The failure of market failure: Towards a 21st century Keynesianism

This morning saw the launch of a new NESTA provocation by Will Hutton and Philippe Schneider on The Failure of Market Failure: Towards a 21st century Keynesianism.  The provocation updates the age-old debate about the efficacy of state intervention versus laissez faire, and in so doing is fiercely critical of economic frameworks used to inform policymaking in the UK. The primacy of the concept of market failure in policymaking - the view that state intervention can only be justified when it can be demonstrated that free markets cannot do better - comes in for particular criticism.
 
The provocation updates the debate in two ways: first, by reference to developments in institutional economics, psychology and behavioural economics which the authors see as jarring with the behavioural and motivational assumptions traditionally made by policymakers; and second, by interpreting the current financial crisis as prima facie evidence that markets need government ('markets fail more often than they do not'). If the UK is to successfully innovate, the authors argue, policymakers must recognise the importance of the government and the private sector working together, not falsely pitch them at opposite sides.
 
At this morning's policy breakfast to launch the Provocation, Will Hutton argued that a number of crucial policy interventions in the UK have been sacrificed at the alter of market failures. For those working on policies to support future innovation and creativity, where well-defined market failures are by their nature difficult to anticipate and evidence, this is a sobering thought. Will finished his comments with a call to the British academic economics profession among others to respond to the thesis set out in his Provocation. Going ahead NESTA looks forward to playing its role in facilitating the debate.

Comments

[Sami Mahroum]

The failure of 'market failure' provocation by Hutton and Schneider finds some echo in the work of people like Ake Bengt Lundvall who has for long argued that 'system failure' is a more sensible case for government intervention in the economy than 'market failure'.

Not least, this is because market failures emerge due to a typically prevalent lack of information transfer between the different agents in an economy, something that is affected by, among other things, the level of trust between different agents.

In fact 'social networks' play two important roles in this respect: On the one hand they allow trust to develop between sets of trading agents, and hence speed up the information transfer between them. And on the other hand they may contribute to complacency among economic agents locked in 'closed networks', reducing the level of trust and information flow across sectors, geographies, and industries.

Again all these social dynamics prevent markets from operating 'freely' and in a 'rational way', due to what Lundvall calls 'sysetm failure' and where many innovation scholars see the greatest role for government to play.

[Stuart Cunningham]

I provide this extract from a recent submission I wrote as a contribution to this discussion:

'System failure not market failure'

The new macro-focus on the knowledge-based economy and innovation policies has been around in some form for a long time, certainly since the information society discussions of the 1950s, with notional sub-divisions of the service or tertiary industry sector into quaternary and quinary sectors based on information management (4th sector) and knowledge generation (5th sector). But the shorter term influence is traceable to new growth theory in economics which has pointed to the limitations for wealth creation of only micro-economic efficiency gains and liberalisation strategies.

Governments are now attempting to advance knowledge-based economy models, which imply a renewed interventionary role for the state after decades of neo-liberal small government. This has meant a focus on emerging industries that exhibit innovation and R&D intensity, skilling and education of the population, and a focus on universalising the benefits of connectivity through mass ICT literacy upgrades.

We acknowledge that governments are often challenged to justify this new interventionary role, with orthodox economists and supporters of small government criticising innovation policy as merely a discredited industry policy (‘picking winners’, propping up failing manufacturing sectors, slowing tariff reform, etc) by another name.

The principle of system failure not market failure, is the basis on which governments can with some confidence proceed to develop policies and invest in innovation on a sound rationale.

The role of government in a ‘national innovation system’ (NIS) is essentially to bring it as a policy construct into existence, promote it, monitor its performance, and contribute directly to it where the role for the public sector is most needed. By definition, a national innovation system needs national governmental oversight, most particularly when it is evident that sub-national, regional, and global innovation processes are impacting the national system more and more.

System failure not market failure is a recognition that many aspects of the innovation process lie outside the market economy, not only in terms of breakthrough science but also public and household sector innovation, and unplanned innovation at the final consumption end. It also implies a central role for government not only in providing key elements in the NIS (agencies, departments, schooling systems, etc), but also in identifying that the linkages between elements which make the system work are robust and optimal. Where links are missing, suboptimal, or not even thought of, government has a role in identifying such systems failure and bringing to bear resources to address the problem.