1. Economics of government failure

2. Key Elements Government Failure Political Process v. Market Process
Special Interests & Political Allocation
Political Incentives & Short- Sightedness
Key Elements

3. The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.
Thomas Sowell

4. Political v. Market Process
Government
Market
Majority rule
No incentive for voters to research deeply
Same outcome for everyone
No incentive to direct resources toward productive activities
Mutual agreement & voluntary exchange
Success or failure based on market research
Allows for individual choice
Profit/loss dictates directing resources in productive direction
Majority rule provides the basis for government action, while market activity is based on mutual agreement and voluntary exchange.
There is little incentive for voters to search for and acquire information about either issues or candidates because their choices will not be decisive. Economists refer to this as the rational ignorance effect. Thus, individuals will be better informed when making market choices than political choices.
The political process imposes the same option on everyone, while markets allow for diverse representation.
The political process does not have anything like profit and loss that can be counted on to direct resources toward productive, and away from counterproductive, activities.

6. Market Failure/Gov’t Failure
Just as markets can fail to allocate resources efficiently (market failure), there is government failure as well.
Government failure occurs when government intervention in the economy to correct a market failure creates inefficiency and leads to a misallocation of scarce resources.
Government can award subsidies to firms, but this may protect inefficient firms from competition and create barriers to entry for new firms because prices are kept ‘artificially’ low. Subsidies, and other assistance, can lead to the problem of moral hazard.
Taxes on goods and services can raise prices artificially and distort the efficient operation of the market. In addition, taxes on incomes can create a disincentive effect and discourage individuals from working hard.
Governments can also fix prices, such as minimum and maximum prices, but this can create distortions which lead to:
Shortages, which may arise when government fixes price below the market rate. Because public healthcare is provide free at the point of consumption there will be long waiting lists for treatment.
Surpluses, which may arise when government fixes prices above the natural market rate, as supply will exceed demand. For example, guaranteeing farmers a high price encourages over-production and wasteful surpluses. Setting a ‘minimum wage’ is likely to create an excess of supply of labour in markets where the ‘market clearing equilibrium’ is less than the minimum.
Examples:
Subsidies
Tariffs
Price Controls

7. Political process
Unless restrained by constitutional rules, special interest groups will use the democratic political process to obtain government favors at the expense of others.

8. Special Interests
Special interest groups are individuals or organizations that attempt to influence public policy in its favor.
All interest groups share a desire to affect government policy to benefit themselves or their causes.
Their goal could be a policy that exclusively benefits group members or one segment of society (e.g., government subsidies for farmers) or a policy that advances a broader public purpose (e.g., improving air quality).

9. Special Interest Impact
Special interest issues usually create benefits for a small organized minority while imposing a cost on everyone.
Often the voter, who will bear the cost of legislation, is uninformed about the issue because it does not directly affect them and because of the rational ignorance effect.

10. Rational Ignorance Effect
Ignorance is regarded as rational when the cost of information and "finding out" exceeds the benefits. This is especially true in situations where it would be a waste of time to learn about the particular issue. A classic example of this would be in general elections, where one vote really does not count much.
A consumer is very involved in how they spend their money. A voter is less involved in how their tax dollars are being spent.
When the cost of acquiring information is greater than the benefits to be derived from the information, it is rational to be ignorant.

11. Special Interest Effect
The political process encourages politicians to support the views of special interests, who support their campaigns.
Most voters will be uninformed and uninterested, as illustrated by the rational ignorance effect.
Tactics used to influence the process include logrolling and pork barrel legislation.

12. Special interest Effect
Logrolling: the exchange of support or favors by legislators for mutual political gain by voting for each other's bills.
Pork-barrel legislation: appropriations of government funds for projects that are not essential (but pump money into the districts of legislators).
"Florida, good luck with no more hurricanes," Rep. Frank LoBiondo (R-N.J.) shouted to any member who might oppose the bill. "California, congratulations, did you get rid of the Andreas Fault? The Mississippi's in a drought. Do you think you're not going to have a flood again? "Who are you going to come to when you have these things? We need this, we need it now. Do the right thing, as we have always done for you."

13. Example
The sugar program provides an example of the special interest effect.
Federal price supports and import quotas cause the price of sugar in the U.S to be 50 to 100 percent above the world level.
Approximately 20,000 sugar growers derive huge personal gains at the expense of millions of sugar consumers.
The sugar lobby contributed more than $16 million to legislators and candidates during the most recent election cycle.
The program continues even though Americans are worse off because their resources are wasted producing a good we are ill-suited to produce.

14. Nash Equilibrium
Method of predicting the outcome of a strategic interaction.
People are in Nash Equilibrium if each one is making the best decision possible, taking into account the decisions of others, as long as the other party’s decision remains unchanged.
Nash Equilibrium is named after its inventor, John Nash, an American mathematician. It is considered one of the most important concepts of Game Theory, which attempts to determine mathematically and logically the actions that participants of a game should take to secure the best outcomes for themselves.

15. Budget deficits & the National Debt
When government spending exceeds revenues, a deficit will occur
When the government runs a deficit, it is financed by borrowing, the issuing of Treasury bonds
The borrowing increases the national debt, the total outstanding bonds on which the government must pay interest
In contrast, a budget surplus (excess of revenue relative to spending) would reduce the government’s outstanding debt

16. Shortsightedness Effect
Occurs with issues that yield current, highly visible benefits at the expense of future costs that are difficult to identify.
The political process is biased toward the adoption of such proposals even when they are inefficient.
The shortsightedness effect explains why politicians will find debt financing and unfunded promises attractive—they make it possible for politicians to provide current benefits to voters without levying an equivalent amount of taxes (to pay for them).
Each member of Congress has a strong incentive to fight hard for expenditures beneficial to his or her constituents. But there is little or no incentive for a legislator to be a spending “watchdog.”
The shortsightedness effect also provides a strong incentive for politicians to support unfunded promises—programs promising benefits that are greater than revenues.

17. National debt and you
What will result if spending continues to outpace revenues?
There will be repercussions in credit markets (higher interest rates, others will be less willing to lend to the U.S. federal government, etc.)
The excessive debt could fuel another financial crisis in the future (consider what has recently happened in Greece)
There will be higher personal and business taxes in the future
The debt could lead to additional money creation and inflation in the future