes instead to look at the social value provided and we ought to ask how efficiently this social value is provided opposed to purely the monetary value. For example, if something is slightly more expensive but delivers a vastly higher social value - perhaps in a highly unquantifiable way such as "egalitarianism" - the efficiency in social value may trump an inefficiency in the monetary value. Indeed a government program can do something no private company can do at length which is to run at a loss under the expectation that the social value is higher than the nominal cost of the losses.

The result of these, and other, inefficiencies is that one has a significant inefficiency gap to make up when privatizing a service. The government service may very well have inefficiencies of their own, but one needs to ask if they are larger than the amount of profit skimmed and the like.

The point here is not to establish that government providing services is a priori better or worse than the market. Indeed, depending on what it is sometimes the market or the government seems best and sometimes it makes little difference one way or the other. However, to determine this in a specific case we need an accurate accounting that takes inefficiencies in the market for what they are and doesn't neglect them from our rhetoric. 

Thoughts on this post? Comment below!

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Justin said...

I have recently come around to this line of thinking, but had not taken into account the social value vs the monetary value of a program or business. However, I would argue that there are many nonprofits that fall below this monetary/social value threshold, and are potentially more of an efficiency drain than profit-maximizing corporations.

As an aside, how do you think patent and copyright law plays into the profit inefficiency? I imagine that without patents or copyrights, the profit curve would quickly shrink to nothing which would have a net benefit on humanity. Curious to hear your thoughts.

bazie said...

Absolutely. Considering these other factors like various social benefits just changes the calculus, any given say government program may still not be a net benefit in this calculus and ought not to be supported.

As for patents, reducing excess profitability (coming from temporary monopolies) absolutely is one factor to consider. Make the patent times too long and profibility soars at the expense of various social factors. That said, if you eliminate things like drug patents entirely then the investment in new drugs declines - a societal loss. One must try and balance these two factors and many others to find the correct things to patent and what times to patent them for

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