Public Economics, Market Failure, and Voluntary Exchange

Abstract

The core of public economics traditionally addresses two situations of market failure: externalities and public goods. The desirability of government action in these cases hinges on decisions made in the revenue-expenditure process. How this process is envisioned can tell us quite a lot about conceptions and understandings of market failure. Reaching back nearly a century to the European continental public finance tradition, Public choice scholars revived voluntary exchange theory as a response to market failure. This theory suggests that the revenue-expenditure process should be determined by the same fundamental laws and procedures that govern market prices in the private aspects of the economy. Voluntary exchange became an ideological anchor for public choice, despite the oddity of suggesting a market-analogous solution for market failure. In this paper, I examine the treatment of Voluntary Exchange Theory in Public choice, as compared to mainstream public economics. Considered are Voluntary Exchange as a theory versus an analogy, the role beliefs about the nature and role of government have on theory-making and theory acceptance, and reactions to failures/inconsistencies/gaps pointed out in voluntary exchange theory conceptions (real or claimed). By exploring these topics, we can see the extent to which the debate over voluntary exchange theory illuminates deeply held and often buried ideological assumptions. One can also see that the nature and extent of market failure in public economics is, on a fundamental level, very closely tied to preconceptions about the economic role of government.