The Guiding Principle in Territorial Development: Remedy Market Failure, Enable Markets

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The Guiding Principle in Territorial
DevelopmentRemedy Market Failure, Enable
Markets

• Jörg Meyer-Stamer

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What is a market?
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Again What is a real market?

• The main point of reference for any company
• The source of its supplies and inputs
• The source of most of the services, information
  and support a company needs
• The target of its production, i.e. the customers.

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What is and what isnt market failure?

• Market failure is
• the lack of response on the supply- or
  demand-side due to
• natural monopoly
• external effects
• indivisibilities
• asymmetrical information
• public goods

• Market failure isnt
• marketing failure
• the failure of a business to identify an adequate
  market
• lack of demand for a companys products
• a crisis due to a downturn in a companys main
  market.

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A case of marketing failure.
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Natural monopoly

• water distribution
• electricity distribution
• roads
• telecommunication in thinly populated rural areas

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External effects

• investment in RD
• investment in skills development
• coordination externalities
• only complementary investments create viable
  business
• e.g. tourism convincing product requires
  accomodation food activities transport
  ... multiple companies

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Indivisibilities

• high cost of
• specialised machine
• software package
• ...
• size of container

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Asymmetrical information

• buyer cannot easily determine the quality of
  product
• e.g. used car
• e.g. residual agrotoxics
• e.g. quality of plant seeds
• business opportunities or suppliers / customers
  are not visible

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Public goods

• information seminars
• agricultural extension service
• easily available, free or low cost testing
  facilities for products

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The five types of market failure and their
possible consequence
Failure
Example
Consequence
Naturalmonopoly
Telecommunication in thinlypopulated rural areas
High price of telecom service, perhaps no access
at all
Externaleffects
Investment in skills (positive) Building a high
chimney (negative)
Underinvestment in skills Contamination that
spreadswidely
Indivi-sibility
Size of a container thatneeds to be filled by
supplier
Small producers cannot connectto market due to
lack of scale
Asymmetricinformation
Information about residual toxics in fresh fruit
Features of distinct products that look alike
Customers dont buy fruit if they suspect use of
toxicsCustomers don buy, e.g., highquality
seeds
Publicgoods
Availability of costly andcomplicated testing
equipment
Producers cannot test and certify their produce
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Preconditions for functioning markets

• John McMillan
• information flows smoothly
• people can be trusted to live up to their
  promises
• competition is fostered
• property rights are protected but not
  overprotected
• side effects on third parties are curtailed.

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Market failure in practice start-up businesses
suffer from Catch-22

• limited funds, limited advertisement effort,
  limited visibility, limited sales, limited funds
• main market failure
• low density of businesses ( shallow market)
• few business contacts (little mouth-to-mouth
  advertisement)
• frequent additional market failure
• lack of formalised business structures
• lack of formalised business information (e.g.
  yellow pages)
• barriers to entry due to government regulations

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Effects of market failure
Barriers to entry for new companies
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Market failure and other causes of barriers to
entry
Business opportunity is not exploited
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Again What is the market?

• The market is a physical or virtual place where
  buyers and sellers meet
• The market is a mechanism to match the offers of
  buyers and the demands of sellers
• The market is a mechanism to take decisions on
  allocation
• what should be produced?
• how much should be produced?
• These decisions are taken in a decentralised way
  by individual producers
• The market is an invisible hand

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What else is there, apart from markets, to
organise the allocation of resources?
Powell (1990) Networksare not just something in
betweenmarket and hierarchy
Network

• Informal network
• producer circle
• Formal network
• producer association

• government
• big companies
• other organisations

Hierarchy
Market
Coase (1937) Why are there companies, and not
just markets?Because of transaction cost.
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Stylised comparison of forms of economic
organisation(Powell 1990, OECD 1992)
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Is there only market failure? No.

• There is also government failure, e.g.
• government monopolising the provision of a given
  service -- and then failing to deliver
• government granting privileges to some companies
• underinvestment in public goods (e.g. education,
  infrastructure, security)
• an ineffective or inefficient legal system

• There is also network failure, due to, for
  instance,
• the problem of numbers (too many participants
  makes effective coordination impossible)
• endless disagreement
• necessity of trust vs opportunistic behaviour
• power disequilibria
• ownership vs transparency and participation
• inter-personal conflict
• the legitimacy dilemma

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Government failure.
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What can be done about these various types of
failure?

• When government fails, markets or networks can be
  the solution
• When markets fail, government or networks can be
  the solution
• When networks fail, government or markets can be
  the solution
• But Sometimes different modes of coordination
  depend on each other
• functioning markets require a strong government
• functioning government requires strong networks .

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Is the market always the best solution?

• No
• But whenever a market works properly, it is the
  most efficient way of allocating things
• Markets work because of the self-interest of
  market participants
• Market vs hierarchy government tends to create
  huge bureaucracies to substitute for markets
• Who is responsible for the supply of bread to
  London?
• Market vs network networks tend to involve
  endless, and not rarely fruitless, meetings
• Nobody has to actively coordinate a market

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How establish addressing market failure as the
guiding principle of developmental activities?

• Make the analysis of market failure a mandatory
  element of the preparation of any initiative
• Try to identify the most relevant market failures
• Try to understand the root causes of very
  relevant market failures
• Design and scope interventions in such a way that
  they address the cause of the market failure, not
  the symptom.

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An example access to ISO certification

• Market failure at the outset few companies need
  ISO certification (e.g. 9000, 14 000),
  certification firms dont enter market due to
  lack of scale
• Option 1 market-eliminating intervention --
• public agency is tasked with providing ISO
  certification
• and has no interest in private providers entering
  the market
• result monopoly high cost of certification,
  bad service
• Option 2 market creating intervention --
• e.g. subsidizing the entry of certifyers
• e.g. emitting vouchers.

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Summary of the argument

• The market is the standard mode of transaction
  for any company
• When a company encounters a business problem, it
  looks at the market for solutions
• Many business problems, i.e. problems many
  companies are facing, are the source of new
  business opportunities
• If these business opportunities are not taken up
  spontaneously by dynamic entrepreneurs, we may be
  facing a market failure
• From an economic viewpoint, market failure is the
  most important justification for economic
  development activities by government and other
  actors

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Addressing Market Failure Options
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Possible approaches to address market failure
Marketfailure
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Theory- and concept-driven approach

• Option 1, in a setting with skilled and educated
  stakeholders Conduct a focus group workshop
• Introduce stakeholders to market failure concept
  and typology
• Conduct brainstorming on market failure
• Cluster and Pareto cards
• Brainstorm on ways of addressing critical market
  failure
• Initiate quick-win activities

• Option 2, in a normal setting
• conduct study on market structure and market
  failure
• identify critical market failure
• engage with local stakeholders to initiate a
  process of addressing critical market failure

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Dedicated market failure mini-workshop in a local
subsector

• Q1 What are areas of strong competition, both at
  the supply side and the demand side?
• Q2 What are areas of little or no competition,
  both at the supply and the demand side?
• Q3 Which business opportunities related to your
  subsector are not exploited?
• Pareto on Q2Q3
• Working groups on high scores
• What are the barriers to entry to this activity?
• Who can do what to lower the barriers to entry?

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Dedicated market failure workshop in a value
chain

• Map the value chain
• which interaction is organised as a market, as a
  hierarchy, as a network?
• Question
• looking at interaction that is currently
  organised as hierarchy or network, would it be
  more efficient to organise it as market?
• what stands in the way of a market solution to
  evolve?
• what can we do to remove obstacles that stand in
  the way of a market solution?

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Opportunity-driven approach

• Conduct workshop with local high-level focus
  group
• Brainstorm Which ideas for developmental
  activities are frequently discussed (in the
  air)?
• Question Which of those ideas may in principle
  be translated into business opportunities?
• What kind of market failure stands in the way of
  realising each business opportunity?
• Which market failure is particularly critical?
• What can we do to address that market failure?

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Addressing market failure in a PACA Exercise

• During the fieldwork
• Many problems / bottlenecks that are mentioned in
  miniworkshops are actually business opportunities
• Investigate why these business opportunities are
  not taken up
• Analyse barriers to entry and other types of
  market failure
• Try to come up with ways of addressing the
  underlying market failure, rather than the
  symptom

• At the Results Workshop
• Question every proposal --
• Is this possibly a business opportunity?
• If it is, is it more efficient to address it
  through hierarchy or network?
• If that is not more efficient, then what can we
  do to advertise this as a business opportunity?
• Who can facilitate a process where an
  entrepreneur takes up the opportunity?

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Thank you for your attention!