Market failure in family-size choice

Raul V. Fabella is the vice chairman of the Institute for Development and Econometric Analysis, a professor at the UP School of Economics, and a member of the National Academy of Science and Technology. This piece was published in the February 9, 2009 edition of the BusinessWorld, page S1/4.

The current global economic crisis which exercises policy makers everywhere is an example of a market failure which justifies costly state intervention because doing nothing is much more costly. The safety-net problem facing our own policy makers today is the more burdensome because of our failure in the past to deal with another market failure, one associated with family-size choice among poor households. And this brings us to a momentous crossroad: the Reproductive Health (RH) Bill.

“Where’s the market failure?” is the first question any economist asks about any state intervention. The economic case for a government intervention, such as the now-ubiquitous fiscal stimulus, stands or falls on the associated market failure. In the case of the RH Bill, it rests on the market failure in the family-size choice of poor households. That market failure has many faces.

The microeconomic case against the RH Bill is that there is no such market failure.”The state should not enter the bedroom,” so the argument goes. Households wanting artificial methods of pregnancy-avoidance can, without the RH bill, already access them. Condoms are, for example, available everywhere at a price. If a household says that it wants no more children but if it doesn’t use part of its budget for procuring pregnancy-avoidance methods, it has no revealed preference for fewer children. In other words, such expression of preference is cheap talk.
This argument, valid for some (especially the affluent) is invalid for many poor households. Consider a poor household that states that it wants to stop at two children because it knows its current budget is just enough for two children to attain what it considers its first best outcome.

The first best outcome, which may include proper nutrition and education for the children, costs an additional C of maintaining a pregnancy-avoidance regime for the rest of the mother’s child- bearing years. If this cost C is high so that subtracts from the more immediate need of food on the table, the household is forced to settle for the second best outcome: have additional children.

However, the welfare W of the household itself under the first best outcome (fewer but healthier and better educated children and better future employment prospect) exceeds its welfare outcome V (more but less healthy and less educated children) in the second best regime. We may indeed have that the welfare difference between W and V exceed the cost of maintaining pregnancy-avoidance, that is, W-V > C. This is a case of a market failure because the net social welfare rises if C can be provided (W — C > V). The same logic governs the Obama argument for his $780-billion stimulus package where C = $780b, W is the national welfare with the package and V is the welfare doing nothing.

In the first best world, the poor household can borrow C from the capital market to finance the pursuit of the first best outcome. Where the capital market is imperfect, such borrowing will not happen since collateral is required which the poor household doesn’t have and the maturity mismatch is severe, i.e., the loan is short-term but the returns to investment is very long-term. Thus, a market failure exists for this household which the government can remedy with subsidized methods. The capital market failure facing borrowers in the crisis-struck OECD countries is similar and justifies state intervention and bailouts!

The second market failure is information-based. The household may have the financial wherewithal but may lack the proper information about the first best outcome and/or the pregnancy- avoidance options that are available and cost efficient. The state, in providing such information at cost I, allows the household to attain first best. Once more, if W-V>I, the state does well by society.

The third market failure is communitarian in character. It is the household’s prerogative to have an additional child as long as this act does not unduly burden others in society. Every liberal society (following John Stuart Mill) allows every member a private space where the citizen is in a sense a dictator. This could be the sense in which opponents of the RH bill argue that the state should stay out of the bedroom. If, however, the outcome of that private act, the additional child, has a high likelihood of becoming a ward of the community as a whole and has in the net to be supported from taxes paid by community members, the community has the every right to intervene in such private sphere. Amartya Sen’s famous theorem, The Impossibility of the Paretian Liberal, says that this private-space empowerment may run counter to other more cherished social values.

Another way of looking at this communitarian dimension is the following: Every society qua society has some form or other of social safety net, by which it provides its members a modicum of wherewithal from contributions by members. That social safety net is a common resource and is subject to some moral hazard-based abuse (known as tragedy of the commons) as is the case for example of able-bodied persons refusing employment to continue receiving unemployment checks. The members’ private actions then need to be regulated to prevent the collapse of the system.

The existence of a market failure alone is of course not sufficient for the state to intervene. It must be the case that the proposed intervention modality can really improve the social outcome, i.e., bring about the first best outcome at reasonable cost C. This is far from automatic as the government, more often than not, is either incompetent, corrupt, or both. But this apparently is not a bone of contention in the RH bill since the state intervention required is fairly simple: information drive and the procurement and distribution of pregnancy-avoidance paraphernalia many of which can be done through public-private partnerships to lower cost.

At its very core, the RH Bill expands the choice set of poor households which raises the likelihood of escape from the poverty trap and future safety nets. Which is why it should be passed.

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