Become a Public Policy Thinker in Three Easy Steps

by Ajay Shah, ajayshahblog

Step 1:What's the market failure?

Each of us tends to get unhappy at some feature of the world or the other. As an example, I don't like rap music. But value judgements of this nature do not justify the use of State power – either to ban rap music or to encourage classical music. Such coercion by the State is just abuse of power.

When should the State intervene? The technically sound answer is: When you are certain there is a market failure, and when you are confident you know how to setup the correct State capacity for the intervention.

Market failures come in four kinds: 1. Asymmetric information, 2. Externalities, 3. Market power and 4. Public goods. These are technical terms in microeconomics and each needs to be carefully understood.

The first hurdle that must be crossed in policy thinking is the question: “Is there a market failure?” Every proposal to do something in public policy faces this test.

A good way to smell market failures is the prices being wrong. In a well functioning economy, the price should be close to marginal cost or to the Ramsey price. When the observed price diverges from these normative ideals, a market failure may be afoot. But while the price being wrong is the diagnostic that alerts you to a problem, direct intervention in the price is seldom the right answer

At present, most of what the government does in India is not about market failures. Using the coercive power of the State to meddle in the voluntary decisions of consenting adults is mostly a bad idea. The Indian State suffers from rampant central planning, license-permit raj, and shameless value judgments.

Step 2: What's the proposed intervention?

Once we agree there is a market failure, we have to figure out what we'd like to do about it. Here, it's important to understand the anatomy of the market failure, and solve it at its root cause.