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Monday, February 27, 2012

Externalities abuse

In this blog I'll focus on two quotes by Christina Romer from her article Do Manufacturers Need Special Treatment?

The author is talking about positive externalities of production clustering which brings more business into the area, and gives them better chances to succeed. Here is what she said?
"If the company that jumps in first and eventually succeeds reaps all the rewards, there’s not a market failure....
On the other hand, if an early entrant paves the way, but other companies come in later and snatch the rewards, government intervention could be helpful." She is basically saying that if private business succeeds, there is no market failure. However, if private enterprise fails (and it happens very often) then it's market failure and government should intervene. I don't think that it is a good definition of market failure. It simply means that if a private firm tried a business and failed, and later, firms that moved into the area become successful it's a normal business process of trial and error. It's not a market failure and thus cannot be justified for government intervention.

"Today, we face a profound shortfall of demand. That truly is a terrible market failure, and it warrants government intervention." This is the biggest joke of all times. That's the biggest lie of all times! But it looks that it was repeated enough times that a lot of people (and economists) believe it. The reason it cannot be true is because market failure can occur in one of three instances:
1. Externalities
2. Public goods
3. Market power (monopoly)

"profound shortfall of demand" is not an externality, because people are directly involved in it: for different reasons, they decided not to buy products and services which is their right. These actions were "market" and "intentional". So, it cannot be an externality. Obviously, it is not a public good.
Someone may argue that it a market power. I would object and say that it's not a market power, but rather a market process, the market itself. It's a voluntary process. If government intervenes to stimulate the demand in a specific area, then it will reallocate resources of production from other uses - less valued, according to the market. Unfortunately government cannot stimulate demand forever, without having to pay for it. Government (taxpayers) will have to pay for current consumption in the future, which will definitely create "profound shortfall of demand."

On the first quotation your interpretation is not really what she is saying. She is not saying business failure is a market failure. Instead she is suggesting that when there are agglomeration economies the first business in a region will "generate benefits" for those that come later that the first business cannot capture. This sounds like a positive externality, and that is the point she is making. However, I think it is not an externality because the presumed benefits are embodied in markets and market relationships.
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