Economics of Developing Countries
Coordination Failure and the Global Economy
Coordination failure problems occur when one firm must coordinate its actions with another to prevent consequences on a larger level. Although it is often true that firms must attempt to strategically out maneuver their competition and other threats their operations, coordination failures occur when the inability to strategically maneuver causes outcomes that impact the entire economy. These issues are often associated with risk and prices, and a recession is often the fault of these coordination failures. Mankiw gives a simple, but eloquent explanation of how coordination failures can come about. He describes an economy made up of two firms; both must decide whether or not to cut its prices after the money supply falls. In this example, both firms must take a risk. The goal of each is to make as much money as possible, but this is determined by not only by what the company in focus does, but also what its competition does. The only way that a recession can be avoided is if both firms cut prices, this also maximizes profits for both firms. If one firm cuts its prices anticipating that the other will do the same, but the other firm does not cut its prices, a recession follows and the firm that cuts prices ends up loosing money. If both firms exercise caution and do not cut their prices, recession ensues for the entire economy (paras. 12-14).
Mankiw writes that this example is meant to suggest the nature of coordination problem. Although real economies are far more complex than the economy that he constructs, what Mankiw emphasizes is the fact that whether or not a recession occurs is at least partially dependant on change and strategic thinking on the part of the other firm. Mankiw states, “If the two firms could coordinate, they would both cut their price and reach the preferred outcome. In the real world, unlike in this parable, coordination is often difficult because the number of firms setting prices is large. The moral of the story is that even though sticky prices are in no one’s interest, prices can be sticky simply because price setters expect them to be” (para. 18). This real life scenario is what Wolfgang Munchau suggests is leading to the global economic crisis. Munchau argues that the world leaders’ failure to act has resulted in a global coordination failure, and the global recession that is currently in full force. Indeed, Munchau says, “Not one of [the London summit’s] resolutions move the world a small step closer to resolving the global economic crisis” (para. 1). The reason for this, according to Munchau, is because they have waited to make crucial decisions, decisions that they are still waiting to make (para. 1).
Munchau’s argument offers a commentary on why some consider governments a part of the coordination failure problem instead of the solution. Governments, at least democratic ones, are traditionally slow to act, since they have a two-level game that requires they both get the approval of their own legislative bodies and that of the global community before they can implement a policy. Furthermore, governments tend to be more hesitant and less likely to act with business savvy than are private corporations. This does not necessarily mean that governments will always be a part of the communication failure problem. However, it does suggest that they must learn to act with more efficiency in order to avoid compounding coordination failure problems. Instead, governments must make decisions — even risky ones — efficiently. When on a global level, it is even more pertinent for governments to act quickly in order to be part of the solution rather than part of the problem.
References
Mankiw, N. Gregory. “New Keynesian Economics.” The Concise Encyclopedia of Economics. 2008. 18 June 2009.
Munchau, Wolfgang. “The Consequence of .” Evro
Intelligence. 4 June 2009. 18 June 2009.
