Research Approach

Markets are central to the functioning of modern societies. They coordinate the economic activities of millions of individuals and firms, and are a source of prosperity. But they may also fail and generate undesirable outcomes. Market forces may contribute to inequality of income and wealth. Prices that do not properly reflect the damage inflicted upon the environment by economic activities undermine efforts to prevent climate change. And the failure of financial markets has led to the global financial crisis, causing a deep recession and taxpayer-funded bank rescues. This calls for the correction of market outcomes through public policy.

Market failures have long been recognized as a justification for policy interventions. The traditional perspective emphasizes market power, externalities and information asymmetries as sources of market failures and tackles them by regulation, taxation or public goods provision.

However, novel problems have arisen due to structural changes in the economy, such as digitalization or the global financial crisis, raising problems that are difficult to address with a traditional perspective on market failures. They require a comprehensive approach, taking account of the latest research developments in economics and neighboring disciplines.

The Cluster therefore develops a new research agenda for the analysis of market failures and government interventions, systematically combining insights from economic theory, behavioural economics, psychology, political science and legal science for the analysis of markets & public policy and thereby contributing to finding innovative solutions to societal challenges. The overarching scientific objective is to advance a new paradigm for the analysis of market failures and government intervention, addressing pressing societal challenges, such as globalization, digitalization, deep financial crises, climate change or political extremism.

Scientific Approach

A comprehensive analysis of markets & public policy necessitates a number of different tasks. Please click on the fields for more information.

Challenges for public policy market failures policy failures
Challenges for public policy market failures policy failures

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A first task is the identification of market failures and policy failures in light of structural changes in the economy, giving rise to new challenges for public policy.

Analysis of policy responses Human behavior Economic theory
Analysis of policy responses Human behavior Economic theory

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Economic theory delivers predictions on how market outcomes are affected by alternative policies, i.e. it enables an analysis of policy responses. This requires an understanding of the relevant drivers of human behavior in the given context, such as the extent to which behavior is driven by monetary incentives, by other motives, such as concerns for fairness, or by behavioral biases.

Implementation and evaluation institutional constrains Casual effects
Implementation and evaluation institutional constrains Casual effects

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The third task comprises the implementation and evaluation of the proposed policy. The implementation process has to take institutional constraints into an account, such as legal frameworks or political implementability. An important task is the evaluation of policy measures, i.e. the identifikation of their casual effects. Naturally, the implementation of policies raises new challenges of public policy, closing the circle.

01

01

A first task is the identification of market failures and policy failures in light of structural changes in the economy, giving rise to new challenges for public policy.

02

02

Economic theory delivers predictions on how market outcomes are affected by alternative policies, i.e. it enables an analysis of policy responses. This requires an understanding of the relevant drivers of human behavior in the given context, such as the extent to which behavior is driven by monetary incentives, by other motives, such as concerns for fairness, or by behavioral biases.

03

03

The third task comprises the implementation and evaluation of the proposed policy. The implementation process has to take institutional constraints into an account, such as legal frameworks or political implementability. An important task is the evaluation of policy measures, i.e. the identifikation of their casual effects. Naturally, the implementation of policies raises new challenges of public policy, closing the circle.

All research activities center around two fundamental questions: To what extent is public policy needed to ensure the proper functioning of markets and to correct undesirable market outcomes? And how should such policies be designed to achieve the desired objectives and avoid policy failures?

Our approach to markets & public policy extends the traditional analysis of market failures in three respects: First, it broadens the view towards new challenges that have appeared due to structural changes in the economy, such as consumer protection in digital markets or financial regulation with a systemic perspective. Second, it takes account of new objectives, such as procedural fairness, social responsibility and morale, which go beyond traditional notions of economic efficiency and welfare. Finally, it employs and advances new tools, developed, for example, in experimental economics, market and mechanism design or computer science.

Three features make the Cluster’s approach distinct in comparison to other national and international research institutions: (1) its focus on tackling public policy questions based on fundamental research on the micro-foundations of economic behavior, (2) its comprehensive approach, combining different research strands within economics and fostering an interdisciplinary perspective, and (3) its innovative approach with respect to research methods. In Germany and other countries, policy-relevant research in economics is often delegated to non university institutions, whereas research at universities remains removed from real-world challenges.

The Cluster attempts to better combine fundamental research with a policy perspective, while maintaining the highest scientific standards.