Government FailureAS Microeconomics

Intervention in the market-place

Government intervention• Markets fail – government intervenes?• Yes – but there is always the risk of

government and or regulatory failure!

What is government failure?

• Government failure occurs when a policy intervention leads to a deepening of the market failure or even worse a new failure may arise

• In other words – intervention creates further inefficiencies and a loss of welfare

• (1) Policies may have damaging long term consequences for the economy or society

• (2) Policies may be ineffective in meeting aims• (3) Policies may create more losers than winners

Root causes of government failure

1. Decisions made in political self interest2. Low value for money from public sector investment3. Policy myopia – short-termism4. Regulatory capture arising from lobbying5. Disincentives arising from specific policies6. Information failures in government policies7. The “law of unintended consequences”8. The costs of regulation may outweigh the benefits

Self interest

• Government may be influenced by lobbying from interest groups

• Examples?– Farm support policies– Reaction to swine flu risks– Government failures to

reform the banking system– Transport investment (power

of the road / air lobby)– Caps on inward migration

Value for money issues

• What is the social benefit of public sector spending?• Is the government getting value for money?• Good grounds for thinking that public goods can be

provided efficiently – e.g. Economies of scale• But there are risks1. Over-staffing in public sector industries2. Relatively low productivity compared to market sector3. Excessive costs of bureaucracy• Note though – waste is not the preserve of

government – there are plenty of examples of private sector waste

Value for money is a key issue

Value for money is a crucial issue when discussing government spending - many projects utilise economies of

scale but there may be inefficiencies too

More value for money issues

The costs of public sector investment projects often over-runAnd many interventions do not meet set targets

Policy myopia and quick-fixes

• Politicians have a tendency to look for short term solutions or “quick fixes” to problems

• They favour short term initiatives rather than fully thought-through policies for the long term

• Examples?– Road widening to cut traffic congestion– ASBOs for young offenders– Offering surgery on the NHS to combat obesity– Zero-tolerance and visible anti-crime measures like CCTV

Legislative diarrhoea?

Government is less responsive than market signalsToo much legislation creates extra costs and uncertainty

Regulatory capture

• This is when the industries under the control of a government agency appear to operate in favour of the vested interest of producers rather can consumers

• Examples:– Allowing self-regulation on

alcohol prices– Over-supply of C02 emissions

permits to industries as part of the EU emissions trading scheme

Does red tape strangle efficiency & enterprise?

Disincentives

• Where policy interventions lead to a loss of incentives either for consumers or producers

• Free market economists argue that attempts to redistribute income and & wealth can damage work incentives

• Examples:– Higher rates of income tax?– The poverty trap facing low income families

Government failure can happen if a policy decision fails to create enough of an incentive to change behaviour

Information failures

• Has there been government policy failure over swine flu?

• In the emergency last summer the government contracted to buy 120 million jabs from the two manufacturers, GlaxoSmith Kline and Baxter, but then reduced the order to just 44 million as the emergency petered out. Only 6million of those have actually been used, nearly 4 million are being given to the World Health Organisation for use in Africa, leaving 34 million on the shelf.

Law of unintended consequences

• Policy interventions have effects that are unanticipated or unintended. Particularly when people do not act in the way that the economics textbooks would predict

• Remember – economics is a social science!• Well-intentioned legislation often act against the

interests of those it is intended to serve

This law is crucial to understanding government failure – not all of the unintended consequences are negative!

Negative unintended consequences

• Higher capital gains tax – reduces new house building - worsens housing shortages /affordability

• Bank bail-outs – raises the problem of moral hazard• Bio-fuel subsidy – causes food price inflation and hits the

poorest in society• Smoking ban – increases demand for and use of energy

inefficient patio-heaters• Windfall tax on North Sea oil and gas companies led to a huge

fall in investment and exploration – just years before oil prices surged

• Tariffs on steel – hits domestic car and construction firms• Targets for treating patients – leads to reduction in the quality

of care e.g. Staffordshire General scandal

Unintended consequences

Providing health care

• “20% of visits to GPs are for coughs and common colds. This costs the NHS £2bn a year, without making any difference to people’s health. The NHS has become a victim of demand-led culture…. £10 per visit should be enough to deter people with sniffles.”

Incentives?

“In Dundee, smokers are being offered £12.50 a week by the NHS if carbon monoxide testing shows they have quit. In Essex, pregnant women can claim a £20 food voucher from the NHS after stopping smoking for one week, £40 after four weeks and another £40 at the end of a year if they have still quit. Brighton offers children £15 for quitting smoking for 28 days, while overweight patients in Kent are also being offered incentives for losing weight.”

A bright idea?

• In 2008 the Government ordered the big energy companies to invest in measures for improving energy efficiency and cutting fuel poverty.

• The result is that 12 million low-energy light bulbs were posted to households over Christmas by an energy company as part of its legal obligation to cut carbon emissions, despite government advice that many would never be used. Over 180 million light bulbs have been issued most are gathering dust in our drawers.

Market forces?

• Many questions refer to the ongoing debate about free market forces versus government intervention

• Markets are hugely powerful:– As drivers of innovation– In finding solutions to long term problems

• The price mechanism performs several key functions– Rationing– Allocation– Signalling

• Smart interventions can enhance the market, poorly-judged interventions can make things much worse

Tutor2u

Keep up-to-date with economics, resources, quizzes and

worksheets for your economics course.