How Government Seeks to Compensate for Market Failures - Essay Example

?Market failures occur when markets fail to allocate resources systematically to their most valued use. The main types of market failures can be of four types – those associated with the public goods, spillovers (externalities), market power or imperfect information (Rama and Harvey, 2009). “Externalities” arise when the rational, profit-driven action of the agents have an adverse impact on third parties (Beljac, 2012). When externalities are present the chances of market failure is high. Financial crisis and climate change are the two vital global crises and are considered market failures where the presence of externalities is robust. Externality effects would gradually become global as globally integrated markets develop. As externalities become huge they pose challenge to achieving macroeconomic stability which in turn challenges the international political architecture. ‘Efficient’ allocation of resources according to economists implies that all possible mutually beneficial trades have been exhausted (Holtom, 2011). This means that proper coordination between willing buyers and sellers has been accomplished. The nature and extent of market failure determines the role that government would play and whether government intervention is at all necessary. Markets rarely correspond to the ideals of a perfectly competitive market as defined by the economic theory (Rama and Harvey). These imperfectly competitive markets may have efficiently allocated resources to derive the best value. Certain conditions termed as ‘market failures’ render government intervention necessary. While failure to systematically allocate resources is evidence of inefficient allocation of resources but this is not sufficient reason to justify government intervention. Government intervention in markets can be costly and the benefits must far outweigh the costs if government were to intervene. However, some governments believe that the role of government is benevolent during such externalities (Dolfsma, 2011). In fact institutional economics believe that market cannot function unless they are embedded in a broader set of interrelated institutions. However, government interventions can reduce efficiency through unintended consequences such as distortionary taxes, special interests or maybe just simple errors of judgment (Holtom, 2011). All market failures do not warrant policy action and hence the cost-benefit analysis is essential. A market-oriented economy may produce income inequalities. A person may produce some very efficient product which benefits the society but there is no gain for the poorer people of the society. Moreover it is not possible to exclude non-payers from utilizing a ‘public good’. However, market failures occur when an inefficiently high or low amount of good in question is produced and is directed to markets where they do not receive the desired value (Holtom, 2011). This reduces in value the perfect market conditions. This can be applied to the entertainment and the theme park industry in Japan. Japan is known for the largest global growth for theme parks and the amusement industry. Tokyo Disneyland (TDL) demonstrated solid performance and made a substantial impact on the host economy (Kawamura and Hara, 2010). Being part of the tourism industry they brought in extensive cash flow from the non-resident tourist. However, the rush of theme parks in Japan overlapped with the bubble economy in the late 1980s and early 1990s. Local governments in Japan suffered as an effect of deindustrialization following the bubble economy. Market failures in the theme park industry led to government intervention in several ways but these were found to be counter productive. To revitalize the local economy the development of theme parks was considered essential. Resources were inefficiently allocated to make the theme parks sustainable and help the local economies. Abundance of construction loans were given for theme parks. In addition, the central governments paid subsidies to the local governments and the licensing procedures were simplified. A comprehensive ‘resort areas act’ was formulated with a view to exempt the theme parks from corporate tax and from fixed asset tax (Kawamura and Hara, 2010). Thus with a decentralized economic structure theme parks were built with tax payer equity even in local areas which did not significant tourism resources. This role of the government was not based on market demand for theme parks but was focused on revitalizing the local economies. As the bubble economy collapsed, the theme parks suffered as the number of visitors to these parks declined. Consumers became selective in visiting the theme parks. The theme parks were not regulated by copyrights and hence there was nothing innovative. TDL continues to achieve success because of low labor costs, because of proactive capital investment in innovative attractions for the park. The developers and the borrowers that were granted facilities for theme parks had no prior experience in this sector and hence failure occurred. Allegations of market failures are used to justify government intervention. Financial markets have always been heavily regulated which necessarily alters the incentives that markets participants would face in a free market (Holtom, 2011). Most financial markets are heavily regulated and not ‘free’ markets. Thus the effects of market failures should be separated from the unintended side effects of the regulations. Thus, government in Japan should have taken into account all these factors before trying to revitalize the economy. This was an imperfect allocation of resources that could have been of much value in revitalizing the manufacturing sector. The national economy cannot be sustained only based on the economic contribution generated by construction activities. Market failures can occur when firms fail to successfully coordinate their activities. Failure to coordinate economic activities can lead to economic recession which in turn impacts the employment market as unemployment rises. National income is thereby affected and this cannot be restored even after the prices and money wages fall back to normal levels. Government as a coordination institution becomes essential because without proper planning resources cannot be properly allocated. However, this requires enormous amount of information which the government lacks. The more rapid the change, the greater the need for intervention. The government has the power to use violence, the authority to monopolize, to subject the people to taxes and to subsidize. This enables the government to restrict competition, create monopoly and create a congenial exchange environment. In post-war Japan various forms of government intervention was conducted under the concept of excessive competition (Yu, 2000). The government used power, authority and fiscal incentive to restrict competition. Sometimes lobbying government officials to secure monopoly rights may be based on self-interest but it is not counter-productive. Similarly if the government provides grants and rights to certain industries it may not necessarily lead to economic waste. When uncertainty prevails market exchange requires some sort of central coordinating intelligence and this role can be played by the government. In post-war Japan the initiatives taken by the private enterprises supported by government coordination led to successful economic performances. Two credit associations in Japan, namely Tokyo Kyowa and Anzen, were caught in the burst of the bubble economy. Investigations revealed that both these organizations had made large loans that exceeded the limits set by the legislation (Nakajima, 2007). They had extended huge loans for development projects without seeking any collateral. Moreover, ninety percent of these loams were unrecoverable. Influential politicians had also availed of loans from these organizations. The Japanese government had to intervene and set up a rescue package to bail out these two credit associations. There were allegations that tax payers’ money was used in rescuing these credit associations. However, the reality was that the government had taken such a step to protect large depositors such as governmental organizations, labor unions, and privatized former national railways employees. Had the government not intervened the situation could have ended up in bankruptcy which meant that large depositors would totally lose out. The government could achieve this at the cost of losing the confidence of the public in the financial system. Without implicating the association with any charges, if the government adopts such a rescue strategy, in future also organizations and individuals would tend to think they would be rescued even if they failed. This sends wrong messages to investors and entrepreneurs. Thus the people responsible for such acts should be taken action against, even if the government has to intervene in the larger interest of the society and the depositors. Japan is a collectivist society where family is given importance. The organization too is considered as an imaginary community or a family that has to be given loyalty. The employee feels a bond with the organization and his wage was determined based on the length of service and status (Adhikari and Hirasawa, 2010). However, as the nation faced acute labor shortage such practices became redundant as companies had to employ part time labor or outsource work. With the burst of the bubble economy companies started restructuring and downsizing their resources. Japan faced persistent pressures from environmental forces in the post-war period and they made regular changes in the way they managed ideas, people and things to cope with the ever-changing business environment and the world of competition. The Japanese always relied on the traditional values to adapt to the socio-economic conditions which also helped it to avert the market failures (Okada, 1998). As the government witnessed that wholesalers used their market power to exploit the producers, supported by lack of information dissemination, governmental guidance helped promote cooperation and stimulate indigenous development. Keirutsu was emphasized upon and the government intervened to avoid over-competition. To emphasize orderly competition interest rates of banks were artificially controlled. All deposit and savings rates were regulated by the Ministry of Finance and this strategy also guaranteed gross profit margins to the banks. To prevent over-competition long term banks with long-term deposits were separated from commercial banks that had up to three year time deposits. To avoid market failures the government kept the financial market restricted. To have harmonized governance structure the government must have an effective system of gathering and analysing information but most importantly they must disseminate information to the actors that are vital for the growth of the economy, which was carried out in Japan. This strategy of the government intervention in Japan does not conform to the theory of market failure which suggests that under certain conditions the production and distribution of good or service in a competitive market where all agents are pursuing their self-interest will result in allocation that is socially inefficient (Aikins, 2009). This implies that those having market power could fix prices and the consumers can be exploited as they lack information but the Japanese government, in this case, could manage to allocate resources efficiently. Japan suffered extensively during the 1990s financial crisis but the regulators hesitated to take strong action for fear of triggering public panic (Aikins, 2009). To a large extent this was because the government did not have the backing of an adequate deposit insurance scheme and a legal framework to deal with the full blow banking crisis. Regulatory governance is essential for the growth and development of nations. The government has to intervene to mitigate the undesirable consequences of market activity through regulation but they should have a proper mechanism in place supported by dissemination of information. During market failures the Japanese government believes in proper dissemination of information and it firmly believes that during such turbulent times, the government can restore the confidence of the people of its nation through Administrative Counselling (AC) (Christensen, 2000). This helps the government to educate people and overcome criticism of its performance and structures. This become essential as Japan has been criticized for not efficiently dealing with national emergencies, corruption and market failures, basically amounting to crisis of confidence. The government has not devoted significant resources to satisfy citizens’ difficulties in dealing with the public sector and market irregularities. However, while the government in Japan can justify that it acted in the larger interest of the people of the nation, but the actions taken by them adversely impacted another group of people. Perfect competition did not prevail. The Japanese government insisted on dissemination of information but Arrow and Debreu's framework suggests that information need not be perfect. However, it could not change as a result of action taken within the economy. Information in developing economies can never be perfect and the development process is always associated with acquiring new information (technology). Stiglitz (1996) contends that the modern theory of market failure recognizes that government intervention does not really improve matters. Government intervention may, in fact, contribute to inefficient resource allocation and hence governments need to exercise caution. In Japan, the government tried to reduce competition but ended up making mistakes in the steel and the automobile industry. The industrial policy underwent reforms in a bid to rationalize the industry. The argument was that without government intervention the firms would continue to remain small thereby reducing the profitability of all firms in the sector. With such control measures, the government did not allow Honda (at that time only motorcycle manufacturer) from entering the automobile market. The government also ignored the concentration in the steel industry in the late 1960s. However, government intervention can support the smaller firms by reducing the costs of capital and thereby increasing economic efficiency. Thus market failures do attract government attention despite good intentions the development of the financial markets can be impeded. The government decisions may fail to promote the development of priority sectors. They can even distort incentives and undermine financial discipline; they can attract abuse and result in high default rates (Vives and Staking, 1997). It thus appears that the government in Japan did not weigh the costs and benefits of its intervention policies efficiently and nor were the resources allocated efficiently. While the intentions were benevolent, the government could not integrate the interests of the interrelated institutions. This resulted in reducing efficiency and inefficient allocation of resources. In the case of promoting theme parks loans were indiscriminately granted without any collateral securities. This led to massive national loss as the cost benefit analysis was not conducted, while distortionary tax measures were adopted. All market failures do not call for intervention and natural phenomenon can reverse the situation and reduce losses, resulting in overall growth and development. Japanese culture promotes cooperation and collaboration and with this principle in mind the government tried to reduce over competition. Some argued that this could have been done with self-interest but this was not the case. The government merely used its power and authority to restrict competition. It can at best be called an error in judgment and inefficient planning. In the case of the two credit associations, the government’s intention was to protect the economy by protecting the large depositors as this could shake the confidence of the public from future deposits. They were criticized for not taking action against the offenders. Hence, government’s intentions may not be evident to the public initially but economists would agree that at times certain actions need to be taken. The Japanese government insists on dissemination of information to the main actors, though. Overall, while the Japanese government did make certain errors but overall it has registered phenomenal growth and today it has a robust economy. However, they did make mistakes such as not taking action against the two credit associations, which subjected them to severe criticism. They always feared action that could likely trigger public panic but this suggests lack of confidence in their systems and legal procedures. However, their restriction in the financial markets and the initiatives taken in post-war Japan led to successful economic performances. References Adhikari, D.R. and Hirasawa, K. (2010) 'Emerging scenarios of Japanese corporate management' Asia-Pacific Journal of Business Administration, Vol. 2(2), pp. 114-132 Aikins, S.A. (2009) 'Global Financial Ctisis and Government Intervention: A case for Effective Regulatory Governance' International Public Management Review, Vol. 19(2), pp. 23-43. Beljac, M. (2012) Global Market Failure and the Future of World Order: The impact of Global Externalities on International relations. [Online] [Accessed on 10 January 2012] http://scisec.net/?p=199 Christensen, M.J. (2000) 'Japan's administrative counselling Maintaining public sector relevance?' The International Journal of Public Sector Management, Vol. 13(7), pp. 610-623. Dolfsma, W. (2011) 'Government Failure - Four Types' Journal of Economic Issues, Vol. XLV(3), pp. 593-605 Haltom, R.C. (2011) 'Market Failure' Region Focus, Vol. 15(1), pp. 10-10 Kawamura, S. and Hara, T. (2010) 'A historical perspective and empirical analysis on development of theme parks in Japan' Worldwide Hospitality and Tourism Themes, Vol. 2(3), pp. 238-250 Nakajima, C. (2007) 'Japan: Recent Failures in the Japanese Banking Sector' International Journal of Financial Crime, Vol. 3(1), pp. 111 Okada, Y. (1998) 'PATH DEPENDENT GLOBALIZATION: THE STATE AND FINANCIAL DEREGULATION IN JAPAN' Humanomics, Vol. 14/15(4/1), pp. 19-48 Rama, I. and Harvey, S. (2009) Market failure and the role of government in the food supply chain: an economic framework. Economics and Policy Research Branch Policy and Strategy Group. [Online] [Accessed on 10 January 2012] http://www.dpi.vic.gov.au/about-us/publications/economics-and-policy-research/2009-publications/market-failure-and-the-role-of-government-in-the-food-supply-chain-an-economic-framework Stiglitz, J.E. (1996) 'SOME LESSONS FROM THE EASTASIAN MIRACLE' The World Bank Research Observer, Vol. 11(2), pp. 151-77 Yu, T.F. (2000) 'A new perspective on the role of the government in economic development Coordination under uncertainty' International Journal of Social Economics, Vol. 27(7/8/9/10), pp. 994-1012. Vives, A. and Staking, K.B. (1997) 'Policy-Based Finance: Is There a Role for Government Intervention in Financial Markets?' IFM Bulletin, Vol. 3(2), June 1997 Read More