Considering the massive recalls by Toyota for problem accelerators, whom should consumers trust to protect them from unsafe products—government or the free market?

If you answered government, you’re probably in the majority. You’re also incorrect. The market does a much better job. And even massive product recalls should be seen not as examples of market failure, but as signs that markets work as they should.

Consider the various incentives of the private sector and government in this case.

A functioning market is one in which companies produce products that meet consumer demands. When companies make products that are unsafe or ineffective, they risk losing customers and money.

The fact that the November 2009 recall of 3.8 million vehicles was initiated by Toyota—while the National Highway Traffic Safety Administration declined to reopen a closed investigation into potential Toyota defects—highlights the private sector’s incentive to compensate for perceived problems. Worldwide voluntary recalls on the part of Toyota confirm this.

While no company is perfect, correcting errors when they occur is a necessary part of doing business—and necessary to a properly functioning market.

Other private organizations and businesses also have an incentive to provide reliable, accurate and timely information on product quality and safety. Such services are a necessary part of the market process.

Customers trust these organizations when shopping for toasters, televisions and even Toyotas.

Kelley Blue Book, for example, has earned a reputation as America’s most trusted source of information on car values. The company recently reduced the values of recalled Toyotas twice in a single week, reflecting its independent evaluation of the magnitude of the problems. Inaccurate measures from Kelley could cost the company future business—an incentive that should give customers confidence in the accuracy and independence of Kelley’s information.

But should they rely on these same organizations when products turn out to be defective or dangerous? And are they more reliable than the government?

Compare the NHTSA and Consumers Union, both of which have just over 600 employees. The government agency costs taxpayers some $870 million annually, while the Consumers Union costs taxpayers nothing and, in fact, generates more than $200 million annually in revenue.

Consumers Union provides free services such as the Web site, where updates on product safety and recalls are available, as well as premium products like Consumer Reports magazine.

Private organizations such as Consumers Union must maintain a reputation for accuracy and integrity. If they fail to do so, they lose support, credibility and revenue. Government agencies must meet no such market test. In fact, it is often failure that gets rewarded with larger budgets, additional employees, and more investigative or regulatory authority. Their incentive, therefore, is to exaggerate problems.

Politicians have other incentives. Among the lawmakers investigating Toyota’s recall are Democratic Sen. Jay Rockefeller, who admits lobbying Toyota to build a plant in his state, West Virginia, and Rep. Darrell Issa, R-Vista, who still serves on the board of the auto alarm company he founded, which sells alarms to Toyota. These lawmakers have a vested interest in the company’s well-being, creating a conflict of interest. Lawmakers at the other extreme may simply be seeking headlines.

Private companies’ incentives are to fix problems when they’re discovered—or undermine the brand and suffer financially. Private organizations, such as Kelley or Consumers Union, have similar incentives, since they profit by providing unbiased product evaluations. These organizations have reputations to protect and face significant penalties for being wrong.

Government’s incentives—beyond doing the right thing, which most government employees want to do—are often at odds with its mission.