1.4.2 Government failure

GOVERNMENT FAILURE

• when gov intervention in the market leads to net welfare loss and a misallocation of resources

• the total social costs from the intervention are greater than the social benefit

GOVERNMENT FAILURE- CAUSES

• distortion of price signals

• unintended consequences

• excessive administration costs

• information gaps

DISTORTION OF PRICE SIGNALS

• some types of gov 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 higher prices (taxes)

• e.g. subsidies keep farmers in employment when they cannot produce cheaply enough to be competitive- the result is that the gov keeps them in business when they should close down and find an alternative use for their resources

• Max and min prices lead to excess demand/supply and make it difficult to allocate resources

• price mechanism aims to allocate resources to their best use- by intervening, the gov distort the mechanism and so resources may be allocated inefficiently

UNINTENDED CONSEQUENCES

• some interventions cause effects which the gov 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

• e.g. is the introduction of the buffer stock scheme CAP (Common Agricultural Policy) in the EU- 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

• targets for treating patients on the NHS has led to a reduction in quality of care- not what the gov intended when they introduced the targets

EXCESSIVE ADMINISTRATION COSTS

• In many cases, a lot of money that is allocated by the gov is actually used up on basic administration costs- 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 administration rather than putting the money into medical care

INFORMATION GAPS

• any decisions that the gov makes must be based on some data but the info they have is always going to be limited-e.g. you cannot accurately predict the no. of cancer patients or the no. of cars on the road

• Cost and benefit forecasts of investment are often wrong and so the gov invests in a system where the costs are higher than the benefits, so there is welfare loss- impractical, and usually impossible, for the gov to get every piece of info they need