Some Thoughts About the Theory of Market Failures



I am currently reading professor Gabriel Zanotti’s very interesting book “La Economía de La Acción Humana” (The Economics of Human Action) where he completes an important task: An in depth epistemological organization of the principal economic theorems according to to the teachings of Ludwig von Mises.

Among the different theorems that professor Zanotti lists, one in particular caught my attention. I quote the following:

“The Market tends to spontaneously coordinate Supply & Demand expectations through the price system”. [1]

Then, professor Zanotti inserts a footnote to explains the relevance of this theorem:

“This theorem is the fundamental theorem of the market process and of political economy. Without it, we couldn’t continue with our task at hand, since it has implications in the monetary market and in the market for the factors of production. It is precisely, the typical Hayekian contribution about spontaneous orders working to minimize dispersed knowledge and thus, enabling the tendency towards unplanned order in the market. On the other hand, for this theorem, we had to present the role of prices, since these, along with private property in the means of production, and the knowledge factor, constitute the conditions for which the market tends to close the gap between supply and demand expectations. Hayek develops this in the before mentioned essays through his work “Individualism & Economic Order”. This theorem does not pretend to replace the enriching contents of the Misesian analysis about the market as a process, but it does intends to epistemologically support Kirzner’s middle ground. Kirzner, in “The Meaning of the Market Process”, presents a unified Mises-Hayek Paradigm about the market as a process, between the different neoclassical general equilibrium models, and the market as a aleatory order. This theorem is key at the same time, to understand why government intervention in the market IS the market failure: because when prices become distorted, which are the synthesis of dispersed knowledge, that knowledge in the market becomes even more dispersed!” [2]

These observations made by professor Zanotti are quite important. One of the most important contributions made by Austrians and particularly by Israel Kirzner are the concepts of alertness from an entrepreneurship perspective and also the notion of the dynamic market process.  Kirzner brilliantly explained , especially in his work The Meaning of the Market Process, how the market is not a situation of equilibrium per se, but that it is a dynamic process, where errors and uncertainty by individual actors occur. The crucial distinguishing element is that Supply and Demand forces tend towards equilibrium, yet such neoclassical construct does not reach a permanent state. The Market, which is dynamically efficient, is constantly evolving through the above mention demand and supply forces, but primarily through the figure of that which is the entrepreneur. The entrepreneur, is alert to different opportunities that are discovered  in the market. This notion of entrepreneurship does not solely rely on the businessman who endures business projects for monetary profits, but an entrepreneur in the strict sense of that individual actor who observes an opportunity in the market for improving his or her previous condition or state of being. The entrepreneur, through his or her alertness, and making use of the price mechanism, which sensitizes  dispersed knowledge, is the true promoter of change and economic growth.

Another important concept deriving from this discussion is the emphasis that Austrians, primarily Mises, Hayek and Kirzner have made is in the concept of Knowledge.  Knowledge is key for the success of the economic system. This notion of Knowledge as key, is why Austrians have opposed Socialism and Interventionism.  Dr. Zanotti, eloquently explains:

“The opposition to Socialism and Interventionism by Austrians is not a mere ideological indulgence, but rather an academic matter. The socialist central planner cannot gather all the necessary knowledge for an optimal allocation of resources, but these resources can be allocated in an optimal manner, which is not the same as “perfectly”, by the use of unhampered market prices which serve as sources of information and through the alertness of entrepreneurs”[3]

The problem of “market failures” is one that is in the mind of the vast majority of economists today, whom unfortunately in many cases, have not been presented with the teachings of the Austrian School regarding the role of the entrepreneur, the coordinating function of unhampered market prices and the notion of the market being dynamically efficient. On the other hand, neoclassical models fail to comprehend these very important concepts, so when a policy design by social engineers doesn’t produce the outcomes desired by such policy (market failures), they become baffled and endorse a series of interventions by state authorities which contribute to the ever increasing dispersion of knowledge and lack of economic coordination. The teachings of Mises-Hayek-Kirzer-Rothbard are more than needed in today’s economic discourse.

Works Cited:

[1] Zanotti, Gabriel. La Economía de la Acción Humana. Unión Editorial, S.A. Pg 41. Translation to English is mine as well as errors made.

[2] Zanotti, Gabriel. Op. Cit. Pg. 41

[3] Zanotti, Gabriel. Op.Cit. Pg 99.



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