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Understanding Market Failures in an Economic Development Context

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Understanding Market Failures in an Economic Development Context See discussions, stats, and author profiles for this publication at: http://www.researchgate.net/publication/264943101 Understanding market failures in an economic development context. BOOK · JULY 2011 DOI: 10.13140/2.1.4734.6562 CITATION DOWNLOADS VIEWS 1 11 44 1 AUTHOR: Shawn Cunningham Vaal University of Technol… 7 PUBLICATIONS 1 CITATION SEE PROFILE Available from: Shawn Cunningham Retrieved on: 15 September 2015 Creative Commons Licence You are free: to share — to copy, distribute, display and perform the work Under the following conditions: Attribution. You must attribute the work to the author and to mesopartner (but not in any way that suggests that they endorse you or your use of the work). For any reuse or distribution, you must make clear to others the licence terms of this work. The best way to do this is through the link to www.creativecommons. org Any of the above conditions can be waived if you obtain permission from the copyright holder. Nothing in this licence impairs or restricts the author's moral rights. Pretoria, 2011 Mesopartner Monograph 4 Edition 1, July 2011 Pretoria, South Africa Front cover illustration by Lina Stamer Understanding market failures in an economic development context Dr Shawn Cunningham Foreword by the author This publication is the completion of a process that I started with the late Dr Jörg Meyer-Stamer in 2008. Sadly, Jörg passed away in May 2009 before we could do much work on this specific publication. We agreed to hold back this project so that I could finish the research for my PhD that looked into market failures. One of my and Jörg’s favourite topics for discussion was market failures. We both brought very different experiences and perspectives to this debate, and my academic research benefited greatly from the debates and coaching from Jörg. We frequently presented sessions together at training events which were important opportunities for us to further refine and synchronise our thinking. In many parts of this publication I have used some of the texts that we developed together, but in the interim I have also gained some additional insights. The completion of this publication is one small task on a to-do list which I started in 2005. Future publications will revisit the use of the Systemic Competitiveness framework to diagnose and address market failures. This publication is targeted at practitioners who are working in and around the field of market development. It should not be seen as an introduction, but more as a technical publication directed at people who are trying to solve problems in a practical way based on a deeper understanding of market system. In many instances I have decided to cite only references to the many gurus who have done so much work on this topic before me. After the last chapter I have provided a list of popular books that readers can consult if they wish to read more about the phenomenon of markets and their role in societies. Dr Shawn Cunningham Contents Chapter 1 Introduction ............................................................. 1 Chapter 2 What are markets? ................................................... 4 Chapter 3 Requirements for a market to function ..................... 8 Chapter 4 When markets fail .................................................. 13 4.1 SOME COMMON TYPES OF MARKET FAILURE ................................. 15 4.1.1 Natural monopoly ....................................................... 15 4.1.2 External effects ........................................................... 15 4.1.3 Indivisibilities or economies of scale .......................... 16 4.1.4 Asymmetric information ............................................. 18 4.1.5 Public goods ................................................................ 19 4.1.6 Incomplete or non-existent property rights ............... 20 4.1.7 Sub-optimal market structures: monopolies and oligopolies ................................................................... 22 4.2 SUMMARISING THE CONSEQUENCES OF MARKET FAILURE ............... 26 Chapter 5 Markets and other modes of coordination .............. 31 Chapter 6 The relationship between market failure, government failure and network failure ...................................... 36 Chapter 7 Addressing market failure ....................................... 38 7.1 ADDRESSING MARKET FAILURE AT THE LOCAL OR REGIONAL LEVEL .... 39 7.2 IMPORTANT CONSIDERATIONS WHEN ADDRESSING MARKET FAILURES ......................................................................................... 43 7.2.1 Who should lead? ....................................................... 43 7.2.2 The appropriate role of government in addressing market failure ............................................................. 44 7.2.3 The problem could be in the system of institutions ... 45 7.2.4 Designing completely new markets ............................ 45 7.2.5 International pressure to reform markets .................. 46 7.2.6 Sometimes it takes some evolution ............................ 46 7.2.7 Technology can sometimes overcome market failures .................................................................................... 47 7.2.8 Sometimes just start with improving the flow of information ................................................................. 48 Chapter 8 Conclusion ..............................................................49 Recommended reading ...............................................................52 Case study 1: Understanding and Addressing Market Failure: .....53 Case study 2: Market, Hierarchy and Network forms of allocation ........................................................................56 Source list ...................................................................................59 List of Tables Table 3.1: Comparison of McMillan's five elements with Rodrik’s non-market institutions ...................................................... 11 Table 4.1: Common market failures and their consequences applied to rural farmers ..................................................... 26 Table 5.1: Stylised comparison of forms of economic organisation ........................................................................ 32 Chapter 1 Introduction In development cooperation, the topic of markets has received a great deal of attention over the past 20 years. The main purpose of the structural adjustment programmes that were launched from the 1980s onwards was to remove distortions that stood in the way of the emergence of functional markets in developing countries. In the 1990s, the promotion of small business went through a paradigm change with the evolution of the BDS (business development services) approach which emphasised the development of BDS markets rather than the substitution or crowding-out of markets through government interventions. Although many people associated this change mainly with donors, there was a global trend towards a more liberal approach to government interventions. In the early 2000s, some donor organisations introduced the Making market systems work for the poor approach, expanding the scope of the developing markets approach from BDS to the wider compass of markets and later to economic sub-systems. Many scholars have argued that markets remain the most efficient way to coordinate transactions in societies simply because of their decentralised nature and the self-interest of the actors involved. One of our favourite authors on the topics, John McMillan, once said that markets are so easy to create that they emerge spontaneously everywhere – even within humanitarian camps or prison cells. In the last few years a whole series of books have been published that have shed more light on market systems (see Recommended Reading at the end of this publication). If markets can emerge so spontaneously, and if they are so good at allocation of resources, then why are we treating them as if they 1 are a problem and not a solution? Why are markets in developing countries often underperforming, or do not exist at all? And why would markets work in countries such as Somalia, where there is hardly a functioning government in place? Markets cannot be separated from the societies and systems in which they are embedded. Many of the underlying issues within a society will be reflected through the performance of its market systems. To give an example, in many Asian societies it is fairly common for shoppers to negotiate fiercely with traders until a price is agreed upon. In South Africa and surrounding countries, people find this kind of behaviour rude and greedy. Are these characteristics of the market, or values of the society? The role of governments and international development organisations in markets has changed over time. In the early days of development aid, half a century ago, it was a widely accepted fact that many markets in developing countries did not work properly, and that in particular there tended to be a low-level equilibrium that created structural barriers to growth for low-income countries. The high degree of state intervention in the economies of developing countries was not only due to the fact that many governments of developing countries flirted with socialism, but also due to the fact that for some time even such agencies as the World Bank assumed that government intervention was necessary because markets could not work properly. The renewed interest in markets that marked the past two decades reflected the fact that government intervention gave rise to government failure.
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