The Markets’ Greatest Failure

The market usually works pretty well. Resources are distributed, transactions are made and the wheels of the economy keep turning. There are occasional glitches and problems though an unrestricted free market still retains many proponents. However, there is one area where the market has failed so catastrophically that even the market fundamentalists cannot defend it. This is the markets disastrous treatment of the environment and global warming.

The market is driven by the desire for profit which contains good and bad elements. However, when dealing with the environment the bad greatly outweighs the good and as a result humanity is facing a crisis. You see, a corporation views the world through the lens of profit. Actions are based on how much profit they will bring in. So if there is more profit in cutting down a forest then keeping it, it will be cut down. If an animal can hunted and its corpse sold, then this will keep happening even if it pushes the animal to extinction. If one company doesn’t, another one will. As a price cannot be placed on the beauty and peace of a forest or the value of a diverse eco-system or even protecting the natural habitat, companies only see the profit to be made in exploiting them and not the cost.

As no charge is imposed on carbon emissions (beyond the cost of fuel) companies don’t see the cost of their actions. The damage to the environment is not included on their balance sheet or in the price they charge consumers so it might as well not exist. The price system is held up by economists as the best transmitter of information in the economy, yet here it completely fails. The reason for this is due to the economic concept of externalities. This essentially means that the costs of the firms’ actions are being paid by someone else. This means that the rest of society is in effect subsidising them and as a result they produce far more than they otherwise would have. When factory smoke pollutes the city, the factory is not paying the cost of the disease and suffering it causes, so have less reason to change it. Likewise, the effect of global warming damages the entire world decades from now, long after some of the worst polluters will be dead.

But why do the usual controls in an economy not solve the problem? Why can’t individuals use the market to solve the problem? Couldn’t individuals and businesses independently reach an agreement (as the Coase Theorem postulates) without the intervention of government? The major reason is incomplete information. It took decades for scientists to discover and confirm the effects of global warming and even today there are many people who refuse to believe it. This is not helped by the fossil fuel companies paying huge money to stall their efforts (the invisible hand of greed doesn’t always lead in the right direction). Even still it is hard to explain to ordinary people such detailed scientific theories as global warming (especially when they are still coming to grips with evolution). Furthermore it is difficult to understand the wide range of chemicals, their effects, which ones are dangerous and in what dosages. Even scientists are unclear about many of these questions, especially regarding how chemicals interact with each other. What chance is there that the ordinary consumer will be able to understand and accurately calculate the risks associated with the gibberish ingredients list on the goods they buy? How can consumers vote with their feet and exercise consumer sovereignty if they lack the information to make an informed choice?

Worse still, it is impossible to measure how each individual is affected. We all know that pollution damages our health, but it is impossible to know by how much. If I get sick, what role did pollution play? Would it have happened anyway? Are much of the recent hurricanes, droughts and floods are due to global warming? We may be able to measure on a national scale, but not on an individual one. Even if we could, it is impossible to find out which individual company is responsible. Even if I could prove, say, my lung cancer is due to smog, how do I prove which company produced it? If a group did, then in which proportion? Obviously no company is going to pay compensation unless they absolutely have to, and no court is going to force them unless they have direct evidence. There is also a collective action problem as it is impossible to organise every single person affected (they may even live in more than one country) by the pollution of one factory, which has access to greater resources and can hire top lawyers. Consumer rights groups are, as a rule, underfunded, poorly organised and containing only a fraction of the affected people. Therefore no agreement can be reached and the businesses are free to continue polluting and people can do nothing about it.

Competition can actually make the problem worse. If one company has a monopoly on fish in a lake or deer in a forest, then they can control the hunting level to prevent overfishing or overhunting. However, if there is a multitude of hunters, then if one hunter limits their kill, someone else will get the deer instead. They would limit their profit, yet the overall stock would still get diminished. So instead there is a race to get as many deer as possible before someone else does. This maximises short term profit, but means that in the long run no one makes any money. It is for this reason that humanity has driven so many animals into extinction. This can be aggravated by the point that any individual has as a minuscule effect on the overall total, so sees little reason to limit themselves. This is why the world’s fish population has declined so dramatically. Each fishing company faces a use-it-or-lose-it dilemma and consoles themselves by thinking that they are having only a slight effect on the number of fish in the ocean. Were the manager of a fishing company to deliberatively limit the amount of fish the company caught, there is no way to ensure other companies would do the same and he would likely lose his job.

Private businesses could be set up which run on green technology and environmentally friendly practices. However, the energy industry is based on large economies of scale; that is to say, small companies are inefficient and expensive, whereas large established companies can produce energy cheaply. Areas like solar and wind power also need a lot of research which existing energy companies have no incentive to undertake and is by its nature an expensive gamble which takes years to pay off (only the government has a long enough time frame to subsidise necessary research). As fossil fuel companies do not pay the full price of their pollution they are able to sell at an artificially low price. So while in the long run green technology is a cheaper and more efficient form of energy, without initial subsidises, it cannot break into the market. This is where the government steps in, to help green tech to achieve economies of scale and to support the research to create the most efficient technologies.

If consumers lack information to only use environmentally friendly products and are too dispersed to bargain collectively with companies, then it is necessary for the government to intervene (even those who idolise the market, reluctantly acknowledge this point). This can come in the form of providing information about chemicals or outright banning the most dangerous ones. As it is impossible for each individual to measure the pollution levels of each company and private regulators hired by the polluters themselves cannot be trusted, it is an obvious choice for the government to step in. As consumers themselves cannot take companies to court, it is better for the government to either impose controls that prevent the damage from happening in the first place or passing laws to ensure proper compensation is provided. As the main problem with pollution is that it is a cost not included in the price, the logical reaction is to impose a carbon tax to make companies pay the full cost of their actions. The rest of society should not subsidise toxic oil and coal companies to destroy the environment.

To best understand why government intervention is the best scenario and why private business cannot reach optimal efficiency by itself, it is necessary to examine the Prisoners Dilemma. Society, the economy and humanity as a whole would be better off if we all reduced of level of emissions and pollution (something even businessmen themselves are starting to realise). However, no one individual can solve the problem unless everyone reduces their emissions. Even if some businesses agreed to switch to (initially) more expensive green technology, they can be undercut by firms using the more polluting energy sources. Even if everyone agreed, there would be huge temptation for one business to break the agreement and switch to cheaper toxic energy, sell at a lower price and dominate the market. Likewise it would be better if we didn’t cut down every tree in the forest and left some fish in the sea, but even if a voluntary agreement was reached, if anyone broke the agreement they could make a fortune in the uncompleted fishing/hunting grounds etc. Therefore even though they know they are driving a species to extinction or destroying all the natural habitats of the country, no one company can stop it, so they are forced to continue along. That is why the government is necessary. Only the government can impose universal standards and force all parties to follow them. Only the government can impose quotas on fishing or declare forests protected areas or impose emission limits and achieve the best outcome for everyone.

The environment is the free markets greatest failure and responsible for the extinction of an enormous number of species and the destruction of vast tracts of the world’s wildlife. The threat of global warming is not a minor academic point but could become the greatest threat to humanity and single most important issue of the 21st century. Even libertarians cannot defend the market and pretend it can solve this problem. Economists are realising that it is only through large scale government intervention that we can tackle this problem and fix the markets greatest failure.


Filed under Economics

6 responses to “The Markets’ Greatest Failure

  1. Bingo! “Pollute the commons and let the people pay, I got mine.” Couldn’t have said it better!

  2. Very well stated Robert.

    “However, there is one area where the market has failed so catastrophically that even the market fundamentalists cannot defend it.”

    I would also include health care in this purview too.

    • Within America, absolutely, however global warming is a universal failure. Luckily precautions have been taken in Europe so that the health market isn’t allowed to fail as America has.

  3. Really, Global warming, the greatest failure of markets?
    Global temperatures have been changing for billions of years, up and down, Long before there was a market, a government, or specifically the people that are supposedly at fault.
    Unfortunately, if you buy into the religion of AGW, then by default, you believe in total government control, at which point, there will be no market. History is ripe with examples of how that does not worked out. Imagine the result on a global scale. Of course, if you have a lust for power and politics, you may be able to carve out a nice life for yourself, above all the little people that your government controls.

    Markets work best when mostly left alone.

    • You do recognise that global warming is a fact right?

      The rise in emissions is correlated with the rise of capitalism. Rather than discouraging or limiting pollution, the free market drives energy companies to continue using fossil fuels.

      I don’t what AGW is, but apparantly I follow it like a religion. I should point out that I am not a Communist and don’t want total government control.

      “Markets work best when mostly left alone.”
      Did you ever hear of this little thing called the Financial Crisis? Kinda disproved that theory.

  4. Pingback: The Croupiers of Libertarian Free Market Thought | Woodgate's View

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