Abstract: The Theory of Institutional Failure: A New Framework

Alan Loeb


This paper critiques the theory commonly used in analysis of pollution problems, the market failure/externalities model. The analysis begins by examining the model logically, then for empirical validation it turns to the historical experience using a case study of the Surgeon General's review of tetraethyl lead in 1925-1926. It is found in both analyses that the model has significant deficiencies, specifically that the theory assumes the incentive to pollute is a variable when in fact it is a constant. Because the starting point for explaining pollution needs to be a variable, externalities theory cannot be right. The paper then considers the possibility of developing a new framework as a replacement for the current model. The founding principle of the new framework is that pollution results not from market failure but from "institutional failure." Analysis of the history shows that the proper variable is the constraint of institutions that offsets the constant economic incentive to pollute and that the occurrence of pollution represents the failure of those institutions to counteract that incentive—hence the term "institutional failure." The reconceptualization accomplished in this paper has broad implications. It suggests that many policy decisions are being wrongly reasoned, and that their success, if any, occurs by coincidence rather than because of a correct diagnosis.