Uwi Government And Business Relations2005summary

SECTION 5SECTION 5THE BUSINESS-GOVERNMENT THE BUSINESS-GOVERNMENT

RELATIONSRELATIONS

This session will address:This session will address: Market FailureMarket FailureThe Development of Public The Development of Public EnterprisesEnterprisesRegulationRegulationGovernment FailureGovernment Failure

The Market MechanismThe Market Mechanism

The operation of the market The operation of the market mechanism focuses on the mechanism focuses on the efficiency of the private sector. efficiency of the private sector.

Focus is placed on two types of Focus is placed on two types of efficiency:efficiency: Allocative EfficiencyAllocative Efficiency Productive Efficiency Productive Efficiency

The Market MechanismThe Market MechanismAllocative Efficiency: Allocative Efficiency: This occurs when This occurs when resources are distributed in such a way that resources are distributed in such a way that no consumers could be made better off no consumers could be made better off without other consumers becoming worse without other consumers becoming worse off.off.

Productive Efficiency: Productive Efficiency: This is achieved This is achieved when production is carried out at its lowest when production is carried out at its lowest costscosts

Market MechanismMarket Mechanism

Allocative and productive efficiency is Allocative and productive efficiency is achieved through the assumptions of achieved through the assumptions of perfect competition, as purported by perfect competition, as purported by Adam Smith- Adam Smith- laissez-faire approachlaissez-faire approach::

Reasons for Market FailureReasons for Market Failure

Imperfect KnowledgeImperfect Knowledge Differentiation of Goods & ServicesDifferentiation of Goods & Services Market PowerMarket Power Inadequate ProvisionInadequate Provision InequalityInequality

Market FailureMarket Failure

Imperfect Knowledge:Imperfect Knowledge:• Consumers do not have adequate technical Consumers do not have adequate technical

knowledgeknowledge• Advertising can mislead or mis-informAdvertising can mislead or mis-inform• Producers unaware of all opportunitiesProducers unaware of all opportunities• Producers cannot accurately measure Producers cannot accurately measure

productivityproductivity• Decisions often based on past experience Decisions often based on past experience

rather than future knowledgerather than future knowledge


Market Power:Market Power:• Existence of monopolies and oligopoliesExistence of monopolies and oligopolies• CollusionCollusion• Price fixingPrice fixing• Abnormal profitsAbnormal profits• Rigging of marketsRigging of markets• Barriers to entry Barriers to entry


Inadequate Provision:Inadequate Provision: Merit Goods and Public GoodsMerit Goods and Public Goods

• Merit GoodsMerit Goods – Could be provided by – Could be provided by the market but consumers may not be the market but consumers may not be able to afford or feel the need to able to afford or feel the need to purchase – market would not provide purchase – market would not provide them in the quantities society needsthem in the quantities society needs

• Sports facilities?Sports facilities?


Merit GoodsMerit Goods Education – Education –

nurseries, nurseries, schools, schools, colleges, colleges, universities – could all universities – could all be provided by the be provided by the market but would market but would everyone be able to everyone be able to afford them?afford them?

Schools: Would you pay if the statedid not provide them?

Private GoodsPrivate GoodsA private good is characterised by:A private good is characterised by:

Excludability: consumers can be excluded from Excludability: consumers can be excluded from consuming consuming the product if they are not willing the product if they are not willing to pay for it.to pay for it.

Rivalry: One person’s consumption reduces the Rivalry: One person’s consumption reduces the amount, another person is able to consume.amount, another person is able to consume.


Inequality:Inequality:• Poverty – Absolute and RelativePoverty – Absolute and Relative• Distribution of factor ownershipDistribution of factor ownership• Distribution of IncomeDistribution of Income• Wealth DistributionWealth Distribution• DiscriminationDiscrimination• HousingHousing


De-Merit GoodsDe-Merit Goods Goods which society over-producesGoods which society over-produces Goods and services provided by the Goods and services provided by the

market which are not in our best market which are not in our best interests!interests!• Tobacco and alcoholTobacco and alcohol• DrugsDrugs• GamblingGambling

ExternalitiesExternalities

Externality: A third party (spill-over) Externality: A third party (spill-over) effect arising from the production effect arising from the production and/or consumption of goods and and/or consumption of goods and services for which no appropriate services for which no appropriate compensation is paid.compensation is paid.

Positive and Negative ExternalitiesPositive and Negative Externalities The effects of a decision by The effects of a decision by

consumers and producers that has consumers and producers that has an impact on a third partyan impact on a third party• Positive ExternalitiesPositive Externalities – beneficial – beneficial

effects on third partieseffects on third parties• Negative ExternalitiesNegative Externalities – costs – costs

incurred by third partiesincurred by third parties


External Costs and BenefitsExternal Costs and Benefits External or social costsExternal or social costs

• The cost of an economic decision to a The cost of an economic decision to a third partythird party

External benefitsExternal benefits • The benefits to a third party as a result The benefits to a third party as a result

of a decision by another partyof a decision by another party

Costs and benefits in consumption:Costs and benefits in consumption: External costs in consumption – where External costs in consumption – where

MSB < MPBMSB < MPB• e.g. passive smoking, litter, noise, anti-social e.g. passive smoking, litter, noise, anti-social

behaviourbehaviour External benefits in consumption – where External benefits in consumption – where

MSB > MPBMSB > MPB • e.g. preventative health care – vaccinations, e.g. preventative health care – vaccinations,

public transport, attractive gardens, bathing public transport, attractive gardens, bathing regularly!regularly!

Positive and Negative ExternalitiesPositive and Negative Externalities

Market FailureMarket Failure External benefitsExternal benefits – –

• by products of by products of production and decision production and decision making that raise the making that raise the welfare of a third partywelfare of a third party

• e.g. education and e.g. education and training, public transport, training, public transport, health education and health education and preventative medicine, preventative medicine, refuse collection, refuse collection, investment in housing investment in housing maintenance, law and maintenance, law and orderorder

Market FailureMarket Failure External CostsExternal Costs Decision makers do not Decision makers do not

take into account the cost take into account the cost imposed on society and imposed on society and others as a result of their others as a result of their decisiondecision• e.g. pollution, traffic e.g. pollution, traffic

congestion, environmental congestion, environmental degradation, depletion of degradation, depletion of the ozone layer, misuse of the ozone layer, misuse of alcohol, tobacco, anti-alcohol, tobacco, anti-social behaviour, drug social behaviour, drug abuse, poor housingabuse, poor housing

Government InterventionGovernment InterventionMarket failure presents a Market failure presents a rationale for government rationale for government intervention in markets – the intervention in markets – the pursuit of individual self pursuit of individual self interest rarely results in interest rarely results in maximum social welfare.maximum social welfare.

Government InterventionGovernment Intervention When does government step in?When does government step in?

• To correct shortages or surplusesTo correct shortages or surpluses• To provide when the market does not or can To provide when the market does not or can

notnot• To regulate and correct where there is To regulate and correct where there is

perceived inequality or inefficiencyperceived inequality or inefficiency• To protect individuals and groups in society To protect individuals and groups in society

and provide a safety net for those unable to and provide a safety net for those unable to help themselveshelp themselves

• To reduce povertyTo reduce poverty

Government InterventionGovernment Intervention

How does government intervene?How does government intervene?• TaxationTaxation – to redistribute and provide incentive – to redistribute and provide incentive

or disincentive effectsor disincentive effects• Subsidies Subsidies – to encourage – to encourage

production/consumptionproduction/consumption• RegulationRegulation – guides, codes of practice, – guides, codes of practice,

legislation, independent regulatorslegislation, independent regulators• Direct provision Direct provision of goods and services – health, of goods and services – health,

education, via public enterpriseseducation, via public enterprises

Government FailureGovernment Failure

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

Government FailureGovernment Failure ‘‘Rent seeking’Rent seeking’ oror ‘Log rolling’:‘Log rolling’:

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

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

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


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

control, minimum wage, agricultural control, minimum wage, agricultural subsidies, taxes on fuelsubsidies, taxes on fuel


Disincentive EffectsDisincentive Effects – – • High taxes hampering business High taxes hampering business

expansion or enterpriseexpansion or enterprise• Welfare benefits reducing the incentive Welfare benefits reducing the incentive

to find workto find work Short termismShort termism – – solving the ‘hot solving the ‘hot

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


Electoral PressureElectoral Pressure• Desire to get elected and pass ‘popular’ Desire to get elected and pass ‘popular’

policies to capture votespolicies to capture votes• e.g. spending on public services at the e.g. spending on public services at the

risk of higher inflation and future risk of higher inflation and future interest rates?interest rates?

Public GoodsPublic Goods

Public goods are services which are in Public goods are services which are in demand, but which must be provided by demand, but which must be provided by government:government:

-Non excludability: the goods cannot be -Non excludability: the goods cannot be confined to those who have paid for itconfined to those who have paid for it

-Non rivalry in consumption: the -Non rivalry in consumption: the consumption of one individual does not consumption of one individual does not reduce the availability of the goods to reduce the availability of the goods to othersothers

Public EnterprisePublic Enterprise

A goal oriented and revenue generating A goal oriented and revenue generating entity owned or controlled by the entity owned or controlled by the government. Its objective is to act as an government. Its objective is to act as an instrument of growth, development and instrument of growth, development and redistribution in society. It may be an redistribution in society. It may be an autonomous/semi-autonomous commercial autonomous/semi-autonomous commercial organisation in the public sectororganisation in the public sector

Public EnterprisePublic Enterprise

Specific Objectives:Specific Objectives: Productive Growth (contribute to GNP)Productive Growth (contribute to GNP) Generate public sector revenueGenerate public sector revenue Effective use of human and other Effective use of human and other resourcesresources Social EquitySocial Equity Policy ObjectivesPolicy Objectives Conservation of vital resourcesConservation of vital resources

Public Enterprise-CritiquePublic Enterprise-Critique

Organisational/Resource IssuesOrganisational/Resource IssuesManagement IssuesManagement IssuesTraining Training Lack of Strategic PlanningLack of Strategic PlanningPolitical InterferencePolitical Interference

Neo-liberalismNeo-liberalism

A response to government failure.A response to government failure.

It purports that underdevelopment It purports that underdevelopment results from poor resource allocation, results from poor resource allocation, incorrect pricing policies and too much incorrect pricing policies and too much state interventionstate intervention


Developing countries are Developing countries are underdeveloped, not because of underdeveloped, not because of predatory actions of TNCs and predatory actions of TNCs and international agencies, but due to international agencies, but due to the “heavy hand of the state”, the “heavy hand of the state”, corruption, inefficiency and lack of corruption, inefficiency and lack of economic incentiveseconomic incentives

NeoliberalismNeoliberalism

There is no need for international There is no need for international economic reform or increases in economic reform or increases in foreign aid.foreign aid.

It is the government interference It is the government interference and resulting distortions in product and resulting distortions in product and financial markets that reduce and financial markets that reduce efficiency.efficiency.


Government must allow the magic of Government must allow the magic of the marketplace and the invisible the marketplace and the invisible hand of market prices to guide hand of market prices to guide resource allocation and stimulate resource allocation and stimulate economic developmenteconomic development

(Adam Smith?)(Adam Smith?)


-Has 3 main components-Has 3 main components

Free Market Approach: Markets alone Free Market Approach: Markets alone are efficient, as they provide the best are efficient, as they provide the best signals for investment and signals for investment and productive activity. Competition is productive activity. Competition is effective, once information and effective, once information and technology are freely availabletechnology are freely available


Public Choice Theory:Government can Public Choice Theory:Government can do nothing right. Politicians and do nothing right. Politicians and bureaucrats are only concerned with bureaucrats are only concerned with self-interest (rent seeking behaviour)self-interest (rent seeking behaviour)

They use government resources to They use government resources to consolidate and maintain position of consolidate and maintain position of power and authoritypower and authority

Market Friendly approachMarket Friendly approach

Governments have a role to play by Governments have a role to play by facilitating the operations of the facilitating the operations of the market through non-selective market market through non-selective market friendly interventionsfriendly interventions

By investing in physical and social By investing in physical and social infrastructureinfrastructure


The International Monetary Fund The International Monetary Fund and World Bank are advocates of and World Bank are advocates of the neoliberal thinking, as the neoliberal thinking, as manifested through structural manifested through structural adjustment programmes.adjustment programmes.

Uwi Government And Business Relations2005summary

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