Should the Economic Crisis
Change our Assessment of
Markets and Government?
Clifford Winston
Brookings Institution
Broad Objectives of the Study
 Base policy debates on empirical
counterfactual evidence.
 Begin accumulating evidence and
identifying common themes so we don’t
have to start from “square one.”
 Provide guidance for policymakers.
Sources of Market Failure
 Market power in input/output
 Natural monopoly
 Imperfect information
 Externalities
 Public goods
Assessment
 Is there evidence of market failure?
 Is government policy improving performance?
 Is government policy optimal?
Conclusions Before the Crisis
 Intervention is often unnecessary.
 There are missed opportunities to improve
efficiency.
 A greater role for market-oriented policies
should be considered.
Conclusions in Light of the
Economic Crisis
 A serious market failure—imperfect
information—did occur and it led to the
economic crisis.
 But the current backlash against markets and
broad claims of market failure are misleading
and may lead to counterproductive policies.
 There is still little evidence that government
micro policies are effective and that
government can prevent the market failure
that contributed to the crisis.
Approaches to the Issue
 Applied welfare economics
 Counterfactual analysis
 Academic studies
 Not major divisions among studies
 More work clearly needed
Market Power: Antitrust Policy
 Monopolization
 Collusion
 Mergers
 Deterrence
Antitrust Update
 Christine Varney, head of DOJ antitrust
division, announced that the Department
planned to restore an aggressive
enforcement policy against corporations
that abuse market dominance.
 Evidence that this will be an effective
strategy?
Natural Monopoly:
Economic Regulation
 Substantial partial deregulation
 Agricultural subsidies
 Quotas and tariffs
Imperfect Information
 False advertising
 Product disclosure
 Product safety standards (offsets)
 Workplace safety
 Deterrence
Information Policy
Figure 1a. US Toy Related Injuries, 1994-2002
1
0.9
0.7
0.6
0.5
0.4
0.3
0.2
0.1
20
02
19
98
19
96
20
00
Source: Consumer Product Safety Review 1995-2003
0
19
94
Injuries per thousand people
0.8
Year
*Injuries include any toy related injury which requires hospital care and all deaths
Information Policy
Figure 1b. Occupational Injuries for Private Industry, 1973-2001*
12
Injuries Per 100 Full-Time Workers
10
8
6
4
2
Source: Bureau of Labor Statistics, Workplace Injury, Illness and Fatality Statistics
0
1973
1978
1983
1988
1993
Year
*Occupational injuries include all injuries sustained on the job, including those that require time off from work and those that do not.
1998
Imperfect Information Update
 Children’s Toys: One CPCS toy tester.
 HOUSING MARKET: home buyers and investors did not
properly weight the credit risks they were assuming.
 Banks and rating agencies underestimated the probability
of a major decline in housing prices.
 NOTE: most defaults were centered in regulated financial
institutions that purchased and invested in sub-primes.
Even Bernie Madoff’s operations were subject to federal
regulation.
Consumption Externalities
 Automobile emissions
 Aircraft noise
 Smoking and drinking
Externalities
Figure 2. Average Ambient Levels of Air Pollutants, 1965-1995
60
160
Carbon Monoxide (95th)
140
Nitrogen Dioxide
50
Ozone (95th)
120
40
100
30
80
Ozone (ppb)
Sulfur dioxide and nitrogen dioxide (ppb)
Carbon monoxide (ppm)
Sulfur Dioxide
60
20
40
10
20
0
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
Calendar Year
Based on data reported in F.W. Lipfert and S.C. Morris, “Temporal and Spatial Relations between Age Specific Mortality and Ambient Air Quality in the
United States: Regression Results for Counties, 1960-97,” Occupational and Environmental Medicine 59, no. 3 (2002), 156-74.
Carbon monoxide and ozone levels are averages of the 95th percentile of daily one hour readings at each monitoring location. Sulfur dioxide and nitrogen
dioxide levels are averages of annual means from each monitoring location.
Externalities
Figure 3. Percentage of Population Exposed to Excessive Aircraft Noise*
3.5
1977 FAA Classifies Planes into
Noise Categories
1990 Airport Noise
and Capacity Act
3
Percentage of US Population
2.5
2
1.5
1
0.5
Source: BTS National Transportation Statistics 2002 Table 4-53
0
75
19
80
19
85
19
90
19
Year
95
19
00
20
*Excessive noise is defined as noise levels of 65 dBA or higher
Production Externalities
 Air pollution
 Emissions trading
 Water pollution
 Superfund
Externalities
Figure 4. Water Bodies Considered “Impaired” or Worse by the US Environmental Protection
Agency, 1992-2000
60
Lakes
Estuaries
Rivers
Coast
40
30
20
10
Source: USEPA National Water Quality Inventory Report to Congress 1992,1994,1996,1998,2000
Year
20
00
19
98
19
96
19
94
0
19
92
Percent of all sampled water bodies of each type
50
Externalities Update
 Raising Corporate Average Fuel Economy
standards: consider tradeoffs.
 Cash for Clunkers: new cars are driven more
than old cars.
 Cap and trade: rights to emit carbon should be
auctioned off.
Public Production
 Highways
 Airports
 Urban transit
Public Production
Figure 6. Average Annual Traffic Delay in Major Metropolitan Areas, 1982-2001
30
20
15
10
5
Source: Texas Transportation Institute
Year
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
0
19
82
Hours of Traffic Delay Per Person
25
Public Production
Figure 7. Changes in Air Travel Time, 1977-2004
16
14
Change in Flight Time (minutes)
12
10
8
6
4
2
0
1977
1979
1981
1983
1985
1987
1989
1991
Year
1993
1995
1997
1999
2001
2003
Public Production
Figure 8. Government Transit Operating Assistance, 1976-2001
16
14
10
8
6
4
2
Source: APTA Transit Fact Book (1992,1998) and www.apta.com
Year
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
19
78
0
19
76
Billions of 2001 Dollars
12
Public Production Update
 Public infrastructure spending: a source of economic
stimulus?
 Two tiny villages in Alaska are getting $28 million for
airport funds.
 Washington state isn’t using stimulus funds to relieve
congestion in Seattle but is spreading the funds to other
regions of the state.
 Money for high speed rail!!!
Synthesis Before the Crisis
Less intervention warranted:
 Antitrust
 Monopsony
 Regulation
 Information
Synthesis Before the Crisis
Missed opportunities to improve economic
efficiency:
 Consumption externalities
 Production externalities
 Public production
Explaining Performance
 Robustness of markets
 Agency inflexibility
 Policy conflicts
 Political forces
 Do policymakers learn?
Updating the Synthesis
 Market failure related to imperfect information
clearly contributed to the economic crisis.
 Government failure is still a major concern as
government intervention expands in several
areas.
 It is far from clear that government has learned
from its past failures. It is clear that markets
are learning—but they will never be able to
eliminate the costs associated with risk and
future crises.
What Should the Interested
Lay-Person Take Away?
 Markets make mistakes—sometimes big ones. Does
that mean government intervention will improve
matters?
 Government Failure imposes large costs; market
performance is often better than recognized.
 Retrospective empirical assessments and the
accumulation of evidence contribute to “truth.”
What Should the Interested
Lay-Person Take Away?
 Policy outcomes and the sources of inefficiencies are
similar across an array of policies.
 Challenge advocates to provide scholarly evidence.