1. Market failure 1.Public goods 2.Externalities 3.Monopoly 4.Information asymmetry 5.Agent misdirection –Agents act on behalf of principals. client – attorney, shareholder - manager, citizen – bureaucrat. 6.Social goals 7.Inequality 8.Economic instability

2. A few concepts Excludability and subtractability Free riding Transaction cost Principal agent relationship Moral Hazard “Obnoxious” markets Merit goods Welfare state Boom and bust cycles Keynesian economics

3. Correcting market failure Hierarchies, bureaucracies and other consciously directed institutions have evolved to coordinate people when the market does not. Public decision making replaces the market through –Subsidies such as tax breaks and loan guarantees –Regulations

4. The state Are organizations that embody legal order within geographic territories. Defining characteristic: sovereign control of territory. The American state is not unitary. Federal, state, and municipal

5. Roles taken by the state to correct market failures Rule-maker Umpire Buyer Producer Promoter Guarantor Broker Regulator Economic manager

6. Can the state make things worse? “Market failures are pervasive; it is only under exceptional circumstances that markets are efficient. The issue for the appropriate role of government is to identify the large market failures where there is scope for beneficial government intervention.” (Stiglitz, 1989:38).

7. How states fail ProblemsSolutions Type 1: Errors of commission: do things that government should not do Too many regulations; excess taxes, inefficient government enterprises and programs Less government activity Type 2: Errors of omission: do not do things government should do Lack of public goods, such as a stable legal environment, sound infrastructure, or environmental protection More government activity

8. Why states fail Rent-seeking as result of… –Special interest group –Inadequate feedback –Office seeking –Voting –Unintended consequences

9. The NGO alternative

10. A tempered view of the state Most of the time the state does not make things worse –Type 1 error is not that rampant –The state is subject to the laws of competition –Just as good intentions go awry, the obviously “bad” things about rent seeking can have positive (though not intended) consequences.