1.4.2 Government failure

Question 1

Government failure

Answer 1

Government failure is when government intervention in the market leads to net welfare loss and a misallocation of resources. The total social costs arising from the intervention are greater than the social benefit. There are a number of causes of government failure:
Distortion of price signals
Unintended consequences
Excessive administration costs
Information gaps

Question 2

Distortion of price signals (govt failure)

Answer 2

• Some types of government intervention change price signals in the market and distort the free market mechanism. As a result, they keep some companies in business when they are inefficient so the resources should be switched to somewhere else (subsidies) or make consumers pay too much for a good (taxes).
• For example, subsidies keep farmers in employment when they cannot produce cheaply enough to be competitive. The result is that the government keeps them in business when they should close down and find an alternative use for their resources.
• Maximum and minimum prices lead to excess demand/supply and make it difficult to allocate resources.
• The price mechanism aims to allocate resources to their best use and where consumers want and value them most highly. By intervening, the government distorts the mechanism and so resources may be allocated inefficiently.

Question 3

Unintended consequence (govt failure)

Answer 3

• Some interventions cause effects which the government did not intend to happen.
Consumers and producers may react to new policies in unexpected ways and so the policy doesn’t have the effect it should.
• One example is the introduction of the buffer stock scheme CAP (Common Agricultural Policy) in the EU. This was meant to smooth out the price fluctuations but it ended up leading to overproduction in the EU and a fall in agricultural prices in other parts of the world as EU surpluses were disposed of at cheap prices outside of Europe; this was not the intention of the scheme.
• On top of this, targets for treating patients on the NHS has led to a reduction in the quality of care. This is not what the government intended when they introduced the targets.

Question 4

Excessive administrative costs (govt failure)

Answer 4

• In many cases, a lot of money that is allocated by the government is actually used up on basic administration costs. The social costs may be higher than social benefits, once administration costs are taken into account.
• A lot of money given to the NHS etc. is actually spent on organisational adminstration rather than putting the money into medical care.
• Excessive administration on the Apprenticeship Levy, which aims to increase the quality and quantity of apprenticeships, has meant that little money is spent by firms.

Question 5

Information gaps (govt failure)

Answer 5

• Any decisions that the government makes must be based on some data but the information they have is always going to be limited, for example you cannot accurately predict the number of cancer patients or the number of cars on the road.
• Cost and benefit forecasts of investment are often wrong and so the government invests in a system where the costs are higher than the benefits, so there is welfare loss. It is impractical, and usually impossible, for the government to get every piece of information they need.