1.4 Gov failure Flashcards
Gov intervention
State gets involved in markets and takes action to correct market failure and improve economic efficiency and change income and wealth distribution.
They use regulations, taxes, subsidies, max and min prices to change price signals, better info or provision of info to change resource allocation.
Fiscal policy intervention
Indirect taxes on de-merit goods and negative externalities goods, increasing opportunity cost of consumption, reducing demand to social optimum level.
Subsidy for consumers to lower price of merit goods. Boosts consumption of positive externality products.
Tax reliefs for R+D, reduced corporation tax to promote new capital investment and extra employment.
Changes to taxation and welfare payments, influencing income and wealth distribution
Evaluating gov intervention
Value judgement
Changing prices to change incentives and behaviour through price mechanism
Law of unintended consequences
Combination of policies is needed
Market force powers (invisible hand) can be powerful in finding profitable solutions to problem.
Evaluating subsidies
Are they effective in meeting their aims; other behavioural nudges may be needed
Will it affect productivity or efficiency? May become dependent on state aid/financial assistance, less innovation over time
Cost of subsidy; will it generate more tax revenue? Extra burden for taxpayers who have not benefitted?
Unintended consequences
Regulation
Can spur business innovation (cutting carbon emissions by banning petrol and diesel vehicles from 2030 in UK)
Regulations are more effective if demand is inelastic.
Regulations are gradually toughened each year - it can stimulate capital investment.
High cost of enforcement/admin of laws.
Unintended consequences
Cost of meeting regulations can discourage small businesses - leads to less competition.
Gov failure
Gov intervention in a market leads to a less efficient allocation of resources and makes a situation worse. Net social welfare loss.
When costs of gov intervention to correct market failure exceeds the benefits.
Can happen if policy decision fails to create enough of an incentive to change people’s behaviour.
Ineffective, inequitable, misplaced.
Causes of gov failure
Political self interest: lobbying
Poor value for money: high waste
Short-term policies: quick fix for political purposes
Regulatory capture: operates in favour of producers not consumers (often when suppliers have significant lobbying power)
Conflicting objectives: minimum carbon price could damage UK international comp and jobs
Bureaucracy and red tape: costs of enforcement may hurt enterprise
Unintended consequences
Evaluating indirect taxes
For:
External costs are cause of market failure
Info failures: people under estimate long term costs of consumption of demerit goods
Tax raises revenue, used for merit activities
Encourages innovation for alternatives
Against:
Monetary value of negative externality hard to measure so setting right tax rate is hard.
Cost of collection of tax
Inelastic demand: little effect on demand
Redistribution effects: regressive indirect taxes can affect low income households most
Increased costs: Inflation, reduced international competitiveness if taxes are higher in one country than another
Pollution permits
Pollution permits involve giving firms a legal right to pollute a certain amount e.g. 100 units of Carbon Dioxide per year.
If the firm produces less pollution it can sell its pollution permits to other firms.
However, if it produces more pollution it has to buy permits from other firms or the government.
This creates a market for pollution permits with the price set by demand and supply.
The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce the external costs associated with it. For example, it is argued carbon dioxide emissions contribute towards global warming.
Pollution permits can also be a way for the government to raise revenue, by selling firms these permits to allow pollution.
Problems with pollution permits
It is difficult to know how many permits to give out. The government may be too generous or too tight.
It can be difficult to measure pollution levels. There is potential for hiding pollution levels or shifting production to other countries, with looser environmental standards. In a globalised world, multinationals increasingly shift production around.
There are administration costs of implementing the scheme and measuring pollution levels.
For global pollution permits, countries who pollute more than their quotas can simply buy permits from other countries. Therefore rich developed countries can simply buy permits from less developed countries. This does not significantly reduce pollution but shifts it from the richer countries to poorer countries.
The biggest carbon trading scheme is the EU Emissions Trading Scheme (ETS), however political interference has created a glut of permits and it has done little to reduce carbon dioxide and reverse global warming.
Environmentalists have argued a higher price of carbon is insufficient to reduce carbon dioxide to levels necessary to stop global warming. Demand for carbon permits is often price inelastic and too slow to act.
Some carbon trading schemes have a component called ‘carbon offsetting. This means if pay to plant trees, this can count against carbon emissions. However, critics argue carbon offsetting effectively enables firms to keep polluting with no guarantee planting trees will on their own solve the pollution problem.
