Government Failure

Question 1

What is Government Failure?

Answer 1

Government intervention worsens the allocation of scarce resources

• It results in a greater net welfare loss

• The cost of the intervention outweighs the benefits gained

• The policy fails to generate a change in behaviour by economic agents and so the policy fails to achieve its aims

Question 2

Causes of Government Failure?

Answer 2

• Political self-interest

• Poor value for money

• Policy short-termism

• Regulatory capture

• Conflicting objectives

• Bureaucracy and red tape

Question 3

What is an Unintended Consequence?

Answer 3

Outcomes that were not foreseen and intended by the government action

• There may be at least one and often many unintended consequences – some may be good, but it is the bad ones that are a cause for concern

• It is impossible for the government to predict outcomes accurately for
the economy – these are inevitable

• Unintended consequences can deepen any existing market failure

Question 4

Examples of Unintended Consequences?

Answer 4

• A minimum wage causes a reduction in non-wage benefits for workers

• An indoor smoking ban increases the use of environmentally-
unfriendly patio heaters

• Tariffs to protect the steel industry increase costs for car makers and
house builders

• Charging for plastic bags encourages a switch to canvas bag use, which could be worse for environment

• Targets for treating patients could lead to lower quality care

• Moral hazard from bail outs to banks after their risky behaviour

Question 5

Arguments against government intervention in markets?

Answer 5

If there is likely to be significant government failure after an intervention, there may be a case for no intervention, especially if the market failure is not too severe:

• The price mechanism is very efficient and can promote innovation

• When resources are scarce, higher prices are potentially a good
outcome

• Profit motive incentivises businesses and entrepreneurs

Question 6

Arguments for Government Intervention?

Answer 6

There are many features an economy needs to function effectively where intervention is required:

• Allocation of property rights and legal system

• Provision of public goods

• Macroeconomic stability

• Measures to reduce inequality

• Rules about competition

Inaction by the government is possibly the biggest government failure

Question 7

Outcomes of Government Failure?

Answer 7

• Greater inequality e.g effects on lower-income households

• High costs of compliance and implementation

• Possible unintended consequences

• Possible conflicts with other micro/macro objectives

• Poor policy choice/outcomes: information failures before a policy is introduced; government may lack information

• Policy may prove ineffective in changing behaviour