Government failure

• What is government failure?

  • Government failure occurs when the government intervenes in a market to correct market failure, but the intervention results in a misallocation of resources from society's point of view
  • Government intervention has reduced overall economic welfare
  • By intervening in a market, a government often creates market distortions which contribute to or cause market failure
• How could a policy decision be ineffective?

  • A policy decision could be ineffective if it fails to create enough of an incentive to change behaviour
  • Government policy decisions could also worsen the original market failure or create a new market failure
• What are the causes of government failure?

  Inadequate information

  Conflicting objectives

  Administrative costs

  Market distortions

  Unintended consequences

  Regulatory capture
• How does regulatory capture cause government failure?

  • Regulatory capture occurs when firms influence the regulators to change their decisions/policies to align more with the interests of the firm
  • Firms spend millions lobbying regulators or politicians who can issue instructions to the regulatory
  • Some lobbying activity is corrupt, and there is a fine line between influencing activity and bribing
  • e.g In 2021 the former UK Prime Minister, David Cameron, was caught lobbying for a failed financial venture by a firm called Greensill Capital
• How do unintended consequences cause government failure?

  • Consequences that are unforeseen may occur
  • Producers and consumers aim to maximise their self interest
  • This often leads them to look for legal or illegal loop holes to bypass government intervention
  • This result creates unintended consequences such as the creation of illegal markets and/or illegal production/consumption

   e.g

  • Reduced consumption of alcohol due to minimum pricing, may lead to an increase in consumption of more harmful intoxicants as they become relatively cheaper 
• how do market distortions cause government failure?

  • Price intervention may distorts price signals
  • signalling function of the price mechanism is artificially altered
  • leads to an inefficient allocation of resources, surpluses and shortages
  • e.g minimum price signals producers to supply more
  • In agricultural markets this results in excess of perishable products which are wasted 

  maximum price signals producers to supply less. In pharmaceutical markets, it leads to excess demand
• How do administrative costs cause government failure?

  • Regulation or administration costs can be expensive
  • The costs of intervention can sometimes be greater than the savings in social welfare, leading to a worsening of allocation of resources
  • e.g
  • The cost of recruiting and paying staff to ensure firms are adhering to regulation may exceed the size of the external cost from the market failure 
• How do conflicting objectives cause government failure?

  • The implementation of one policy can come at the expense of achieving another. The government has to make a trade-off that it believes will maximise social welfare. Governments often face a trade-off between achieving long term and short term policy objectives
  • e.g
  • E.g In the UK there is much debate about the issuing of new offshore gas drilling licences. They will generate economic growth but lead to environmental degradation
• How does inadequate information cause government failure?

  • Governments and regulators do not have perfect information or they often do not understand the market they are trying to regulateGovernment decision making is subject to the same information gaps and cognitive biases (e.g. anchoring) that consumers face
  • e.g
  • Many financial markets are fast moving and incredibly complex
  • Government regulators find it difficult to keep pace with the change of products