1.4.2 Government failure

What is government failure?

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

What are the causes of govt failure?

3 causes of govt. failure=

• distortion of price signals

• unintended consequences

• excessive administration costs

• information gaps

Why is the distortion of price signals a cause of govt failure?

Distortion of price signals is a cause of govt failure=

• Changes in 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 government might end up subsidising an industry which is failing.

• Maximum and minimum prices lead to excess demand/supply and make it difficult to allocate resources.

  • For example, a minimum price sends a signal to producers to supply more. In agricultural markets this has often resulted in an excess of perishable products which end up going to waste i.e. inefficient allocation of resources. In demerit markets, higher prices seem to be sending the message to increase supply (e.g. minimum price on alcohol). If producers do that, they will make greater losses. They often have to reduce supply

• 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.

Why is unintended consequences a cause of govt failure?

Unintended consequences is a cause of govt failure=

• 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.

• e.g 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.

• Producers and consumers aim to maximise their self interest. This often leads them to look for legal or illegal loop holes to bypass government intervention. This result creates unintended consequences such as the creation of illegal markets and/or illegal production/consumption

Why is excessive administration costs a cause of govt failure?

Excessive administration costs is a cause of govt failure=

• 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.

Why is information gaps a cause of govt failure?

Information gaps is a cost of govt failure=

• 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.