The Guiding Principle in Territorial Development:Remedy Market Failure, Enable MarketsJrg Meyer-Stamer

What is a market?

Again: What is a real market?The main point of reference for any company: The source of its supplies and inputsThe source of most of the services, information and support a company needsThe target of its production, i.e. the customers.

What is and what isnt market failure?Market failure isthe lack of response on the supply- or demand-side due tonatural monopolyexternal effects indivisibilities asymmetrical informationpublic goods Market failure isnt marketing failurethe failure of a business to identify an adequate marketlack of demand for a companys productsa crisis due to a downturn in a companys main market.

A case of marketing failure.

Natural monopolywater distribution electricity distribution roads telecommunication in thinly populated rural areas

External effectsinvestment in R&Dinvestment in skills developmentcoordination externalities only complementary investments create viable businesse.g. tourism: convincing product requires accomodation + food + activities + transport + ... = multiple companies

Indivisibilitieshigh cost of specialised machinesoftware package...size of container

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

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

The five types of market failure and their possible consequenceExternal effectsIndivi- sibilityAsymmetric informationPublic goodsNatural monopolyInvestment in skills (positive)Building a high chimney (negative)Size of a container that needs to be filled by supplierInformation about residual toxics in fresh fruit Features of distinct products that look alikeAvailability of costly and complicated testing equipmentTelecommunication in thinly populated rural areasUnderinvestment in skillsContamination that spreads widelySmall producers cannot connect to market due to lack of scaleCustomers dont buy fruit if they suspect use of toxics Customers don buy, e.g., high quality seeds Producers cannot test and certify their produce High price of telecom service,perhaps no access at all FailureExampleConsequence

Preconditions for functioning markets John McMillaninformation flows smoothlypeople can be trusted to live up to their promises competition is fosteredproperty rights are protected but not overprotected side effects on third parties are curtailed.

Market failure in practice: start-up businesses suffer from Catch-22limited funds, limited advertisement effort, limited visibility, limited sales, limited fundsmain market failure: low density of businesses (= shallow market) few business contacts (little mouth-to-mouth advertisement) frequent additional market failure: lack of formalised business structureslack of formalised business information (e.g. yellow pages)barriers to entry due to government regulations

Effects of market failure Barriers to entry for new companies

Market failure and other causes of barriers to entry Business opportunityis not exploited

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 sellersThe 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 producersThe market is an invisible hand

What else is there, apart from markets, to organise the allocation of resources? NetworkMarketHierarchy government big companies other organisationsInformal network producer circle Formal network producer association Coase (1937): Why are there companies, and not just markets? Because of transaction cost.Powell (1990): Networks are not just something in between market and hierarchy

Stylised comparison of forms of economic organisation(Powell 1990, OECD 1992)

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 companiesunderinvestment 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

Government failure.

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 governmentfunctioning government requires strong networks .

Is the market always the best solution? NoBut 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

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 initiativeTry to identify the most relevant market failuresTry to understand the root causes of very relevant market failuresDesign and scope interventions in such a way that they address the cause of the market failure, not the symptom.

An example: access to ISO certificationMarket failure at the outset: few companies need ISO certification (e.g. 9000, 14 000), certification firms dont enter market due to lack of scaleOption 1: market-eliminating intervention --public agency is tasked with providing ISO certification and has no interest in private providers entering the marketresult: monopoly = high cost of certification, bad serviceOption 2: market creating intervention --e.g. subsidizing the entry of certifyerse.g. emitting vouchers.

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

Addressing Market Failure: Options

Possible approaches to address market failure Market failure

Theory- and concept-driven approachOption 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 cardsBrainstorm 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 failureengage with local stakeholders to initiate a process of addressing critical market failure

Dedicated market failure mini-workshop in a local subsectorQ1: 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 Q2+Q3Working groups on high scores: What are the barriers to entry to this activity? Who can do what to lower the barriers to entry?

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?

Opportunity-driven approachConduct 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?

Addressing market failure in a PACA Exercise During the fieldwork: Many problems / bottlenecks that are mentioned in miniworkshops are actually business opportunitiesInvestigate why these business opportunities are not taken upAnalyse barriers to entry and other types of market failureTry 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?

Thank you for your attention!