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26 February 2018 | Blockchain Vs. Inefficient Governments

Blockchain and Market Failure

If you were awake during your Intro to Micro class, you might remember the topic of market failures. Generally, markets lead to efficiency.  Market failures are situations where the market does not provide for an efficient result.  People making decisions in their own self-interest, under these circumstances, make things worse for the masses.  The fight over what is a market failure and the government’s response is the crux of economic and political debate.  

Generally, proponents of big government identify, label and argue for more government intervention to fix these failures. Education, healthcare, inequality, and housing are areas where the debate over market failure are intense.  Libertarians and other small government proponents feel government intervention just makes the problem worse.  Consequently, they label these situations government failures.  Governmental failures create massive misallocation, more central planning and other inefficiencies that create a huge market for lobbyists and rent-seekers.  The historical track record of central planners making economic decisions in the aggregate is very poor.

Market Failures

Even Libertarians and other small government proponents would admit that markets do fail and a little government intervention is necessary to remedy true market failures. Economists have identified a few common market failures. They include monopolies, externalities, asymmetric information and public goods.  These failures justify some type of intervention.

Monopolies – A monopolist is a producer who is the sole supplier of a good without a close substitute. Monopolists have the ability to raise the market price above equilibrium price where there is competition.   Consequently, they can reduce output of a good and increase scarcity.  Monopolists must be protected by some sort of barrier to entry.

Asymmetric Information – This situation occurs when one side of a transaction has more information than the other.  Usually, this involves the seller having more information than the buyer.  What really is in that medicine?  How much revenue does that business actually produce?  What is in that food?  Food labeling laws, restaurant inspections, FDA approval, and the SEC are examples where the government has created laws to head off this sort of market failure.

Negative Externalities – Negative externalities are situations that arise from an economic activity that effects unrelated parties.  Pollution is a classic example of a negative externality. Consumers and producers, acting in their own self-interest, create pollution which is harmful and destructive to everyone.  

Non-Excludable Public Goods –  The free market does a horrible job providing public goods that are non-excludable and nonrival.  Non-excludable means that one cannot be excluded from using the good or service.  Because one cannot be excluded from enjoying the benefits of the good, many people choose not to pay and become free riders.  With so many free riders, beneficial public goods won’t be created.  National defense, dams, and lighthouses are examples of public goods.  The free market alone has a hard time raising money for these projects.  Government is needed to raise the money for their construction and, in theory, everyone is better off once they are built.

Blockchain on Monopoly and Asymmetric Information

This is a simple brainstorm of how blockchain could help cure traditional market failures. This could help lead to more freedom, more efficiency, less scarcity and a more productive allocation of resources.  Entire academic papers could be written on each of these topics.  Once again, blockchain is a decentralized, tamper-proof ledger.

Monopoly – Generally, monopolies are created through regulation.  Natural monopolies are very rare and some economists say they don’t exist.  Essentially, monopolies need a moat, or a barrier to entry to protect them from competition.  Cable companies, telecommunications, railroads and taxi cartels are examples of government-created monopolies.  Because blockchain can circumvent regulation, government created monopolies will feel pressure with this new technology. Think Uber-like destruction in all government-created monopolies.

Asymmetric Information – When the seller of a product has more information that the buyer, they can take advantage of the buyer.  Blockchain can verify.  Blockchain can prove.  Where and when did this meat originate? How much does this medical procedure cost?  Why does it cost so much?  What are the true revenues of this company and what is the history of this used car?  What is in this drug and what are the verifiable results of people who have taken it?  Blockchain can clearly help even the score between buyers and sellers.  Markets could become more efficient. Less licensing will be needed and barriers to entry will be reduced.  More people of all socioeconomic classes could start businesses easier.  Prices can become more transparent. Life-saving drugs will be approved faster. Insurance pools will be more transparent and providers could be held more accountable.  

Blockchain on Externalities and Public Goods

Negative Externalities – Many economists feel negative externalities result from situations where there is no market.  They also usually occur where property rights are very weak.  The air and ocean are good examples.  It’s easy to dump pollutants into the air when property rights are so weak.  Blockchain will help create markets in places with weak property rights.  Think Cap and Trade.  What is the optimal level of pollution in the air?  Environmentalists could buy clean air credits and polluters would finally have to pay a price for creating negative externalities on common resources.  Remember the tragedy of the commons?  Imagine each cow and the pasture being recorded and priced with blockchain contracts.

Non-Excludable Public Goods – Groupon meets the Hoover Dam.  Bureaucratic allocation of public goods and bridges to nowhere will decrease.  Blockchain contracts will create public projects with more consumer choice.  The more people join together on public goods, the cheaper the per person contribution will be. Unnecessary, bloated, corrupt projects will not happen.  There could be lots of radical breakthroughs here leading to more efficiency with an increase in consumer and producer surplus.

Conclusions

Markets generally supply goods and services the most efficient way possible.  Blockchain will slowly shine a light on the inefficiency of many government solutions to market failures.  Economists and public policy analysts have barely scratched the surface of how blockchain can offer solutions to traditional market failures.  Blockchain has the potential to increase choice.  Consumers will make decisions based on their preferences.  This will push out our production possibility curve, allowing us to do more with less, lessening the burden of scarcity and fight against rent-seeking.  Additionally, it can reduce central planning and the misallocation of resources that accompany it. The traditional way of corrupt, inefficient, and expensive government solutions to these failures now will have competition.  In free societies, logic, efficiency, and productivity usually win. I’m betting on blockchain.

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