Market Failure and Environment
Market failure has not been well defined but typically refers to inefficient market where pricing, costs and benefits are not in equilibrium for the society as a whole. Environmental degradation and climate change are often known to be the biggest examples of market failure.
Introduction: What is Market Failure
Market failures are a result of inefficient market. A market failure is a situation when economic forces or market forces do not provide for:
- Efficient allocation of resources (Samuelson & Nordhaus, 2004)
- Capture all costs and benefits within the price
Inefficient markets lead to externalities. (Samuelson & Nordhaus, 2004). While externalities could be negative or positive, failure of market would, typically, refer to negative externalities.
An efficient market mechanism would typically set the price of a product such that the Marginal Private Costs include the Marginal Social Cost of a product. Marginal Private Cost is the cost that a producer would incur during production. Marginal Social Cost is the cost that a society would incur for the production of a good. For example, the production of a good may cause pollution, the effects of which are borne by the society. This is the social cost. The effects of pollution are therefore, the social cost of producing the good. Social Cost is represented by a net loss of social good. (Samuelson & Nordhaus, 2004)
Diagram 1: Negative Externalities: Loss of Social Good. Prepared by Author. Source: (Riley, 2005)
Market Failure and Environment
Environmental Externalities are often described as market failure. These negative externalities include green house gas emissions, deforestation, air and water pollution, waste and land degradation and more. Environmental quality is a public good since it is consumed by all. Clean air, water etc. are essential to sustenance of life and must be treated like other natural resources like minerals etc. Additionally, there are subsidies on the use of fossil fuels: Subsidies not only ignore negative externalities resulting from fossil fuels but also encourage users to adopt them. (Stern, 2007) (Thomas, 2017) (International Monetary Fund, 2015)
Stern (2007) argued that climate change was one of the biggest market failures of the free world. The key to addressing environmental negative externalities is the correct valuation of all critical natural resources. For example, non-valuation of environmental quality is one of the key faults of the system, according to some economists. (Hurricane Harvey Damage Costs Could Reach $75 Billion, Research Firm Says, 2017)
Policy levers are designed to make the market pay for the social costs or impose caps on the environmental externalities of every economic activity. (Stern, 2007). Effects of climate change such as floods, droughts etc. would have serious impact on growth and GDP and there will be adaptation costs too. (Arrow, 2007).Thus, the costs will be borne by the society. These include the increased health care costs due to environmental degradation, the impact on vulnerable communities, loss of future growth due to diminishing availability of natural resources, disruptions in the economy due to extreme temperatures etc. (Thomas, 2017). For example, hurricane Harvey has been estimated to have cost $75 billion to the USA economy.
Arrow, K. J. (2007, June). Global Climate Change:A Challenge to Policy. Economists' Voice .
Hurricane Harvey Damage Costs Could Reach $75 Billion, Research Firm Says. (2017, August 30). Retrieved September 6, 2017, from CNBC: https://www.cnbc.com/2017/08/30/hurricane-harvey-damage-costs-could-reach-$75-billion-research-firm-says.html
International Monetary Fund. (2015). IMF Survey: Counting the Cost of Energy Subsidies. Paris: International Monetary Fund.
Lipsey, R., & Chrystal, A. (2011). Economics. Oxford: Oxford University Press.
Riley, G. (2005). European Economy in Focus. BerkShire (UK) : Tutor 2 u online.
Samuelson, P., & Nordhaus, W. (2004). Economics: Seventeenth edition. New Delhi: Tata McGraw Hill.
Stern, S. N. (2007, November 29). Stern: Climate Change A 'MArket Failure'. (A. Benjamin, Interviewer)
Thomas, V. (2017, July 12). The Danger of Dismissing Market Failures. Retrieved August 30, 2017, from Brookings Insitute: htttp/www.brookings.edu/the-danger-of-dismissing-market-failure