Government Failure (2)€¦ · Government Failure Lesson Objective In this lesson we will: • Learn how government intervention can lead to greater market failure Learning Outcomes

Link all of these words in one or two sentences:

• Externalities• Scarcity• Consumption• Socially optimal• Government

Government Failure

Government FailureLesson ObjectiveIn this lesson we will:

• Learn how government intervention can lead to greater market failure

Learning OutcomesBy the end of the lesson you should be able to:

• define accurately government failure, and a range of other related concepts

• Discuss what causes government failure

• explain why it can be difficult for governments to intervene successfully

Why might a government intervene in a

market?

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

How could a government intervene?

How can governments intervene in markets?

• Price intervention – minimum/maximum pricing or buffer stocks

• Financial Intervention – Taxation – to redistribute and provide incentive or disincentive effects

– Subsidies – to encourage production/consumption

• Legislation and Regulation – guides, codes of practice, legislation, independent regulators

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

• Correction of information failure – public information campaigns and policies

Government Failure

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

• In English…the government’s intervention has made the market failure even worse!

Causes of Government Failure

• Political self‐interest

• Policy myopia

• Regulatory capture

• Disincentive effects

• Imperfect information

• Law of unintended consequences

• Cost of administration and enforcement

• Conflicting objectives







Government FailurePublic 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.

Decisions taken ‘in the public interest’ may not always please everyone.

Regulatory Capture• ‘Rent seeking’ or ‘Log rolling’:

– 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 in favour of projects that have less importance in order to gain support for other, more important decisions (a ‘trade‐off’)

Regulatory Capture

• Should taxes be raised on chocolate?

• If so, what will the reaction of the chocolate industry be?

• Do they have sufficient power to influence decision making?


• Disincentive Effects– High taxes hampering business expansion or enterprise– Welfare benefits reducing the incentive to find work

• Short Termism (policy myopia)– Solving the ‘hot topics’ of the day rather than the long term important issues – e.g. EU membership versus Middle East crisis?


• Electoral Pressure (political self interest)

– 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?

Law of Unintended Consequences

• When the actions of consumers, producers and governments have effects that are unanticipated.

• Examples: McDonald’s Happy Meal• Seatbelt Paradox

Law of Unintended Consequences

• Should motorway speed limits be raised to 80mph?

• What unintended consequences might result?

• How might this policy result in government failure?

• BBC News Clip

http://www.tutor2u.net/blog/index.php/economics/comments/the-cure-for-economic-slowdown-drive-faster#extended


• Further– e.g. building new motorways rather than investing in public transport?

Is the real answer to road congestion building more motorways?

Government FailureImperfect 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?







Government Failure (2)€¦ · Government Failure Lesson Objective In this lesson we will: • Learn how government intervention can lead to greater market failure Learning Outcomes

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