Market Failure and Government Failure

Seung-Hoon Lee
Seoul National University
Market economy is based upon the principle of laissez-faire. Given freedom to
choose her action, each individual will behave according to her own value which may
be identified with her own self interest. Adam Smith persuaded readers so eloquently
as to how selfish individuals might co-operate, rather than predate, each other in
pursuit of their self interest. He wrote
Give me that which I want, and you shall have this which you want . It is
not from the benevolence of the butcher, the brewer, or the baker, that
we expect our dinner, but from their regard to their own interest. 1

He also wrote
In civilized society [man] stands at all times in need of cooperation and assistance of great multitudes,
while his whole life is scarce sufficient to gain the friendship of a few persons 2

to explain why selfishness, rather than fraternity, must be practically the only
incentive for an individual to co-operate with others in modern social division of labor.
Of course the conflict arose inevitably, however, whenever individual self interests
collide with each other in real world, jeopardizing laissez-faire ideal. If each individual
acts in pursuit of his own self interest, then the immediate consequence will be a
keen social conflict rather than harmony. Social control usually introduces itself to
prevent chaotic development of conflict among self interests from occurring.
Individual freedom is viable only when it is properly protected, and to protect my
freedom is to delimitate freedom of others since it is others freedom, including the
states, that attacks my freedom.
Adam Smith introduced the notion of the moral sentiments in order for his
celebrated Invisible Hand to rule out such conflicts from free market. He thought, or
wished, that the moral sentiment in human nature might guide each individual to
pursue after her self interest without harming others. Thus free market will be guided
by the invisible hand of benevolent god toward a harmonious and efficient equilibrium
rather than chaotic disaster.
But the invisible hand has never been perfect. Market often fails and invites a variety
of state interventions in reality. A standard microeconomics class teaches that a free
market allocates resources efficiently if individual preferences are locally non-satiable
and if there are no externalities (the First Welfare Theorem), market failure occurs if
these conditions are not met, and government intervenes in order to remedy market
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Clarendon Press
(Cambridge), 1976, pp.26-27.
2
Adam Smith, ibid., p.26.
1

failure, but the government also fails in many occasions, and etc.
Now it is widely accepted that the invisible hand is not perfect anymore and state
interventions are necessary on certain occasions. But this theorem is often abused
to justify many dislocated government interventions, too. This abuse usually leads
government to correct superficially the visible results only without addressing directly
to the fundamental cause of the failure. It is this pattern of intervention that turns the
government intervention into another failure, the so-called government failure.
In this paper I will review the spectrum for the notion of market failure, will illuminate
the issue of market failure from the perspective of property right, and will argue that
all the market failures in standard definition arise from failure in protecting property
right. Thus a perfect protection of property right will realize a resource allocation that
the Smiths invisible hand intended to. But there may still be another kind of market
failure which represents a discrepancy between social goal and market outcome. I
will argue that even in this case the reallocation by the state intervention is advised
to minimize the distortion of property right in order to maximize the social welfare.
1. The basic principle of free market
1.1 The nature of market competition
Competition occurs whenever too many demanders generate shortage, and
therefore every competition has to eliminate a number of competitors. This
elimination is often criticized as ruthless and inhumane. In particular, the market
competition has been blamed to be so inhumane as to produce numerous miserable
losers victimized by the greed of the powerful few.
A selfish individual may attain his self interest by making use of various means, but
these means are classified broadly into two types; the one comprising all the means
that infringe upon others property right such as predation and free-riding, and the
other addressing those where each individual works for others and gets paid for the
work. It is the latter that enables selfishness to realize self interest not by hurting
others but by helping them.
If a social system succeeds in harnessing selfishness to pursue after self interest by
means of helping others only, then the ideal of free market may be realized.
Selfishness will have to look for self interest not in exploitation of but in co-operation
with others only when one may not benefit at all from hurting others. Effective
protection of property right will lead free choice of each individual to seek for self
interest only in working for others for compensation, because no one may make use
of others property without the consent of its owner under a system of well-protected
property right.
Selfish individuals compete with others for their own interest in the free market, and
the protection of property right leads people not to predate but to work for others,
and rectifies the market competition to select best workers by the demanders. Both
you and I competed for a job and you won it only because the demanders wanted you
rather than me. If some other mechanism eliminated you and forced me to have the
job, then the demanders property right would have been unfairly intruded upon. The
competition for higher income develops itself into the one where each individual
competes with others to work for higher compensation, namely to seek for and carry

out jobs which are desired more and thus paid higher by the entire economy. If you
are a winner in such a competition, then your success evidences that you satisfied
your customers better than your competitors did.
Some losers could certainly have been victimized unfairly in competition of the real
market under poor protection of property right. But in the market of well protected
property right the losers are those who could by no means have satisfied their
customers properly while the winners have done so. In this case an extra protection
of losers may infringe upon freedom and property right of their customers.
1.2 The nature of income distribution by market
When I pay price for the goods I purchase, I explicitly approve to transfer a part of
my income to the seller as much as that price. The market economy induces each
individual to earn her income in this manner. Thus the market determines income
distribution under unanimous consensus where nobodys property right is ever
intruded upon in the market competition.
The price determines the amount of income transfer, and competition raises price
whenever the concerned commodity is in shortage. It is well-known that market
competition realizes the law of demand and supply when there are numerous buyers
and sellers. In such a market a buyer needs not to pay higher price when there are
sellers willing to sell at lower price. The same is true for a seller; he needs not to sell
at lower price if there are buyers willing to pay higher price.
The price is determined, however, not by the law of demand and supply but by
bargaining if there are only a small number of buyers and sellers. Here the bargaining
power will crucially influence the process and the result of price determination. If
each partys bargaining power is legitimate, then the determined price may not be
challenged. But if some partys bargaining power is attained in somewhat unfair
manner, for instance by means of forming a cartel, and is made use to determine the
price to its favor, then this process unduly transfers income from victimized party to
the favored one, and the resulting income distribution may face a serious challenge
as for its legitimacy.
Competition law has been introduced to restore fair competition in the real world
market. This legislation may also be viewed as a device to enforce property right, as
it prevents undue market power from coercing transfer of income. In a word the
income distribution of a market economy is fair as long as property right is well
protected, since each individual earns exactly as much as she contributed to satisfy
others needs in such a case. But one may still raise an opposition against the
income distribution that market realizes under effective protection of property right.
Suppose that an individual is so incompetent that he cannot survive with the income
that he duly earns from the market. If the society deserts such a loser alone to
starve, then the market economy will surely be working in an inhumane manner. It is
desired socially to allow some extra income to such losers so that they may carry out
their living together with other fellow citizens. An individual may also encounter an
unfortunate disaster that she cannot wage through by herself, even though she
normally fares well in market competition. Again she needs some help from her fellow
citizens.
A humane society allows for redistribution of income in order to take care of such

tragedies and unexpected misfortunes, even though the initial income distribution is
fair and legitimate. Although the initial income distribution may be justified in the
sense that everybody earns as much as she contributed to satisfaction of other
citizens, this justification does not necessarily reflect the social need for
commonwealth of fellow citizens.
2. Market failure and state intervention
2.1 The nature of market failure
The terminology of market failure delivers a variety of delicate nuances, but mainly
refers to the performance of market that deviates away from the socially desired one.
Narrowly it covers only the externalities including public goods, but broadly it
comprises anti-competitive performances of dominant agents and even the socially
undesired form of income distribution. Now observe that the market failure, whatever
is its form, always raises the issue of proper protection of property right.
(1) Failure in competition
The ultimate source of anti-competitive behaviors is the dominant position of a
single agent or several agents in the market. The dominant player enjoys a superior
bargaining power to tilt trade toward his favor. Because all the market transactions
occur on voluntary bases, the resulting transfers of property and income are approved
by both parties and their legitimacy may not be challenged no matter how abnormal
the associated income distribution may look.
The bargaining power of an agent is to reflect the value of the agents capability to
satisfy others desire; if every customer wants me and I am the only one who can
serve the customers as I am doing, then I may enjoy a superior bargaining power in
comparison with my competitors. An example is the monopolist who can produce a
good of higher quality at much lower cost than others so that her monopoly price is
lower than the average cost of a best competitor. Here the monopoly may be viewed
as a prize awarded to the winner in competition under well protected property right for
that specific sector.
One can, however, also strengthen her bargaining power without developing
successfully such a superior capability to satisfy her customers. She can merge with
all the other competitors in order to build up a monopolistic giant and attain a
superior bargaining power. She may also collude with competitors to form a cartel. Or
she may exercise predatory pricing to drive out all the competitors and monopolize
the market. In a word she may intentionally eliminate competition to attain unduly
superior bargaining power.
If one party attains undue bargaining power and makes use of it to set unfair price
and/or delivery conditions to exact improper transfer of income in market
transactions, then the legitimacy of this income transfer may be challenged. The U.S.
Sherman law outlawed both cartel and monopolization, and subsequent judicial cases
clarified that unlawful monopolization is the one resulting from improper elimination
of competition while every monopoly which is awarded to the winner in fair
competition is legitimate. On the other hand the legal system of EU views that every

dominant position, regardless of legitimacy of its bargaining power, is apt to eliminate

competition and intervenes in the exercise of its superior bargaining power.3
The U.S. competition law acknowledges the superior bargaining power awarded to
the winner in fair market competition as a legitimate property right, and this view is
consistent with our stance that the nature of anti-competitive behaviors is to infringe
upon the property right of other party making use of undue bargaining power.
Monopoly pricing is not illegal in the U.S. legal system if that monopoly is the result
of a due market competition for instance. But EU system does not care about the
legitimacy of dominance and only notes if a dominant player makes use of its
superior bargaining power to its advantage in market transactions.
(2) Externalities
Externalities obstruct compensation for the benefit or damage from individual action
under no clearly defined property right. Polluters contaminated fellow citizens air
without any compensating payment, and a beekeeper used to fly generously his bees
to bless apple orchard with a harvest of abundance without any compensation. 4 Such
failures to pay had occurred because there were no clearly defined property right as
for environment and the service of bee flying.
It is free to pollute the river or air in a society where there is no well-defined
property right of environment. Thus polluters bear no private cost from the pollutions
they cause. But the entire community suffers social cost of polluted river and air. The
discrepancy of private cost from social one makes a socially undesired act to be a
privately profitable one, and encourages polluters to choose the socially undesired
act destroying the economic efficiency of market economy.
The same explanation applies to beekeepers. The benefit of bee fly is not
compensated properly, and thus the beekeepers private benefit is smaller than
social benefit, which discourages a beekeeper from flying his bees to a socially
optimal level. Both external economy and diseconomy give rise to discrepancy of the
social benefit and cost from private ones, and this discrepancy leads to market
failures. In other word, this kind of market failure is nothing but a failure in
delineating and protecting property right properly.
(3) Failure in income distribution
It is rather clear to see that the cases of anti-competitive behavior and externalities
arise from failure in protecting property right. But the case is somewhat subtle for the
discrepancy of market-determined income distribution from a socially desired one. It
is certainly a kind of market failure, if market does not realize a socially optimal
allocation even under effective protection of property right. Can we still blame the
failure in property right protection for this kind of market failure?
When market fails in eliminating this discrepancy, one may conclude that some
3

The U.S. competition law is known as Anti-Trust law, rather than anti-monopoly law. In this context
one may call the EU competition law as anti-monopoly law.
4
To be accurate, there is a report that beekeepers are paid for their services by apple orchards in
some places. See Steven Cheung. The Fable of the Bees: An Economic Investigation, Journal of Law
and Economics, 1973.

individuals are earning unduly low income, which means that their property rights are
not properly protected. This definition of property right failure differs, however, from
that of the first two cases for anti-competitive behavior and externalities, since it
views that some individuals incomes are unduly low not because they are not paid
due compensation for what they did to their customers but because their earnings
are too small for them to live on. It extends the concept of property right to cover the
needs of individuals, while the property right in narrow sense concerns only with
individuals ability and performance to earn income.
(4) Two different sources of market failures
So there are two different sources of market failures; the one arising from failure in
protecting property right in narrow sense, and the other originating from inability to
satisfy basic human needs due to either deficient income earning capability or
unexpected misfortune. The former ranges over a wide spectrum from anticompetitive restraints in trade to various externalities and may be cured by proper
restoration of property right protection for each case, but the latter needs a different
kind of approach, the social safety net.
One may argue that the social safety net too is a form of property right protection
since the satisfaction of basic need is a basic human right. But if one agrees with the
view that the market competition renders a fair or legitimate income distribution when
individual property right is well protected, then he may disagree with such a claim.
The safety benefit comes only at the expense of the legitimate incomes of other
fellow citizens. If the safety benefit is a right of the beneficiary, then the cost must be
the duty of the benefactors.
It is certainly the right of beneficiary to demand the safety benefit, only when his
income is unduly low because his customers do not pay him a right amount of
compensation. It is a favor from benefactors otherwise. Thus the society may coerce
a transformation of the market-determined income distribution to a socially desired
one, if the market operates under poor protection of property right. But it must solicit
favors from benefactors when property right is well protected. On the other hand, the
government must enforce property right more effectively in other cases of market
failures when the failures are due to poor protection of property right.
2.2 State interventions
The government intervenes where the market fails. This widely known formula is the
basis of every intervention of government into market. Some authors argue that even
the market itself is the outcome of a conscious and often violent intervention on the
part of government.5 John Gray wrote
As the democratic franchise was extended, so was state intervention in the economy.
From the 1870s to the First World War, a spate of reforms was implemented, limiting
market freedoms for the sake of social cohesion (and sometimes economic efficiency).6
See, for instance, Karl Polanyi, The Great Transformation The Political and Economic Origins of Our
Time, Beacon Press(Boston), 2001, p.258.
6
John Gray, False Dawn The Delusions of Global Capitalism, The New Press (New York), 1998, p.
5

These authors claim that resource allocation by market is so disappointing to many

people that modern democracy has been curbing the function of market and must
continue to do so. In fact 20th century history observed a variety of violent state
interventions into market economy under the just cause of the democratic control of
market.
Unfortunately most interventions turned out to be government failures. We will
investigate the nature of some typical state interventions to demonstrate that the
source of government failure comes from failure in property right protection.
(1) Employment protection legislation
Job stability is a prerequisite for the stable life of a worker, and it is desired for any
worker to be protected from unexpected and unfair job loss. Most European countries
have adopted a legal system, called the employment protection legislation (EPL), in
order to provide employees with extra security for their jobs. An employer may lay off
his employees only at specific occasions and must go through difficult and
complicated procedures to do so. Both the occasions and procedures are stipulated
in the law.
This protection certainly renders a desired job security to employees. The
employers, however, may not easily replace an employee by a superior alternative
even though it is available in the market; he has to maintain the employment despite
that he does not need anymore the skill of some employees. Employed workers
remain in their jobs, while better workers are still unemployed and looking for jobs
outside the firm. Employees incentive is weakened to improve their productivity as
her job is not threatened by superior competitors from outside. The cost of job
security is the inflexibility of labor market which invites inefficient allocation of
workforce.
Resignation is the only practical mode for a normal employee to quit his job under
EPL, but it imposes on the employer an extra payment to persuade an employee to
resign. This imposition will inflate the cost to hire an alternative outside worker. EPL
has thus enlarged the cost for employer to replace an employee by an outside
alternative, and the employees make the use of this advantage to demand higher
wage. EPL not only provides employees with greater job security but also awards
them with extra bargaining power in wage renegotiation.
Market competition works, only when buyers can buy from the best seller and
sellers can sell to the highest bidder, to encourage production of goods of higher
qualities at cheaper prices and consumption on economized budget. As EPL
handicaps employer in replacing an employee by a best alternative, it seriously
lessens competition in labor market. Job security by EPL thus weakens the incentive
of employees to improve productivity and misleads them to be unduly tough on wage
bargaining. It clearly infringes upon employers property right by awarding employees
with unfair bargaining power in extra.
The cost to employ a new worker soars up if employers will not be free to lay off him
later. Employers may give up hiring new workers if they are needed only for a short
14.

period of time. Also employers must evaluate each job applicant more deeply and
seriously in order to avoid hiring a potential trouble-maker, and so respond to EPL by
reluctance to employ new workers. The overall consequence is a low level of
employment, a kind of government failure.
There is an alternative solution for the workers job security. If labor market is so
efficient that a laid-off worker easily finds a new job, then his life is not endangered.
What a worker needs is not job security but employment security. Employment
security exposes workers to competition with outsiders, while job security protects
inferior employees from competition with superior outsiders. Government intervention
better aims at improving efficiency of labor market rather than EPL. Well-functioning
intermediaries will provide unemployed workers with proper retraining and channel
them to proper new job openings, if the intermediaries are given proper incentives. It
is the role of the government to define and protect property right so that
intermediaries in labor market find it profitable to work for unemployed workers.
(2) Cross subsidization in regulated industry
Scale economies are not consistent with market competition. Examples are the
traditional utility industries such as electricity and telephony, which require huge
amount of initial investment in building network facilities, and they used to be run as
regulated monopolies. Government awarded each operator with franchise for each
region, and regulated its monopoly operation by approving the prices and monitoring
the qualities for the services it supplies. Such state intervention is accepted as a
natural solution where market competition is not viable because of scale economies.
Cross subsidization has been a widely used mode to realize some social goals in
such regulated industries. Some services of utilities were classified as universal
services, which any human being must be able to consume regardless of the level of
his income. For instance the local phone calls must be made available to everybody
as a universal service, and the rate was set at very low level, even below the
production cost. This pricing gave rise to a loss, and this loss was covered by
revenue from long distance and international calls, which were considered to be
luxurious services and their rates were allowed to be set at very high levels. Cross
subsidization occurred from long distance and international calls to local calls in
order to realize universal service principle in telephone communication.
Densely populated urban area spreads the cost of power distribution over many
individual consumers, while an isolated consumer in the remote mountain side must
be responsible the entire cost for that area. But a uniform tariff on electricity does
not reflect this cost difference by individual consumer, and thus subsidizes the loss
in sparsely populated area by the savings in densely populated one. A nationwide
uniform tariff on railroad transportation is another example; the highly utilized lines
subsidize the ones of low utilization. Poor customers of low income are often
awarded with reduction or exemption of the rate payment for some services such as
power. Other rate payers are subsidizing the poor customers in this case.
The rates were set to transfer income from a group of rate payers to another group,
not by market mechanism but by regulatory approval. It is equivalent to imposing tax
on some rate payers to subsidize others, and this taxation is called the taxation by

regulation.7 The taxation by regulation aims to finance provision of universal services

which is a kind of social welfare program. But this mode of financing is radically
different from an orthodox social welfare program that is financed by the budget of
government.
An orthodox social welfare program is adopted by parliamentary decision and
therefore its spending is authorized in government budget. The tax payers bear the
cost to implement a socially desired program, and thus it is financed by tax payers.
The cost is borne fairly by all the citizens since they have agreed to pay tax to procure
various public services according to the prevailing tax scheme. But the taxation by
regulation is different; its payment is made not by lawful tax scheme but by rate
structure. It is determined not by parliamentary approval but by discretion of the
regulator.
Some reduction of power bill for poor families is certainly a desired social goal.
Suppose that A and B are earning the same amount of income now, and As incomeearning activity consumes more electricity than Bs. If a society decides to pursue
after this social goal by means of cross subsidization, then it forces A to bear more
cost than B, even though A earns exactly the same amount of income as B does. The
burden of taxation by regulation goes to some rate payers according to rate structure
approved by regulator, while the regular tax is levied from tax payers according to tax
scheme approved by parliament. Taxation by regulation is quite vulnerable to
challenges as for its legitimacy and fairness.
(3) Unemployment insurance
Unemployment insurance is one of the four major social insurances, which is
designed to provide temporarily unemployed workers with living expenses and
assistances to find new jobs. In many countries employees bear some of its
insurance bill and employers are required by law to bear the remainder. Now the
program itself is socially as desired as other social welfare programs but again the
cost is borne not by tax payers but by employers who are not the beneficiaries of that
insurance. One may still argue that it is benefit of employers to maintain the reserved
workforce intact, but unemployment insurance is not just for employers and
employees but for the entire society.
If unemployment insurance imposes some portion of insurance bill on employers,
then it will raise the burden of labor cost to firms. This raise is effectively equivalent
to a rise in wages, and distorts allocation of labor away from the market-determined
one. It may achieve the social goal to stabilize the living of unemployed workers, but
it definitely infringes upon property right of employers to invite inefficiency to labor
market.
(4) Affirmative actions
Women, minorities and the handicapped are very often discriminated in the labor
market. The discrimination may come from socio-cultural prejudice. But it is also
Richard A. Posner, Taxation by Regulation, Bell Journal of Economics and Management Science 2
(Spring 1971): 22-50.
7

caused by the simple economic motive that it is more costly to employ the
discriminated. For instance, the female work force is usually tied with baby delivery
and child rearing while the male workers are free of such obligation. A female worker
is apt to disturb her work schedule by the needs of child rearing, and often quits from
their jobs early after an expensive training program. Therefore, an employer usually
prefers a male worker, since he is less costly than a female worker with the equal
productivity.
Many countries assign quotas for female workers to each employer of certain
qualification in order to eliminate such discrimination. Again this action, called as an
affirmative action, forces employers to take the extra cost for employing female
workers. It is no doubt that the affirmative action aims at elimination of undue
discrimination and is socially desired. But its mode is not right in that it imposes the
associated cost only on employers. 8 Again it obstructs the property right of the
employers under the justification to achieve a socially desired goal.
Employers respond to this imposition of additional cost by replacing the ordinary
workers by the discriminated workers precisely as much as by the quota. 9 This
change causes more cost for employing the same number of workers of the equal
productivity, aggravates profit prospect, and thus discourage investment. Of course
there is an alternative means. If the government chose to intervene by paying
employers the full additional cost that they are to incur by hiring the discriminated
workers, then it could have met the same social goal without discouraging business
investment.
2.2 The democratic control of the market
Market economy produces failures here and there in practice as the government has
not been perfect in protecting private property right. Individual reaction to infringed
property right shrinks down his cooperation with outsiders and generates economywide chain reaction that invites overall slowdown of economy and blunting
employment. As the number of discontented increases, so rises their socio-political
voice. Majority of population begin to blame the inhumane failure of free market for
ruthlessly greedy selfishness, and urge to adopt political measures to control the
greedy behavior of individuals, and hence the market operation in democratic
manner.10
The democratic control restricts market to change the allocation into the one that
the majority rule selects. This change is justified to remedy the market failure. But
the change incurs cost, and the decision by majority rule often imposes major portion
of the cost to some minority in population, and the victimized minority usually fails to
raise objection since the change is an accepted justice. This mode of cost bearing
gives rise to another form of obstruction of property right, and it is the starting point
of a new government failure.
Undoubtedly a market failure must be rectified. But it is not a proper remedy to
introduce another obstruction of property right in order to correct the market failure.
8

In some cases the government provides with some subsidies.

The imposition of quota q changes the demand for labor simply to l = l* - q, where l* denotes the
demand before imposing the quota.
10
John Gray(1998), ibid.
9

EPL infringes upon employers property right in order to provide employees with job
security. But it blunts employment, distorts efficiency of labor market, and
unintentionally fortifies the employees power of wage bargaining. Both unemployment
insurance and affirmative action call for extra cost burden on employers, which
worsens profit prospects and discourages business investment. Cross subsidization
handily realizes universal service principle, but creates arbitrary tax schemes which
are by no means fair. All these examples show how the democratic control infringes
upon individual property right.
As we saw, there are means to rectify market failures without unilaterally infringing
upon individual property right. To develop an efficient labor market is a better
alternative to EPL. Replace regulation tax by orthodox tax scheme. Do not impose
cost for social welfare program unilaterally on employers. Prevailing democratic
control identifies market failures successfully, but its prescription to remedy them is
simply wrong.
The politically oriented government intervention misses to capture the true economic
nature of market failure, which is nothing but the failure in property right protection.
Thus the democratic control of market has been conducted to further infringe upon,
rather than to restore, individual property right. The result is to generate another form
of failures which we call the government failure. All the examples we discussed in
previous sections disclose how the government interventions head for the
government failures.
3. Social welfare programs in a market economy: Individual vs. Collective
Responsibility
Market competition differs from a competition to predate others under effective
protection of property right. It leads individuals to compete with each other in working
to satisfy others; a better worker will get paid better. Nobody may challenge the
legitimacy of income distribution here, since each individual earns income only as
much as her customers agree voluntarily to transfer. But if a loser or an unfortunate
one hit by catastrophic misfortune is not able to make living on his own, then the
society must extend hand to deliver him some help. So a market-determined income
distribution is not necessarily socially desired as it is even when property rights are
well protected as indicated earlier.
Social assistance and social insurance are devices of social welfare program to
assist those who need such help. It costs to implement welfare programs and the
cost of these programs is financed by their fellow citizens. Some well-to-do citizens
donate their personal wealth for this purpose. But it is the tax revenue that finances
most of social welfare works. In case of social insurance it is designed so that
beneficiaries and their employers share the burden of insurance bill. In democratic
society, individuals have somehow agreed upon the tax schemes and cost sharing in
social insurances. It has been controversial whether each individual is responsible for
his own poverty or all the citizens must stand responsible the poverty in the society. 11
If property right is not well-protected and predation/free-riding is rampant in the
David Schmidtz and Robert E. Goodwin, Social Welfare and Individual Responsibility, Cambridge
University Press (New York), 1998.
11

market, then an individual may tumble down to become a loser in market competition
even though he worked very hard for others; he may be a victim of predation. In this
case the loser may be justified to take the social welfare benefit as a small
compensation for what he has been unduly predated. The welfare benefit is not
others favor extended to him but his due right. He will not be grateful at all for the
benefit; he may even be very angry instead for the insufficiently small compensation.
It is often the case that recipients make use of the moral high ground to demand a
raise in welfare benefit and government is apt to comply with this request. Such a
development may make welfare benefit more attractive than income from hard
working and may mislead the population to be less and less individually responsible
for his or her living. Workers are encouraged to switch themselves from employment
to welfare benefit, and the economy slows down while the welfare spending soars up.
But when property right is well-protected, then every citizen deserves what she earns
in market-determined income distribution. In this case every penny of social welfare
benefit comes from the favor of fellow citizens, and it is far from being the right of
recipients. Social welfare programs are supported not because the citizens must
stand collectively responsible for the poverty in the society, but because even
individually responsible person may occasionally need assistance from fellow
citizens. It is not easy for recipients to demand a larger welfare benefit and
government has to be prudent in designing and implementing welfare programs. The
irresponsible adulthood is hard to coexist with effective protection of property right.
So if there are individuals who lose in market competition by undue predation or freeriding, then the solution is to be found not in an expanded social welfare system but
in elimination of such predation and free riding by restoring property right protection.
Effective protection of property right alone cannot solve the necessity of social
welfare program. But it will certainly help to keep the adult population more
responsible individually, and save the country from overspending in social welfare.
4. Conclusion
We discussed market competition, market failure, and government intervention from
the perspective of property right protection. Effective protection of property right leads
selfish individuals to pursue after their own interest only by working to satisfy others
for compensation. Here individuals compete with each other for higher income but
market competition is not brutal to eliminate innocent human competitors, but
successful to allocate workforce in a most efficient way. Property right protection
calls for a market-determined income distribution where everyone deserves her own
share.
We noted that there are two types of market failures; the one arising from failure in
property right protection, the other due to failure for some individuals to earn incomes
to meet their basic needs. State intervention aims to remedy market failures. But
most interventions tend to directly redress the income distribution rather than to
restore the property right protection. We showed that this kind of intervention always
calls for government failure. Government intervention to help the poor and the
unfortunate also brings forth another arbitrary intrusion on private properties to impair
efficient operation of economy.
The beneficiaries of social welfare tend to regard the benefit as their right rather

than favor from fellow citizens in the society where private property rights are not duly
honored. Their political voice urges so called democratic control of market and
expanded social welfare system, which will eventually slow down the economy and
blunt the employment.
But in a society where private property right is well-protected, every penny of welfare
benefit comes from due income of other citizens, and therefore the benefit is not the
right of the beneficiaries but the favor from the benefactors. Beneficiaries are not to
demand higher benefits and the government is more prudent to design and finance
the social welfare programs.

<References>
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations,
Clarendon Press (Cambridge), 1976.
Steven Cheung. The Fable of the Bees: An Economic Investigation, Journal of Law
and Economics, 1973.
John Gray, False Dawn The Delusions of Global Capitalism, The New Press (New
York), 1998.
Karl Polanyi, The Great Transformation The Political and Economic Origins of Our
Time, Beacon Press(Boston), 2001.
Richard A. Posner, Taxation by Regulation, Bell Journal of Economics and
Management Science 2 (Spring 1971): 22-50.
David Schmidtz and Robert E. Goodwin, Social Welfare and Individual Responsibility,
Cambridge University Press (New York), 1998.