Copyright 2006 – Biz/ed Government Failure

Copyright 2006 – Biz/ed Government Failure Government failure refers to situations where efficiency may have been reduced following government intervention in markets designed to correct market failure.

Copyright 2006 – Biz/ed Government Failure How does Government Failure manifest itself? –Distortion of markets – e.g. rent control, minimum wage, agricultural subsidies, taxes on fuel –Welfare impact – erosion of consumer surplus and producer surplus – e.g. EU tariff support for manufactured goods and food

Copyright 2006 – Biz/ed Government Failure Electoral Pressure –Desire to get elected and pass ‘popular’ policies to capture votes –e.g. spending on public services at the risk of higher inflation and future interest rates?

Copyright 2006 – Biz/ed Government Failure Public Choice Theory: –Politicians, bureaucrats and others acting on behalf of the ‘public’ may act in their own self interest as ‘utility maximisers’. –‘Rent seeking’ or ‘Log rolling’ - two important concepts. Subsidies may be designed to correct a perceived market failure but they do not always please everyone – public choice? Title: Czech farmer protest EU accession. Copyright: Getty Images, available from Education Image Gallery

Copyright 2006 – Biz/ed Government Failure ‘Rent seeking’ or ‘Log rolling’: –Politics involves a series of trade-offs in public policy making –Traditional theory would suggest that decisions will be made that give the greatest utility to the maximum number of people –Rent seeking – where decisions are made leading to resource allocation that maximises the benefit to the decision maker at the expense of another party or parties. –Log rolling – where decisions may be made on resource allocation to projects that have less importance in return for the support of the interested party in other decision making areas. –Results from lobbying – often powerful sectors of the economy. Chosen good may not be in interests of all but only to a minority who have a powerful influence over decision makers

Copyright 2006 – Biz/ed Government Failure Regulatory Capture –Regulatory agencies become dominated by the firms they are supposed to be regulating! The railways – who controls who? Copyright: Bo de Visser,

Copyright 2006 – Biz/ed Government Failure Disincentive Effects – –High taxes hampering business expansion or enterprise –Welfare benefits reducing the incentive to find work –Income taxes – distort incentives to work –May encourage ‘underground markets’ – smuggling, forgeries, etc. Short Termism – solving the ‘hot topics’ of the day rather than the long term important issues – e.g. ID cards versus pension crisis?

Copyright 2006 – Biz/ed Government Failure Imperfect information: Lack of knowledge of: –Prices –Value –Costs –Benefits –Long term effects –Behavioural changes –External costs and benefits –Value of producer and consumer surplus – all mean less than efficient allocation may result from government intervention. What value can be placed on the destruction of a natural environment through development? How do we value aesthetic beauty? Source: Lynne Lancaster,

Copyright 2006 – Biz/ed Government Failure Inadequate Information: –Knowing the consequences of the policy (e.g. building new motorways) –Knowing the effect on other markets (e.g. steel tariffs in USA) –Lack of knowledge on costs and benefits – private costs – possibly yes; social costs??? –Lack of knowledge about what the public actually wants – do we want a ban on smoking in public places??

Copyright 2006 – Biz/ed Government Failure Administrative Cost: –High levels of bureaucracy –e.g. cost of administering CAP and farm support scheme is huge! Conflicting Objectives: –e.g. reducing smoking and beneficial effects on health and welfare against rights of people to do as they please and tax revenue –Governments do not always know what is best for us – e.g. are the policies on illegal drugs/prostitution/pornography, etc. the right ones??