Market failures and legal intervention

Market failures are believed to occur when markets ‘fail’ to produce the results people would like to see. ‘We need a law to make sure this never happens again!’ they cry. If law were automatically able to produce the intended results then passing more laws to fix problems would be the perfect solution to market failures. But unfortunately, law generates spectacularly costly failures of its own, plus some unforeseeable new problems that didn’t exist before, plus the risk of losing your liberty if you inadvertently break the law, plus the legal bill. Now on top of your market failures, you have legal problems and legal fees to pay. ‘We need a new law to make sure the old law will work better!’ the people cry. Oh dear. Luckily, there is a better way.
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A comparative institutional perspective tests the different methods, and evaluates their results, to see which works better: free markets or legal coordination. The comparative analysis is not designed to pronounce which system is perfect: clearly no system is going to be perfect. Free markets are neither perfectly free nor perfectly competitive, and market participants do not always make welfare-maximising decisions. Central planning also has imperfections: decision-makers may have a genuine intention to 'correct' the market, but they lack the necessary information, knowledge and incentives to make the right decisions. 

Political economy is concerned primarily with the comparative performance of social and economic institutions. human action always takes place in a specific institutional milieu and the conditions that people face under different institutions affect the character of their behaviour and the resultant social outcomes...

If people are 'perfect' or at least 'perfectible' then questions of comparative institutional analysis may cease to arise - one would expect beneficial outcomes irrespective of the institutional framework. If, however, people are 'imperfect' in a variety of ways, then questions of institutional robustness assume centre stage. Certain institutions may be better placed than others to withstand the stresses and strains wrought by the relevant human weaknesses.

Mark Pennington, Robust Political Economy: Classical Liberalism and the Future of Public Policy (Edward Elgar, 2011), 2.

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Human beings regularly make mistakes which lead to wrong decisions, whether they are acting privately or on behalf of central planners.

Most economic models assume that economic actors (“rational representative agents”) are, in effect, omniscient. Notably, this is the default theory in popular politics and in much of political science, too: In the populist theory, major problems aren’t caused by human error; instead, some evil person or cabal must be at fault—“special interests,” lobbyists, or, indeed, greedy bankers. Mistakes simply don’t fit into standard economic and political models, because standard economic and political models take ignorance out of the human equation. 

Instead of mistakes—caused by ignorance—the standard models focus on motives, i.e., “incentives.” The effect is to model economic and political agents as if they automatically get what they want (unless they are blocked by agents with contrary desires, as in game theory), which side-steps the question that actual human beings constantly confront: How do I get what I want? Desires are not self-actualizing, and to assume that they are might be called magical thinking to emphasize how unscientific it is.

Jeffrey Friedman, 'A Crisis of Politics not Economics: Complexity, Ignorance and Policy Failure', (2009) 21 Critical Review 127, 151.

This means it is not possible to evaluate different proposals based only on the virtuous desires or motives expressed by the proponent: very important in this virtue-signalling era when everybody claims to be acting in the best interests of Justice and Fairness. Everybody intends to produce a Just and Fair world, but nobody knows how to do it. Nor can we ever attain consensus on what a Just and Fair world would look like. All proponents tend to assume that their statement of intent is proof that their proposed solutions will work. Yet they are all acting out of limited knowledge and insight, and are bound to make mistakes.​ Only magical thinking would suppose that the mere fact of stating an ideal automatically ensures that it will materialise into reality, with no errors or unintended consequences.
 
So, identifying the flaws in both free markets and regulatory systems may be informative, but examining their respective flaws will not, by itself, supply the answer as to which works better. Proving that problems exist is not very interesting, in itself, except in so far as it increases our knowledge and understanding of what's going on. Proof of the problem is not proof of the correct response. Nor does the mere fact that somebody experienced or discovered a problem mean that they have perfect information concerning the best solution.

Given a choice between two solutions X and Y, we don’t choose Y just because X has some flaws. X may have fewer and more tolerable flaws than Y. Nor is it wise to choose by simple ‘majority opinion’. Majorities have been known to produce disastrous outcomes, and majority opinion includes very many people who know nothing about the matter but have an ignorant opinion to express. So public opinion polls are not the most reliable approach when you’re trying to fix market failures and coordination problems.
 
An alternative approach is to ask: which system is most efficient? Now, efficient outcomes are not perfect (see perfection above) but the issue is whether an efficient outcome might be better than an inefficient one in some circumstances – if so, in which cases, where, and why. Nobody would (I hope) argue that efficiency is always the best test. For example, nobody makes friends or chooses hobbies based on maximizing the efficiency of their lifestyle. But in many situations, large-scale coordination problems are best addressed by identifying the most efficient solution.

​What does efficiency mean? Efficiency involves trying to make things better for X, but stopping when further efforts to improve X's position involve making things worse for Y. 

​Pareto efficiency or Pareto optimality is a state of allocation of resources from which it is impossible to reallocate so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off. 

​Wikipedia.​

If markets allow some people to acquire more stuff than others, we could call that a market failure in that the market has 'failed' to ensure that everyone has equal amounts of stuff. So, should we fix that by using the force of law to steal stuff from the rich and award the stolen loot to the poor? Efficiency requires that we do what we can to help, but stop short of sacrificing some people to make things better for others; we do not sacrifice rich people to make things better for poor people, because that would not only be inefficient, but also sinister and evil. ​

​Being poor really sucks, but fixing poverty problems by stealing from other people is worse, and it doesn't become acceptable even if it's backed by force of law and labelled Fairness.