Http:// Copyright 2006 – Biz/ed Government Failure.

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Copyright 2006 – Biz/ed

Government Failure



Government Failure

• Government failure refers to situations where allocative efficiency may have been reduced following government intervention in markets designed to correct market failure.



Government Failure

• When does government step in?– To correct shortages or surpluses– To provide when the market does not or can

not– To regulate and correct where there is

perceived inequality or inefficiency– To protect individuals and groups in society

and provide a safety net for those unable to help themselves

– To reduce poverty– To influence property rights



Government Failure

• How does government intervene?– Taxation – to redistribute and provide

incentive or disincentive effects– Subsidies – to encourage

production/consumption– Regulation – guides, codes of practice,

legislation, independent regulators– Identifying property rights – ownership of

property, e.g. intellectual property, granting of patents, etc.

– Direct provision of goods and services – health, education, etc.



Government Failure• Public Choice Theory:

– Politicians, bureaucrats and others acting on behalf of the ‘public’ may act in their own self interest as ‘utility maximisers’.

– The ‘invisible hand’ may not work in the provision of public goods.

– ‘Rent seeking’ or ‘Log rolling’ - two important concepts.

Subsidies may be designed to correct a perceived market failure but they do not always please everyone – public choice?Title: Czech farmer protest EU accession. Copyright: Getty Images, available from Education Image Gallery



Government Failure• ‘Rent seeking’ or ‘Log rolling’:

– Politics involves a series of trade-offs in public policy making

– Traditional theory would suggest that decisions will be made that give the greatest utility to the maximum number of people

– Rent seeking – where decisions are made leading to resource allocation that maximises the benefit to the decision maker at the expense of another party or parties.

– Log rolling – where decisions may be made on resource allocation to projects that have less importance in return for the support of the interested party in other decision making areas.



Government Policy• e.g. – decisions

made on genetically modified crops – were they made on the basis of the public interest at large or to satisfy the farming lobby, the health lobby, the environmental lobby or the GM business lobby?

The GM Debate – are decisions made in the interest of the public at large or for the benefit of the powerful few? How would we know?Title: Government Report on genetically modified crops. Copyright: Getty Images, available from Education Image Gallery



Government Failure• Should taxes be raised

extensively on tobacco? If so what will the reaction of the tobacco industry be? Do they have sufficient power to influence decision making?

Image Copyright: Zaid Zolkiffli, RosikaVoermans (http://www.sxc.hu)



Government Failure

• How does Government Failure manifest itself?– Distortion of markets – e.g. rent

control, minimum wage, agricultural subsidies, taxes on fuel

– Welfare impact – erosion of consumer surplus and producer surplus – e.g. EU tariff support for manufactured goods and food



Government Failure

• Disincentive Effects – – High taxes hampering business

expansion or enterprise– Welfare benefits reducing the

incentive to find work• Short termism – solving the ‘hot

topics’ of the day rather than the long term important issues – e.g. ID cards versus pension crisis?



Government Failure

• Electoral Pressure– Desire to get elected and pass

‘popular’ policies to capture votes– e.g. spending on public services at

the risk of higher inflation and future interest rates?



Government Failure• Impact on the

environment – e.g. building

new motorways rather than investing in public transport?

Is the real answer to road congestion building more motorways?Title: Motorway Intersection. Copyright: Getty Images, available from Education Image Gallery



Government Failure

• Regulatory Capture– Regulatory agencies

become dominated by the firms they are supposed to be regulating!

The railways – who controls who?Copyright: Bo de Visser, http://www.sxc.hu



Government Failure• Imperfect information:• Lack of knowledge of:

– Prices – Value– Costs– Benefits– Long term effects– Behavioural changes– External costs and benefits– Value of producer and

consumer surplus • – all mean less than efficient

allocation may result from government intervention.

What value can be placed on the destruction of a natural environment through development? How do we value aesthetic beauty?

Source: Lynne Lancaster, http://www.sxc.hu

Http:// Copyright 2006 – Biz/ed Government Failure.

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