Market Failures

by David Deutsch

Recently I found myself struggling away on an elliptical machine at the gym, deciding whether I should watch Fox News, ESPN, or CNBC to distract me from feeling like a hamster on a Habitrail. Not being a sports fan and despising everyone on Fox except Shepard Smith, I settled on CNBC. I suppose I could have watched nothing, but I needed a distraction from the tedium of going absolutely nowhere fast.

I couldn’t help but notice a stark and startling contradiction in the demeanor and tone of the anchors. On the one hand they could barely contain their glee at Wall Street’s record profits, longingly gazing at the Big Board as all the pretty numbers kept going up, up and higher up still, surpassing 12,000 for the first time in years. Meanwhile, in virtually the same breath, they oozed with disdain at the current administration, as if President Obama himself was standing behind them, poised to steal their rightful inheritances. This was both baffling and fascinating: how could these wealthy elites simultaneously cheer their soaring profits, complain about the allegedly unbearable burden placed on them by the Obama administration, and ignore our awfully high unemployment rate?

While I could rant all day at their audacity, there is another point to be made here, and it has to do with the inherent limitations of markets, especially as it pertains to unemployment. In the real world—that is to say, for those of us who work for a living and don’t live off stock dividends and trust funds—the official unemployment rate remains stubbornly high, at over 9%. And yet corporate America sits on some $1.6 trillion in wealth and refuses to hire people or invest in capital stock. What gives? Why isn’t corporate America spending its record profits on job creation?

The CNBC crowd would have you believe regulatory uncertainty is causing them to stop hiring. Yes, they insist with a straight face, America’s tough, brilliant and self-certain corporate titans tremble at the thought of a spooky, yet-to-be-articulated governmental regulation lurking around the corner, ready to dismantle corporate America with the stroke of a pen. This argument does not hold up. Business leaders don’t hide under tables, terrified at the prospect of government regulation. If they did they would be kicked out of their jobs, since their number one legal obligation is to maximize shareholder value, not cower in fear.

The real reason corporate America isn’t spending its money is because people are not buying stuff. Businesses respond to market demand for goods and services, not the prospect of government regulation. So we’re trapped: consumers won’t spend until unemployment goes down, and the unemployment rate won’t go down until consumers start spending.

Economists have a term for this vicious cycle: it’s called a market failure.

The very mention of markets failing sends an irrational panic through those who worship at the altar of unfettered free markets. Indeed, many free market ideologues act like a market failure is as impossible as, say, jumbo shrimp. (The not-very-liberal Economist Magazine defines market failure as “When a market left to itself does not allocate resources efficiently.”) To them I say this: markets are simply the collective buying and selling of goods and services by people and firms, and the only way markets can be perfect is if people and companies make 100% perfect and 100% rational economic decisions 100% of the time, both for themselves and for the good of the nation. Since this is not possible, markets often fail, requiring some form of government intervention to make them right again.

As I said earlier, American corporations are sitting onlots of money and refuse to use that money to hire people. To some extent this is a rational decision: firms should not hire if nobody is going to buy their stuff. While this may be rational, it is also a market failure, and an example of when governments should assist the marketplace. In this case the government should provide an additional job-creating stimulus package. While deficits will rise in the short run, additional stimulus will mean more people earning more money. With this increased buying and selling firms will start hiring again. And with increased economic activity, tax revenues will go up and decrease deficits. (Earlier I argued that our long term goal should be to become an export-oriented economy, which I still believe; but before we can do that we must get our economy moving again with increased consumer activity.) So the only way out of this slump is for increased government intervention in the form of spending, regardless of the political popularity of such a move.

As a side note, here’s one thing I do not understand: smart companies should be eager to hire people now because qualified labor is so cheap. After all, when the economy turns around and unemployment falls, wages will rise and it will cost these companies a lot more to retain qualified employees. Why aren’t they hiring cheap, plentiful labor now? My guess is that they are generally risk-averse and do not wish to harm profitability on a perceived gamble.

To pull ourselves out of this unemployment ditch, demand for stuff has to increase in the short run. But demand for stuff will not increase until government stimulates the economy. And that cannot happen until people realize that markets can, and often do, fail, and that government intervention is not always a bad thing.

But don’t tell that to the CNBC crowd: they just might need smelling salts.

David Deutsch is Principal and Founder of Synergi Communications. He is also a former Federal Auditor at the Department of Transportation, Office of Inspector General. He can be reached at .(JavaScript must be enabled to view this email address).

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