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Government Failure
Copyright 2006 – Biz/ed
http://www.bized.ac.uk
Government Failure
• Government failure refers to
situations where efficiency may
have been reduced following
government intervention in
markets designed to correct
market failure.
Copyright 2006 – Biz/ed
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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
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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?
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Government Failure
• Public Choice
Theory:
Subsidies may be designed to correct a perceived
market failure but they do not always please
everyone – public choice?
– Politicians, bureaucrats
and others acting on
behalf of the ‘public’
may act in their own
self interest as ‘utility
maximisers’.
– ‘Rent seeking’ or ‘Log
rolling’ - two important
concepts.
Title: Czech farmer protest EU accession. Copyright: Getty Images,
available from Education Image Gallery
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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.
– Results from lobbying – often powerful sectors of the
economy. Chosen good may not be in interests of all but only
to a minority who have a powerful influence over decision
makers
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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
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Government Failure
• Disincentive Effects –
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High taxes hampering business expansion or enterprise
Welfare benefits reducing the incentive to find work
Income taxes – distort incentives to work
May encourage ‘underground markets’ – smuggling,
forgeries, etc.
•Short Termism
– solving the ‘hot topics’ of the day rather than the long
issues – e.g. ID cards versus pension
term important
crisis?
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Government Failure
• Imperfect information:
• Lack of knowledge of:
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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
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Government Failure
• Inadequate Information:
– Knowing the consequences of the policy
(e.g. building new motorways)
– Knowing the effect on other markets (e.g.
steel tariffs in USA)
– Lack of knowledge on costs and benefits –
private costs – possibly yes; social costs???
– Lack of knowledge about what the public
actually wants – do we want a ban on
smoking in public places??
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Government Failure
• Administrative Cost:
– High levels of bureaucracy
– e.g. cost of administering CAP and farm support
scheme is huge!
• Conflicting Objectives:
– e.g. reducing smoking and beneficial effects on
health and welfare against rights of people to do as
they please and tax revenue
– Governments do not always know what is best for us
– e.g. are the policies on illegal
drugs/prostitution/pornography, etc. the right ones??
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