Government FailureAS Economics Unit 1

Aims and ObjectivesAim:• Understand government failure

Objectives:• Define government failure• Assess different forms of government

failure

Starter• How can government intervention,

cause government failure?

Government Failure• Governments can tax, control and

regulate, but the outcome may be a deepening of market failure, or even worse a new failure may arise.

• Government intervention can be ineffective, inequitable and misplaced.

Causes of Government Failure

Political Self Interest

Policy Myopia

Regulatory Capture

Disincentive Effects

Imperfect Information

Unintended Consequences

Political Self Interest• Think of a realistic policy that would make

people want to elect you as an MP.

• Often before an election governments will decide on popular policies, to gain favour with the voter.

• E.g. boosting spending on welfare benefits• This leads to a further misallocation of resources

and government failure.

• Some argue that tobacco and media companies have too much power over politicians and government policy, leading to a misallocation of resources.

Policy Myopia• The government is currently widening

the M1 motorway to combat congestion problems.

• Is this an effective form of government intervention to reduce congestion?

Policy Myopia (distortion)• Politicians look for short term fixes to a

complex economic problem.• By widening existing motorways, are they

not encouraging more traffic to use it, and therefore congestion?

• Subsidies can also cause government failure, if for instance the government subsidises a declining industry. E.g. mining

• This may be an inefficient allocation of resources.

Regulatory Capture• CAP (Common Agricultural Policy)• In the EU, as system of intervention

is in place to protect the farming sector. Its objectives are:– Stabilisation of agricultural markets– Increase in productivity and efficiency– Maintaining a good standard of life for

farmers– Maintaining reasonable consumer prices

• Main method of intervention is a system of price support, in effect a buffer stock scheme, which in practice has meant that European Consumers pay prices determined by the least efficient European farmers rather than the world market prices.

Is this producing an efficient allocation of resources or is it

contributing to resources being allocated more inefficiently?

Regulatory Capture• When regulators of industries appear to

operate in favour of producers rather than consumers.

• Prevent market from operating freely.

• Results in an even more inefficient allocation of resources.

• E.g. CAP ensuring farmers price support, but consumers suffer higher prices.

Imperfect InformationHow can government failure be caused by imperfect information?

• Imperfect information exists when the government are forming policies.

• If policies are not targeted correctly etc they may result in an inefficient allocation of resources.

Unintended Consequences• Actions of consumers, producers and

governments always have effects that are unintended or unanticipated.

• This could lead to an inefficient allocation of resources.

E.g. Government Raises Taxes on Demerit Goods

Development of Grey Markets

Smuggling

Tax Evasion

Increase in Tax Avoidance

Government Increases Tax on Demerit Goods

Exam Questions• Define the term demerit good. (5 marks)

• Define the term negative externality. (5 Marks)