Government Failure
Economics: Edexcel A A Level, topic 2.2.6
Causes of Government Failure
Government failure is the unintended worsening allocation of resources as a consequence of a policy the government has implemented to correct a market failure. It produces a net welfare loss.
Misallocation of resources
- Government failure is the result of a policy trying to correct a market failure that has led to a misallocation of resources.
- This means there is a welfare loss to society.
- E.g the council might charge people for some forms of waste disposal.
- This may increase fly-tipping, which is a worsening of the initial pollution externality.
Inadequate or imperfect information
- In a world of perfect information, governments should be able to make the right decisions to improve allocation.
- Asymmetric information limits the governments ability to critically assess market failures and possible solutions.
- So the right decision isn't always made and government failure can arise.
Administrative costs
- Resources are needed to implement government intervention.
- If the cost is too high, the intervention may not be worthwhile.
- Daniel Kahneman's inside view explains why governments may frequently underestimate the cost of their projects. The Scottish parliament in Holyrood was forecast to cost £10-40M but cost £414M.
Bureaucracy
- The private sector has the incentive to maximise profits, but individuals working for governments rarely get the benefits.
- Governments are also very large and may suffer from managerial diseconomies of scale.
Consequences of Government Failure
Government failure can lead to the following issues:
Conflicting Policy Objectives
- In trying to satisfy one objective, others can be compromised.
- E.g macroeconomic policy objectives often clash with environmental policy.
- By causing firms to cut down on emissions, you may be limiting their potential growth, which is bad for the economy.
- Politicians may be influenced by what's politically acceptable or unacceptable.
- E.g governments won't ban car use to try to cut down on greenhouse gas emissions because people rely on cars for convenience.
Market distortions
- Market distortions can affect the way the price mechanism works. These can be caused by government intervention. For example:
- Income taxes give people less incentive to work hard, which reduces efficiency.
- Subsidies may allow firms to make profit without being efficient. This is distortionary.
- Minimum and maximum price controls can distort price signals (e.g overproduction because producers can guarantee a minimum price).
Test yourself on Government Failure
What is the term for the inefficiency caused by state officials making decisions when they don't have a profit incentive?
How much were the costs of the Scottish Parliament building, despite predictions of £10-40 million?
Which of the following are market distortions?