Market Failure and Government Failure
Seung-Hoon Lee
Seoul National University
Market economy is based upon the principle of laissez-faire. Given freedom to
choose her action, each individual will behave according to her own value which
may be identified with her own self interest. Adam Smith persuaded readers so
eloquently as to how selfish individuals might co-operate, rather than predate,
each other in pursuit of their self interest. He wrote
Give me that which I want, and you shall have this which you want …. It is
not from the benevolence of the butcher, the brewer, or the baker, that
we expect our dinner, but from their regard to their own interest. 1
He also wrote
In civilized society [man] stands at all times in need of cooperation and assistance of
great multitudes, while his whole life is scarce sufficient to gain the friendship of a few
persons2
to explain why selfishness, rather than fraternity, must be practically the only
incentive for an individual to co-operate with others in modern social division of
labor. Of course the conflict arose inevitably, however, whenever individual self
interests collide with each other in real world, jeopardizing laissez-faire ideal. If
each individual acts in pursuit of his own self interest, then the immediate
consequence will be a keen social conflict rather than harmony. Social control
usually introduces itself to prevent chaotic development of conflict among self
interests from occurring. Individual freedom is viable only when it is properly
1
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Clarendon Press
(Cambridge), 1976, pp.26-27.
2
Adam Smith, ibid., p.26.
protected, and to protect my freedom is to delimitate freedom of others since it
is others’ freedom, including the state’s, that attacks my freedom.
Adam Smith introduced the notion of the moral sentiments in order for his
celebrated Invisible Hand to rule out such conflicts from free market. He thought,
or wished, that the moral sentiment in human nature might guide each individual
to pursue after her self interest without harming others. Thus free market will be
guided by the invisible hand of benevolent god toward a harmonious and
efficient equilibrium rather than chaotic disaster.
But the invisible hand has never been perfect. Market often fails and invites a
variety of state interventions in reality. A standard microeconomics class teaches
that a free market allocates resources efficiently if individual preferences are
locally non-satiable and if there are no externalities (the First Welfare Theorem),
market failure occurs if these conditions are not met, and government intervenes
in order to remedy market failure, but the government also fails in many
occasions, and etc.
Now it is widely accepted that the invisible hand is not perfect anymore and
state interventions are necessary on certain occasions. But this theorem is often
abused to justify many dislocated government interventions, too. This abuse
usually leads government to correct superficially the visible results only without
addressing directly to the fundamental cause of the failure. It is this pattern of
intervention that turns the government intervention into another failure, the socalled government failure.
In this paper I will review the spectrum for the notion of market failure, will
illuminate the issue of market failure from the perspective of property right, and
will argue that all the market failures in standard definition arise from failure in
protecting property right. Thus a perfect protection of property right will realize a
resource allocation that the Smith’s invisible hand intended to. But there may still
be another kind of market failure which represents a discrepancy between social
goal and market outcome. I will argue that even in this case the reallocation by
the state intervention is advised to minimize the distortion of property right in
order to maximize the social welfare.
1. The basic principle of free market
1.1
The nature of market competition
Competition occurs whenever too many demanders generate shortage, and
therefore every competition has to eliminate a number of competitors. This
elimination is often criticized as ruthless and inhumane. In particular, the market
competition has been blamed to be so inhumane as to produce numerous
miserable losers victimized by the greed of the powerful few.
A selfish individual may attain his self interest by making use of various means,
but these means are classified broadly into two types; the one comprising all the
means that infringe upon others’ property right such as predation and free-riding,
and the other addressing those where each individual works for others and gets
paid for the work. It is the latter that enables selfishness to realize self interest
not by hurting others but by helping them.
If a social system succeeds in harnessing selfishness to pursue after self interest
by means of helping others only, then the ideal of free market may be realized.
Selfishness will have to look for self interest not in exploitation of but in cooperation with others only when one may not benefit at all from hurting others.
Effective protection of property right will lead free choice of each individual to
seek for self interest only in working for others for compensation, because no
one may make use of others’ property without the consent of its owner under a
system of well-protected property right.
Selfish individuals compete with others for their own interest in the free market,
and the protection of property right leads people not to predate but to work for
others, and rectifies the market competition to select best workers by the
demanders. Both you and I competed for a job and you won it only because the
demanders wanted you rather than me. If some other mechanism eliminated you
and forced me to have the job, then the demanders’ property right would have
been unfairly intruded upon. The competition for higher income develops itself
into the one where each individual competes with others to work for higher
compensation, namely to seek for and carry out jobs which are desired more and
thus paid higher by the entire economy. If you are a winner in such a competition,
then your success evidences that you satisfied your customers better than your
competitors did.
Some losers could certainly have been victimized unfairly in competition of the
real market under poor protection of property right. But in the market of well
protected property right the losers are those who could by no means have
satisfied their customers properly while the winners have done so. In this case an
extra protection of losers may infringe upon freedom and property right of their
customers.
1.2 The nature of income distribution by market
When I pay price for the goods I purchase, I explicitly approve to transfer a part
of my income to the seller as much as that price. The market economy induces
each individual to earn her income in this manner. Thus the market determines
income distribution under unanimous consensus where nobody’s property right is
ever intruded upon in the market competition.
The price determines the amount of income transfer, and competition raises
price whenever the concerned commodity is in shortage. It is well-known that
market competition realizes the law of demand and supply when there are
numerous buyers and sellers. In such a market a buyer needs not to pay higher
price when there are sellers willing to sell at lower price. The same is true for a
seller; he needs not to sell at lower price if there are buyers willing to pay higher
price.
The price is determined, however, not by the law of demand and supply but by
bargaining if there are only a small number of buyers and sellers. Here the
bargaining power will crucially influence the process and the result of price
determination. If each party’s bargaining power is legitimate, then the determined
price may not be challenged. But if some party’s bargaining power is attained in
somewhat unfair manner, for instance by means of forming a cartel, and is made
use to determine the price to its favor, then this process unduly transfers income
from victimized party to the favored one, and the resulting income distribution
may face a serious challenge as for its legitimacy.
Competition law has been introduced to restore fair competition in the real
world market. This legislation may also be viewed as a device to enforce property
right, as it prevents undue market power from coercing transfer of income. In a
word the income distribution of a market economy is fair as long as property
right is well protected, since each individual earns exactly as much as she
contributed to satisfy others’ needs in such a case. But one may still raise an
opposition against the income distribution that market realizes under effective
protection of property right.
Suppose that an individual is so incompetent that he cannot survive with the
income that he duly earns from the market. If the society deserts such a loser
alone to starve, then the market economy will surely be working in an inhumane
manner. It is desired socially to allow some extra income to such losers so that
they may carry out their living together with other fellow citizens. An individual
may also encounter an unfortunate disaster that she cannot wage through by
herself, even though she normally fares well in market competition. Again she
needs some help from her fellow citizens.
A humane society allows for redistribution of income in order to take care of
such tragedies and unexpected misfortunes, even though the initial income
distribution is fair and legitimate. Although the initial income distribution may be
justified in the sense that everybody earns as much as she contributed to
satisfaction of other citizens, this justification does not necessarily reflect the
social need for commonwealth of fellow citizens.
2.
Market failure and state intervention
2.1 The nature of market failure
The terminology of market failure delivers a variety of delicate nuances, but
mainly refers to the performance of market that deviates away from the socially
desired one. Narrowly it covers only the externalities including public goods, but
broadly it comprises anti-competitive performances of dominant agents and even
the socially undesired form of income distribution. Now observe that the market
failure, whatever is its form, always raises the issue of proper protection of
property right.
(1) Failure in competition
The ultimate source of anti-competitive behaviors is the dominant position of a
single agent or several agents in the market. The dominant player enjoys a
superior bargaining power to tilt trade toward his favor. Because all the market
transactions occur on voluntary bases, the resulting transfers of property and
income are approved by both parties and their legitimacy may not be challenged
no matter how abnormal the associated income distribution may look.
The bargaining power of an agent is to reflect the value of the agent’s capability
to satisfy others’ desire; if every customer wants me and I am the only one who
can serve the customers as I am doing, then I may enjoy a superior bargaining
power in comparison with my competitors. An example is the monopolist who
can produce a good of higher quality at much lower cost than others so that her
monopoly price is lower than the average cost of a best competitor. Here the
monopoly may be viewed as a prize awarded to the winner in competition under
well protected property right for that specific sector.
One can, however, also strengthen her bargaining power without developing
successfully such a superior capability to satisfy her customers. She can merge
with all the other competitors in order to build up a monopolistic giant and
attain a superior bargaining power. She may also collude with competitors to
form a cartel. Or she may exercise predatory pricing to drive out all the
competitors and monopolize the market. In a word she may intentionally
eliminate competition to attain unduly superior bargaining power.
If one party attains undue bargaining power and makes use of it to set unfair
price and/or delivery conditions to exact improper transfer of income in market
transactions, then the legitimacy of this income transfer may be challenged. The
U.S. Sherman law outlawed both cartel and monopolization, and subsequent
judicial cases clarified that unlawful monopolization is the one resulting from
improper elimination of competition while every monopoly which is awarded to
the winner in fair competition is legitimate. On the other hand the legal system
of EU views that every dominant position, regardless of legitimacy of its
bargaining power, is apt to eliminate competition and intervenes in the exercise
of its superior bargaining power.3
The U.S. competition law acknowledges the superior bargaining power awarded
to the winner in fair market competition as a legitimate property right, and this
view is consistent with our stance that the nature of anti-competitive behaviors is
to infringe upon the property right of other party making use of undue
bargaining power. Monopoly pricing is not illegal in the U.S. legal system if that
monopoly is the result of a due market competition for instance. But EU system
does not care about the legitimacy of dominance and only notes if a dominant
player makes use of its superior bargaining power to its advantage in market
transactions.
(2) Externalities
Externalities obstruct compensation for the benefit or damage from individual
action under no clearly defined property right. Polluters contaminated fellow
citizens’ air without any compensating payment, and a beekeeper used to fly
generously his bees to bless apple orchard with a harvest of abundance without
any compensation. 4 Such failures to pay had occurred because there were no
clearly defined property right as for environment and the service of bee flying.
It is free to pollute the river or air in a society where there is no well-defined
property right of environment. Thus polluters bear no private cost from the
pollutions they cause. But the entire community suffers social cost of polluted
river and air. The discrepancy of private cost from social one makes a socially
3
The U.S. competition law is known as Anti-Trust law, rather than anti-monopoly law. In this
context one may call the EU competition law as anti-monopoly law.
4
To be accurate, there is a report that beekeepers are paid for their services by apple orchards in
some places. See Steven Cheung. “The Fable of the Bees: An Economic Investigation,” Journal of
Law and Economics, 1973.
undesired act to be a privately profitable one, and encourages polluters to
choose the socially undesired act destroying the economic efficiency of market
economy.
The same explanation applies to beekeepers. The benefit of bee fly is not
compensated properly, and thus the beekeeper’s private benefit is smaller than
social benefit, which discourages a beekeeper from flying his bees to a socially
optimal level. Both external economy and diseconomy give rise to discrepancy of
the social benefit and cost from private ones, and this discrepancy leads to
market failures. In other word, this kind of market failure is nothing but a failure
in delineating and protecting property right properly.
(3) Failure in income distribution
It is rather clear to see that the cases of anti-competitive behavior and
externalities arise from failure in protecting property right. But the case is
somewhat subtle for the discrepancy of market-determined income distribution
from a socially desired one. It is certainly a kind of market failure, if market does
not realize a socially optimal allocation even under effective protection of
property right. Can we still blame the failure in property right protection for this
kind of market failure?
When market fails in eliminating this discrepancy, one may conclude that some
individuals are earning unduly low income, which means that their property rights
are not properly protected. This definition of property right failure differs,
however, from that of the first two cases for anti-competitive behavior and
externalities, since it views that some individuals’ incomes are unduly low not
because they are not paid due compensation for what they did to their
customers but because their earnings are too small for them to live on. It extends
the concept of property right to cover the needs of individuals, while the
property right in narrow sense concerns only with individual’s ability and
performance to earn income.
(4) Two different sources of market failures
So there are two different sources of market failures; the one arising from failure
in protecting property right in narrow sense, and the other originating from
inability to satisfy basic human needs due to either deficient income earning
capability or unexpected misfortune. The former ranges over a wide spectrum
from anti-competitive restraints in trade to various externalities and may be cured
by proper restoration of property right protection for each case, but the latter
needs a different kind of approach, the social safety net.
One may argue that the social safety net too is a form of property right
protection since the satisfaction of basic need is a basic human right. But if one
agrees with the view that the market competition renders a fair or legitimate
income distribution when individual property right is well protected, then he may
disagree with such a claim. The safety benefit comes only at the expense of the
legitimate incomes of other fellow citizens. If the safety benefit is a right of the
beneficiary, then the cost must be the duty of the benefactors.
It is certainly the right of beneficiary to demand the safety benefit, only when
his income is unduly low because his customers do not pay him a right amount
of compensation. It is a favor from benefactors otherwise. Thus the society may
coerce a transformation of the market-determined income distribution to a
socially desired one, if the market operates under poor protection of property
right. But it must solicit favors from benefactors when property right is well
protected. On the other hand, the government must enforce property right more
effectively in other cases of market failures when the failures are due to poor
protection of property right.
2.2 State interventions
The government intervenes where the market fails. This widely known formula is
the basis of every intervention of government into market. Some authors argue
that even the market itself is the outcome of a conscious and often violent
intervention on the part of government.5 John Gray wrote
5
See, for instance, Karl Polanyi, The Great Transformation – The Political and Economic Origins of
As the democratic franchise was extended, so was state intervention in the economy.
From the 1870s to the First World War, a spate of reforms was implemented, limiting
market freedoms for the sake of social cohesion (and sometimes economic efficiency). 6
These authors claim that resource allocation by market is so disappointing to
many people that modern democracy has been curbing the function of market
and must continue to do so. In fact 20th century history observed a variety of
violent state interventions into market economy under the just cause of the
democratic control of market.
Unfortunately most interventions turned out to be government failures. We will
investigate the nature of some typical state interventions to demonstrate that the
source of government failure comes from failure in property right protection.
(1) Employment protection legislation
Job stability is a prerequisite for the stable life of a worker, and it is desired for
any worker to be protected from unexpected and unfair job loss. Most European
countries have adopted a legal system, called the employment protection
legislation (EPL), in order to provide employees with extra security for their jobs.
An employer may lay off his employees only at specific occasions and must go
through difficult and complicated procedures to do so. Both the occasions and
procedures are stipulated in the law.
This protection certainly renders a desired job security to employees. The
employers, however, may not easily replace an employee by a superior alternative
even though it is available in the market; he has to maintain the employment
despite that he does not need anymore the skill of some employees. Employed
workers remain in their jobs, while better workers are still unemployed and
looking for jobs outside the firm. Employee’s incentive is weakened to improve
their productivity as her job is not threatened by superior competitors from
Our Time, Beacon Press(Boston), 2001, p.258.
6
John Gray, False Dawn – The Delusions of Global Capitalism, The New Press (New York), 1998, p.
14.
outside. The cost of job security is the inflexibility of labor market which invites
inefficient allocation of workforce.
Resignation is the only practical mode for a normal employee to quit his job
under EPL, but it imposes on the employer an extra payment to persuade an
employee to resign. This imposition will inflate the cost to hire an alternative
outside worker. EPL has thus enlarged the cost for employer to replace an
employee by an outside alternative, and the employees make the use of this
advantage to demand higher wage. EPL not only provides employees with greater
job security but also awards them with extra bargaining power in wage
renegotiation.
Market competition works, only when buyers can buy from the best seller and
sellers can sell to the highest bidder, to encourage production of goods of higher
qualities at cheaper prices and consumption on economized budget. As EPL
handicaps employer in replacing an employee by a best alternative, it seriously
lessens competition in labor market. Job security by EPL thus weakens the
incentive of employees to improve productivity and misleads them to be unduly
tough on wage bargaining. It clearly infringes upon employers’ property right by
awarding employees with unfair bargaining power in extra.
The cost to employ a new worker soars up if employers will not be free to lay
off him later. Employers may give up hiring new workers if they are needed only
for a short period of time. Also employers must evaluate each job applicant more
deeply and seriously in order to avoid hiring a potential trouble-maker, and so
respond to EPL by reluctance to employ new workers. The overall consequence is
a low level of employment, a kind of government failure.
There is an alternative solution for the workers’ job security. If labor market is so
efficient that a laid-off worker easily finds a new job, then his life is not
endangered. What a worker needs is not job security but employment security.
Employment security exposes workers to competition with outsiders, while job
security protects inferior employees from competition with superior outsiders.
Government intervention better aims at improving efficiency of labor market
rather than EPL. Well-functioning intermediaries will provide unemployed workers
with proper retraining and channel them to proper new job openings, if the
intermediaries are given proper incentives. It is the role of the government to
define and protect property right so that intermediaries in labor market find it
profitable to work for unemployed workers.
(2) Cross subsidization in regulated industry
Scale economies are not consistent with market competition. Examples are the
traditional utility industries such as electricity and telephony, which require huge
amount of initial investment in building network facilities, and they used to be
run as regulated monopolies. Government awarded each operator with franchise
for each region, and regulated its monopoly operation by approving the prices
and monitoring the qualities for the services it supplies. Such state intervention is
accepted as a natural solution where market competition is not viable because of
scale economies.
Cross subsidization has been a widely used mode to realize some social goals in
such regulated industries. Some services of utilities were classified as universal
services, which any human being must be able to consume regardless of the level
of his income. For instance the local phone calls must be made available to
everybody as a universal service, and the rate was set at very low level, even
below the production cost. This pricing gave rise to a loss, and this loss was
covered by revenue from long distance and international calls, which were
considered to be luxurious services and their rates were allowed to be set at very
high levels. Cross subsidization occurred from long distance and international
calls to local calls in order to realize universal service principle in telephone
communication.
Densely populated urban area spreads the cost of power distribution over many
individual consumers, while an isolated consumer in the remote mountain side
must be responsible the entire cost for that area.
But a uniform tariff on
electricity does not reflect this cost difference by individual consumer, and thus
subsidizes the loss in sparsely populated area by the savings in densely
populated one. A nationwide uniform tariff on railroad transportation is another
example; the highly utilized lines subsidize the ones of low utilization. Poor
customers of low income are often awarded with reduction or exemption of the
rate payment for some services such as power. Other rate payers are subsidizing
the poor customers in this case.
The rates were set to transfer income from a group of rate payers to another
group, not by market mechanism but by regulatory approval. It is equivalent to
imposing “tax” on some rate payers to subsidize others, and this “taxation” is
called the taxation by regulation. 7 The taxation by regulation aims to finance
provision of universal services which is a kind of social welfare program. But this
mode of financing is radically different from an orthodox social welfare program
that is financed by the budget of government.
An orthodox social welfare program is adopted by parliamentary decision and
therefore its spending is authorized in government budget. The tax payers bear
the cost to implement a socially desired program, and thus it is financed by tax
payers. The cost is borne fairly by all the citizens since they have agreed to pay
tax to procure various public services according to the prevailing tax scheme. But
the taxation by regulation is different; its payment is made not by lawful tax
scheme but by rate structure. It is determined not by parliamentary approval but
by discretion of the regulator.
Some reduction of power bill for poor families is certainly a desired social goal.
Suppose that A and B are earning the same amount of income now, and A’s
income-earning activity consumes more electricity than B’s. If a society decides to
pursue after this social goal by means of cross subsidization, then it forces A to
bear more cost than B, even though A earns exactly the same amount of income
as B does. The burden of taxation by regulation goes to some rate payers
according to rate structure approved by regulator, while the regular tax is levied
from tax payers according to tax scheme approved by parliament. Taxation by
regulation is quite vulnerable to challenges as for its legitimacy and fairness.
(3) Unemployment insurance
7
Richard A. Posner, “Taxation by Regulation,” Bell Journal of Economics and Management Science
2 (Spring 1971): 22-50.
Unemployment insurance is one of the four major social insurances, which is
designed to provide temporarily unemployed workers with living expenses and
assistances to find new jobs. In many countries employees bear some of its
insurance bill and employers are required by law to bear the remainder. Now the
program itself is socially as desired as other social welfare programs but again
the cost is borne not by tax payers but by employers who are not the
beneficiaries of that insurance. One may still argue that it is benefit of employers
to maintain the reserved workforce intact, but unemployment insurance is not
just for employers and employees but for the entire society.
If unemployment insurance imposes some portion of insurance bill on
employers, then it will raise the burden of labor cost to firms. This raise is
effectively equivalent to a rise in wages, and distorts allocation of labor away
from the market-determined one. It may achieve the social goal to stabilize the
living of unemployed workers, but it definitely infringes upon property right of
employers to invite inefficiency to labor market.
(4) Affirmative actions
Women, minorities and the handicapped are very often discriminated in the
labor market. The discrimination may come from socio-cultural prejudice. But it is
also caused by the simple economic motive that it is more costly to employ the
discriminated. For instance, the female work force is usually tied with baby
delivery and child rearing while the male workers are free of such obligation. A
female worker is apt to disturb her work schedule by the needs of child rearing,
and often quits from their jobs early after an expensive training program.
Therefore, an employer usually prefers a male worker, since he is less costly than
a female worker with the equal productivity.
Many countries assign quotas for female workers to each employer of certain
qualification in order to eliminate such discrimination. Again this action, called as
an affirmative action, forces employers to take the extra cost for employing
female workers. It is no doubt that the affirmative action aims at elimination of
undue discrimination and is socially desired. But its mode is not right in that it
imposes the associated cost only on employers. 8 Again it obstructs the property
right of the employers under the justification to achieve a socially desired goal.
Employers respond to this imposition of additional cost by replacing the
ordinary workers by the discriminated workers precisely as much as by the
quota. 9 This change causes more cost for employing the same number of
workers of the equal productivity, aggravates profit prospect, and thus discourage
investment. Of course there is an alternative means. If the government chose to
intervene by paying employers the full additional cost that they are to incur by
hiring the discriminated workers, then it could have met the same social goal
without discouraging business investment.
2.2 The democratic control of the market
Market economy produces failures here and there in practice as the government
has not been perfect in protecting private property right. Individual reaction to
infringed property right shrinks down his cooperation with outsiders and
generates economy-wide chain reaction that invites overall slowdown of economy
and blunting employment. As the number of discontented increases, so rises their
socio-political voice. Majority of population begin to blame the inhumane failure
of free market for ruthlessly greedy selfishness, and urge to adopt political
measures to control the greedy behavior of individuals, and hence the market
operation in democratic manner.10
The democratic control restricts market to change the allocation into the one
that the majority rule selects. This change is justified to remedy the market failure.
But the change incurs cost, and the decision by majority rule often imposes
major portion of the cost to some minority in population, and the victimized
minority usually fails to raise objection since the change is an accepted justice.
This mode of cost bearing gives rise to another form of obstruction of property
8
In some cases the government provides with some subsidies.
9
The imposition of quota q changes the demand for labor simply to l’ = l* - q, where l* denotes
the demand before imposing the quota.
10
John Gray(1998), ibid.
right, and it is the starting point of a new government failure.
Undoubtedly a market failure must be rectified. But it is not a proper remedy to
introduce another obstruction of property right in order to correct the market
failure. EPL infringes upon employers property right in order to provide
employees with job security. But it blunts employment, distorts efficiency of labor
market, and unintentionally fortifies the employees’ power of wage bargaining.
Both unemployment insurance and affirmative action call for extra cost burden on
employers, which worsens profit prospects and discourages business investment.
Cross subsidization handily realizes universal service principle, but creates
arbitrary tax schemes which are by no means fair. All these examples show how
the democratic control infringes upon individual property right.
As we saw, there are means to rectify market failures without unilaterally
infringing upon individual property right. To develop an efficient labor market is a
better alternative to EPL. Replace regulation tax by orthodox tax scheme. Do not
impose cost for social welfare program unilaterally on employers. Prevailing
democratic control identifies market failures successfully, but its prescription to
remedy them is simply wrong.
The politically oriented government intervention misses to capture the true
economic nature of market failure, which is nothing but the failure in property
right protection. Thus the democratic control of market has been conducted to
further infringe upon, rather than to restore, individual property right. The result
is to generate another form of failures which we call the government failure. All
the examples we discussed in previous sections disclose how the government
interventions head for the government failures.
3. Social welfare programs in a market economy: Individual vs. Collective
Responsibility
Market competition differs from a competition to predate others under effective
protection of property right. It leads individuals to compete with each other in
working to satisfy others; a better worker will get paid better. Nobody may
challenge the legitimacy of income distribution here, since each individual earns
income only as much as her customers agree voluntarily to transfer. But if a loser
or an unfortunate one hit by catastrophic misfortune is not able to make living
on his own, then the society must extend hand to deliver him some help. So a
market-determined income distribution is not necessarily socially desired as it is
even when property rights are well protected as indicated earlier.
Social assistance and social insurance are devices of social welfare program to
assist those who need such help. It costs to implement welfare programs and the
cost of these programs is financed by their fellow citizens. Some well-to-do
citizens donate their personal wealth for this purpose. But it is the tax revenue
that finances most of social welfare works. In case of social insurance it is
designed so that beneficiaries and their employers share the burden of insurance
bill. In democratic society, individuals have somehow agreed upon the tax
schemes and cost sharing in social insurances. It has been controversial whether
each individual is responsible for his own poverty or all the citizens must stand
responsible the poverty in the society.11
If property right is not well-protected and predation/free-riding is rampant in
the market, then an individual may tumble down to become a loser in market
competition even though he worked very hard for others; he may be a victim of
predation. In this case the loser may be justified to take the social welfare benefit
as a small compensation for what he has been unduly predated. The welfare
benefit is not others’ favor extended to him but his due right. He will not be
grateful at all for the benefit; he may even be very angry instead for the
insufficiently small compensation.
It is often the case that recipients make use of the moral high ground to
demand a raise in welfare benefit and government is apt to comply with this
request. Such a development may make welfare benefit more attractive than
income from hard working and may mislead the population to be less and less
individually responsible for his or her living. Workers are encouraged to switch
themselves from employment to welfare benefit, and the economy slows down
while the welfare spending soars up.
11
David Schmidtz and Robert E. Goodwin, Social Welfare and Individual Responsibility, Cambridge
University Press (New York), 1998.
But when property right is well-protected, then every citizen deserves what she
earns in market-determined income distribution. In this case every penny of social
welfare benefit comes from the favor of fellow citizens, and it is far from being
the right of recipients. Social welfare programs are supported not because the
citizens must stand collectively responsible for the poverty in the society, but
because even individually responsible person may occasionally need assistance
from fellow citizens. It is not easy for recipients to demand a larger welfare
benefit and government has to be prudent in designing and implementing
welfare programs. The irresponsible adulthood is hard to coexist with effective
protection of property right.
So if there are individuals who lose in market competition by undue predation
or free-riding, then the solution is to be found not in an expanded social welfare
system but in elimination of such predation and free riding by restoring property
right protection. Effective protection of property right alone cannot solve the
necessity of social welfare program. But it will certainly help to keep the adult
population
more
responsible
individually,
and
save
the
country
from
overspending in social welfare.
4. Conclusion
We discussed market competition, market failure, and government intervention
from the perspective of property right protection. Effective protection of property
right leads selfish individuals to pursue after their own interest only by working
to satisfy others for compensation. Here individuals compete with each other for
higher income but market competition is not brutal to eliminate innocent human
competitors, but successful to allocate workforce in a most efficient way. Property
right protection calls for a market-determined income distribution where
everyone deserves her own share.
We noted that there are two types of market failures; the one arising from
failure in property right protection, the other due to failure for some individuals
to earn incomes to meet their basic needs. State intervention aims to remedy
market failures. But most interventions tend to directly redress the income
distribution rather than to restore the property right protection. We showed that
this kind of intervention always calls for government failure. Government
intervention to help the poor and the unfortunate also brings forth another
arbitrary intrusion on private properties to impair efficient operation of economy.
The beneficiaries of social welfare tend to regard the benefit as their right rather
than favor from fellow citizens in the society where private property rights are not
duly honored. Their political voice urges so called democratic control of market
and expanded social welfare system, which will eventually slow down the
economy and blunt the employment.
But in a society where private property right is well-protected, every penny of
welfare benefit comes from due income of other citizens, and therefore the
benefit is not the right of the beneficiaries but the favor from the benefactors.
Beneficiaries are not to demand higher benefits and the government is more
prudent to design and finance the social welfare programs.
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Steven Cheung. “The Fable of the Bees: An Economic Investigation,” Journal of
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John Gray, False Dawn – The Delusions of Global Capitalism, The New Press
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Karl Polanyi, The Great Transformation – The Political and Economic Origins of
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Richard A. Posner, “Taxation by Regulation,” Bell Journal of Economics and
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David Schmidtz and Robert E. Goodwin, Social Welfare and Individual
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