Theme 5 - Government failure

Describe benefits and costs in deciding whether to intervene in a market 

• Aims to maximise society’s welfare, only intervenes if the benefit of the intervention from society’s perspective outweighs the cost of the intervention

Benefits

Costs

Gain in welfare for society (reduction in welfare loss)  More significant the market failure or inequity, greater the benefit of intervention

Administrative costs from implementation Monitoring costs (For regulation) Production costs (For direct provision  when supplementing output of the private sector) Implementation costs (For production subsidy) Costs of gathering information on the benefits (Eg. How big the welfare loss when left to the free-market mechanism is and extent of the gain in welfare of society by intervening)  Opportunity cost

Describe benefits and costs in deciding between measures

• Choose measure that yields the most benefits and least costs 

Benefits

Costs

Effectiveness of measure: How well it leads to the attainment of its intended outcome ITPW Depends on:  Information available to government  Adequate information needed for tax and subsidy  PED  Market-oriented policies more effective when price is elastic Inelastic good needs higher tax and subsidy amount    Whether monitoring is required  For command measures, need adequate monitoring and consistent enforcement of law  Time lag   Eg. One way to enable the structurally unemployed to get a job is to incentivises to upgrade skills by heavily subsidized training courses But unemployment benefits would be quicker in helping the unemployed maintain a decent standard of living

Appropriateness of measures: extent of costs  Financial cost Political cost  Some policies unfavourable with people  Trade-off  A measure to improve AE in one market could worsen it in another market / worsen equity

Describe benefits and cost in deciding whether to pursue a project

• Government will pursue project if social benefits of the project outweigh the social costs of the project -> gain in net TSB

• The government would estimate the monetary and non-monetary external costs and into the calculation of TSC 

• To address these concerns, the government might internalise these external costs (Eg. compensate residents for relocation) -> add to the private monetary costs incurred by the government

• A rational government would: 

1. Rank net TSB from various projects 

2. Do those with greatest TSB, subject to budget constraints 

Describe constraints

• Key constraint is limited financial resources 

• Governments that have budget deficits could finance the deficit via borrowed funds -> persistent and large budget deficits would eventually reduce creditors’ confidence in the government’s ability to pay back the loans with interest and so might stop lending -> harms the government’s ability to promote growth 

NOTE: This does NOT include cost incurred by government or views of different stakeholders

Describe imperfect info

Gather accurate quantitative and qualitative information on costs and benefits of every available choice

Describe unintended consequences

• If the government tries to mitigate the adverse unintended consequence, then this increases the overall cost of intervening in that market

• Eg. Banning the use of PMDs on footpaths, the cost of the intervention includes monitoring costs and costs incurred in compensating PMD owners to enable them to afford an alternative means of transport that they need in order to earn a living

Define government failure

(Def.): Occurs when government intervention fails to improve market outcomes, and actually makes them worse, causing a more inefficient allocation of resources and/or a more inequitable distribution of goods or services as compared to a situation where the government does not intervene at all

State causes of GF

Conflicting goals between equity and efficiency

Imperfect information leading to over-correction

Unintended consequences

Time lag

Lack of profit motive

Policy myopia

Describe

Conflicting goals between equity and efficiency

Imperfect information leading to over-correction

Conflicting goals between equity and efficiency	Eg. School canteen vendors are required to include fruits as a side dish to encourage healthy eating due to underconsumption  Causes higher costs for canteen vendors and consumers -> inequity
Imperfect information leading to over-correction	Difficult to price value of negative externality (Eg. Health problems caused by pollution) -> overtax

Describe lack of profit motive

Lack of profit motive

Market forces incentivises producers to innovate, compete and use the least-cost method of production  Government may address market power through nationalisation (situation where the ownership and control of a firm is transferred from private hands to the state)   Government employees not profit-motivated -> productive inefficiency

Describe policy myopia

Policy myopia

Politicians have an in-built tendency to look for short term solutions or “quick fixes” to solve difficult economic problems to gain political favours  Since an elected government’s tenure period is only around five years, and governments would want to use measures that show results within this time frame rather than taking a long-term perspective in solving the problems

Describe time lag

1. Lags in data and recognition

• It takes time for authorities to recognise a problem in the economy

• Economic statistics such as prices are only available with a considerable lag

• Many economic indicators (Eg. unemployment rate) tend to be backward-looking (tell yous what has already happened instead of what is happening right now) 

• The government may not have information until months after, during which the economy may have already changed course

2. Lags in implementation 

• Due to bureaucracy and red tape in large government organisations, long periods of time may be needed for policies to pass through the parliament process to be approved

3. Lags in impact 

• Policies need time to be implemented and to take effect