I am often stunned at how development agencies and practitioners justify their interventions to support enterprises as “overcoming market failure”. To me it seems there is a huge misunderstanding of what a market failure is, and how one can intervene to overcome the under-performance of markets. Over the last 8 years I have done intensive research into market failures, so let me do some copying and pasting from my thesis (Cunningham, 2009). The sarcastic comments where of course added in today ;-). Sorry Anja and Lucho, this is not the summarised version yet.
Here is the theory part….
Although economists describe perfectly competitive markets, in the real world markets do not always perform perfectly or optimally. When markets do not perform in an optimal way economists refer to the situation as a “market failure”. The MacMillan Dictionary (1986) describes market failure as “The inability of a system of private markets to provide certain goods either at all or at the most desirable or ‘optimal’ level”. Reference is made to the allocation of resources not being at the desired or optimal level. Samuelson and Nordhaus (1992:741) define a market failure as “An imperfection in a price system that prevents an efficient allocation of resources”. In this definition reference is made to the importance of the price system being able to reflect the true costs and value of a product, with natural monopoly, imperfect competition, asymmetry of information and externalities cited as examples.
Market failures are often visible in the forms of the growth of monopolistic firms and other non-competitive organisations, and when factors of production stand idle or certain kinds of opportunities are not pursued by business. Markets also fail when externalities such as water and air pollution are not included in their costs by firms, so that they make private profit at the cost of society. Roberts and Boudreaux (2007) explain that when a market fails this is effectively caused by failures in the institutional arrangements that support the market.
What this means in practice
Thus addressing market failure is about getting markets to perform more efficiently or optimally in the way that resources are allocated or decisions made regarding the production of goods and services. While certain interventions will be aimed directly at the market, other interventions are needed at the institutional level, and only some will be aimed directly at enterprises.
So a quick test here would be for you to check how much time you are spending working with enterprises, and how much time on market systems and the supporting institutions (which could be organisations, but mostly means far more than this).
It takes time. Lots of it.
At this point it is important to realise that it takes demand and supply some time to find the right signals such as price. Unfortunately us development practitioners don’t like this part, but it can take a long time (sometimes a decade) for a market to figure out what the main drivers are (price, quality, value, etc). In a healthy market there is a range of product offerings at different prices targeting different customer profiles. These offerings may have very little relationship with the original products and firms that created the market in the first place.
So it takes time, that is why a market can be described as a dynamic system with feedback loops.
“But firms dont know what to produce or who to sell to – there is a market failure!”
This argument is held forward mainly by small enterprise development practitioners, although even academics in business schools sometimes argue that you can solve a market failure through better marketing.
It is important to distinguish between the economics concept of market failure, and the business management result of a marketing failure. In marketing management literature a marketing failure implies that a firm has made a poor judgement in its marketing strategy, or that marketers have failed to understand that marketing should not be seen as a functional discipline but as an integrative business process. When firms fail to capture a market share due to poor marketing strategies, this can be referred to as a marketing failure. The solution too marketing failure is not in economics or sociology, but in better business management.
So how can a development practitioner claim to assist in overcoming market failure by assisting a firm to write a business plan, or by helping a firm to find a venture partner or a new customer? Or how can a university justify developing a product for a firm using state funds in order to overcome market failure.That is just bad development practice. Even if you could somehow justify these interventions on some sub-clause somehow related to a market failure, it remains highly un-systemic and the “failure” will persist.
Recycling old ideas under new labels
I suspect that despite huge international policy pressure for development programmes to address market failure, many practitioners are simply recycling their old tools like poverty alleviation and small enterprises development under new labels.
Perhaps it is best if you just call what you are doing marketing and business management support, then at least you can refer to a whole pile of business management books.
Bear in mind there is a whole group of people that dispute that market failures even exist (I even agree with many of their arguments), as well as many groups that believe that markets are evil and should not exist (I agree that markets ARE NOT ALWAYS the best transaction mechanism). But let us leave something for another day.
CUNNINGHAM, S. 2009. The role of market failure in the utilisation of Quality Management services by the tooling industry. Ph.D Thesis, North West University,
PEARCE, D.W. 1986. Market Failure. In Macmillan dictionary of modern economics. Pearce, D.W. (Ed.).
ROBERTS, R. & BOUDREAUX, D. 2007. Boudreaux on market failure, government failure and the economics of antitrust regulation. In Library of Economics and Liberty – EconTalk. Liberty Fund, Inc., Indianapolis, IN. [Web] http://www.econtalk.org//archives/2007/10/boudreaux_on_ma.html [Date of access: 2 February 2009].
SAMUELSON, P.A. & NORDHAUS, W.D. 1992. Economics. 14th ed. New York, NY: McGraw-Hill.