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Sunday, September 30, 2007

International market failure with China?

Numerous TV anchors and commentators, such as CNN's Lou Dobbs and Jack Cafferty, are expressing outrage over the dangerous Chinese imports. They blame the free market proponents for allowing things like tainted dog food and toys with lead paint into the country. Clearly their beloved free markets failed, right?

Looking at the lead paint example, there are no clear third parties, so it's hard to call it an externality. Public goods are obviously not involved, as the toys are both excludable and rival.
Neither of our class models fit at all, so maybe we should think about the incentives and ask if there truly seems to be a market failure. Is there an incentive to use lead paint for either the American toy company or the Chinese toy factory? The toy company almost certainly wouldn't be that stupid, and as for the factory, any temptation for using cheaper supplies and keeping the profits hidden is gone now. What about the Chinese government? They have a huge incentive to look clean for PR purposes. The last thing Beijing needs is the American people panicking. Considering this, I don't think there's a market failure.

Let's suppose that I have no idea what I'm talking about and there is a failure. What is the best way to fix it? I really don't know, but I do have an idea about the worst way. In the recent Democratic debate Senator Dodd was asked if he would halt all toy imports from China with Christmas coming:
"We would shut down a company in this country in 20 minutes if they were using excessive lead paint... so I would certainly do that." Would we shut down the entire auto industry or just mandate a simple recall?

I think this example shows that the market is functioning efficiently. The incentive for quality assurance is internalized in the market, so the problem will be corrected. Christmas is saved!

I agree there are no clear 3rd parties.

There are buyers and sellers, and the harm falls on buyers.

There would seem to be a couple of conceptual approaches to these situations: "buyer beware," or "seller beware." This should remind you of Coase, and it should be another reason for concluding there doesn't seem to be the market failure of an externality involved here.
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