A perfectly functioning market is a beautiful thing. It’s also vanishingly rare. The main work of economists is figuring out how to make markets function well when the messy, real world intrudes on our textbooks’ elegant models.
The pandemic, unfortunately, provides instructive examples of markets that are failing in predictable and harmful ways. The failures are particularly glaring in dozens of college towns across the United States that are coronavirus hot spots.
Introductory economics focuses on the “invisible hand of the market”: Independent actors, by pursuing their own interests, maximize the common good. In this idealized world, the best thing a government can do is get out of the way so the free market can work its magic.
But 95 percent of economics is about the imperfections of markets, and how the government can correct them. In fact, some market failures require government intervention for the invisible hand to do its work. Economic theory predicts when markets are likely to work with minimal intervention, and when they will fail without government involvement.
Pollution is the textbook example of a market failure. A manufacturer sending fumes into the air creates what economists call a “negative externality.” Simply by doing what it does — making its product — the firm harms others. Pollution reduces air quality for those living and breathing nearby, but since neighbors’ health doesn’t affect the bottom line that drives daily decisions at the factory, the pollution keeps flowing.
A pandemic is powered by the ultimate negative externality: The very act of breathing can spread a deadly disease.
A key task of economic policy is to “put a price” on externalities. The trick is to build external costs (or benefits) automatically into internal choices about behavior. For example, a government might impose a tax on gas that reflects the harm that fossil fuels do to the environment.
Free markets can’t solve externalities; collective action is required to force people and firms to internalize the costs that their own behavior creates for others. There are lots of tools for this job: taxes, regulation and social norms.
To see what happens when policy does not properly price externalities, take a look at college campuses across the country, many of which have become growth centers for the pandemic.
Colleges, and college towns, are designed to maximize social interaction, generating personal and professional opportunities for a lifetime. But in a pandemic, the brainstorming, talking, networking and socializing create negative externalities, so colleges have tried using norms and punishments to stop students from gathering. They have expelled violators and trained peers to model safe behavior.
It’s an uphill battle. Keeping students off campus would have been a wiser choice than struggling to keep them apart.
But with government funds evaporating and family incomes pinched, schools faced an existential crisis. Colleges get much of their revenue from tuition-paying students, who want the social, campus experience that now feeds the pandemic.
Schools that chose not to open their campuses risked losing customers to those that did. Without the government’s telling them (or paying them) to keep students away, schools did what they could to survive.
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With so much revenue on the line, the incentive to open campuses was irresistible. In a perfect market, that’s how it is supposed to work: Customers demand a product, firms supply it, and the world is better off. But with negative externalities, this tidy dynamic fails to maximize the common good.
There was no market force to force colleges to consider the external consequences of opening campuses — as there was when worries about the risk of infection shut down elementary schools in neighboring towns.
Stopping campuses from reopening would have required coordinated government action. Practically, this could have taken many forms: subsidies to colleges that didn’t bring students to campus, tuition breaks for students who agreed to stay home or outright government bans on communal living arrangements such as fraternities, sororities and dormitories.
By making huge investments in testing, tracing and quarantine, a few colleges have reopened without spreading the virus in their communities. Science has identified strategies that allow colleges to open safely. But market forces won’t consistently produce this outcome.
When one actor’s choices affect the well-being of others, as with infection and pollution, the invisible hand does not deliver the best outcome for society. Each of us could do more to help end this pandemic, but individual action is neither the core of the problem nor its solution. Externalities require collective action.
Autonomy — which fosters institutional individuality — is a historical strength of American colleges and universities, contributing to their research excellence. But that very autonomy has made a coordinated response impossible. Only in places with strong oversight and governance of colleges (for example, the California State University System) did schools move quickly to keep campuses closed.
Countries where the government traditionally plays a more active role in shaping markets have had more success in changing behavior and controlling the pandemic. Competitive, free markets work when individuals and institutions pursuing their own interests converge, making everyone best off. In the case of colleges reopening, self-interested action has instead led to a predictable market failure: fueling viral spread.
Sarah Cohodes is an associate professor of economics and education at Teachers College, Columbia University. Follow her on Twitter: @SarahCohodes.
Susan Dynarski is a professor of public policy, education and economics at the University of Michigan. Follow her on Twitter: @dynarski.
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