1.4.8 Government failure Flashcards
Government failure
Where government intervention can lead to resources being misallocated and a net welfare loss.
- Government failure is often an unintended consequence of an intervention to correct a market failure.
Examples of government failure
- Income taxes can act as a disincentive to working hard – if you increase your earnings by working hard then you’ll have to pay more income tax.
- Governmental price controls (such as maximum or minimum prices) can lead to the distortions of price signals. For example, producers will overproduce a product if they’ll receive a guaranteed minimum price for it and flood the market with surplus goods. Without the minimum price, the price signals given by the by the price mechanism would stop large surpluses from occurring.
- Subsidies may encourage firms to be inefficient as they remove the incentive to be efficient.
Administrative costs as a cause of government failure
Government measures to correct market failure such as policies and regulations can use a large amount of resources, which can result in high costs. For example, the maintenance costs of a scheme to offer farmers a minimum price for a product can be substantial.
Some government interventions require policing, which can also be expensive. For example, pollution permit schemes the emissions of the firms included in the scheme must be monitored to check they aren’t exceeding their allowances.
Lobbying as a cause of government failure
Large companies can lobby the government (or regulatory bodies) and influence them towards favourable policies for them – and not consumers.
Time as a cause of government failure
It can take time for governments to work out where there is market failure, and then theorise and implement a policy to correct it – meanwhile the problem may have changed.
External shocks as a cause of government failure
Government policies can be affected by issues outside of its control. For example, covid.
Inadequate information as a cause of government failure
Imperfect or asymmetric information can make it difficult for governments to assess the extent of market failure, and that makes it hard to put a value on the government intervention that is needed to correct the failure.
Governments may not know how the population want resources to be allocated. Some economists would argue that the price mechanism is a better way of allocating resources than government intervention.
Governments don’t always know how consumers will react. For example, campaigns to discourage under-18s drinking alcohol may lead to alcohol being viewed as desirable and increasing drinking by this age group.
Conflicting policy objectives as a cause of government failure
A government’s efforts to achieve a certain policy objective may have a negative impact on another.
- For example, if a government introduces stricter emission controls for industry this would contribute towards its environmental objectives. However, this could increase costs for firms and reduce their output – causing unemployment and a fall in economy growth.
Politicians are constrained with what is politically acceptable. For example, its unlikely that the UK government would ban the use of private cars to reduce greenhouse houses because of the idea’s political unpopularity.
Governments often favour short-term solutions because they’re under pressure to solve issues quickly. For example, increasing the capacity of the UK road network will help with short-term congestion, but may increase road usage (and congestion) in the long term.
Government buraucracy and ‘red tape’ as a cause of government failure
Governments have many rules and regulations – often referred to as ‘red tape’. These exist to prevent market failure.
The enforcement of these rules and regulations by government officials is known as bureaucracy. Excessive bureaucracy (too many regulations, slowing down a process unreasonably) is seen as a form of government failure.
Red tape can interfere with the forces of supply and demand – it can prevent markets from working efficiently. For example, planning controls can create long delays in construction projects. If these delays affect housing developments, this could restrict supply for the housing market.
In general, lots of red tape could mean that there are time lags so governments can’t respond quickly to the needs of producers and/or consumers. This might result in a country having a competitive disadvantage to countries that are able to respond more quickly.
Bureaucracy can lead to a lack of investment and prevent an economy from operating at full capacity.
Friedrich Hayek
Friedrich Hayek believed that government failure derives from their inability to have all of the necessary information – how can a government intervene if they do not understand the full scale or complexity of the issues? Not knowing the socially optimum level (Q * ) is a classic example of this.
It can be seen in the context of potholes - roads are provided by the government (state provision) but the failure to know about and fix pot-holes (information failure) is government failure too.
Government failure includes anything where the government intervenes and makes the situation worse or creates different problems (unintended consequences).
Example of government failure: Fishing quotas
Fishing quotas were introduced by the EU in an attempt to make fish stocks remain stable in European waters. They aim to prevent overfishing – which has severe negative impacts on fish populations – by setting limits on the amount of fish that can be caught.
Quotas have been somewhat successful, with the stocks of some species increasing to sustainable levels.
However, there are some issues with the quota system:
- Stocks of some species are depleting even with quotas in place. This could indicate that quotas have been set too high and overfishing is still taking place.
- Some fishing boats that exceed their quotas throw dead fish back into the sea (known as discards). As well as depleting fish stocks, these discards are wasteful.
- There has been moor monitoring of fish catches, so overfishing may not always have been detected.
One reform proposed is landing obligation – which means that everything fishermen catch must be kept on board and be counted against their quotas (they are not allowed to discard and fish). However, this is very difficult to police – it would be a huge task to check that every fishing boat hasn’t discarded any fish at sea.
Example of government failure: Use of subsidies with public transport
Bus and train journeys may be subsidised to reduce car usage and pollution levels.
Subsidies don’t always lead to increases in passenger numbers – bus transport is an inferior good so demand may not increase even if it becomes cheaper.
The allocation of resources to public transport services that don’t increase their usage and don’t cause a reduction in pollution can be seen as a misallocation of resources, leading to a net welfare loss. Underused public transport services may actually contribute to higher overall emissions as people aren’t using their cars less.
Example of government failure: Increased uni tuition fees
In 2011 the Coalition Government increased the maximum level of tuition fees from £3,000 to £9,250. This was intended to reduce government expenditure on university tuition.
Government failure occurred here because the tuition fee rise deters people from going to university – despite education having positive externalities and benefits for the government and economy.
Example of government failure: National Minimum Wage
The National Minimum Wage was introduced by Tony Blair’s Labour Government.
This worked to create a minimum wage for all employees, regardless of job role – increasing costs for businesses.
However, firms worked to cut costs in other ways, by reducing overtime and paid breaks – potentially leaving some employees worse off or even unemployed if their employer cannot afford to pay the minimum wage.
Example of government failure: Road Congestion Schemes
Road congestion schemes are a method of reducing the external costs linked to road congestion and the (air and noise) pollution that it creates.
The schemes work by charting users to travel on roads in areas where congestion is a problem. For example, the Congestion Zone in London.
The charge needs to be set at a level that will result in the socially optimal level of traffic. However, working out this socially optimum level can be difficult.
- If the price is set too low, then it will have limited impacts of traffic levels.
- If the price is set too high, then too few cars will use the area covered by the charge. This will result in reduced trade for businesses within the congestion charge area, and under-utilisation of the road space in the congestion charge area, and may also cause congestion in other areas.
Road congestion may unfairly impact poorer motorists in an area, and encourage them to seek alternative transport methods.
