Government Failure - A-Level Economics

Reasons for Government Failure

Government failure occurs when government intervention leads to a net welfare loss in society and a more inefficient allocation of resources.

Remember, the reasons why governments intervene in markets is because of market failure, so there is already an inefficient allocation or resources and a net welfare loss. Government failure is effectively when the government interfere and make the situation even worse.

There are some common reasons for government failure:

• Development of Illegal Markets-­ raising taxes on goods such as alcohol and cigarettes can lead to the formation of black markets in order to avoid tax

• Short-­‐term  solutions-­ if the government only consider the immediate effects of their intervention, no action is taken to prevent government failure in the long run. For example, if the government decided to invest in the building of new roads to improve transport and communications, they might not consider the long-­‐term externalities such as pollution and congestion which might lead to market failure in the future.

• Electoral  Pressures-­  governments might  elect  a ‘quick-­fix’ policy to boost the economic outlook in the run up to an election

• Regulatory  Capture-­  this is when industries controlled by government agencies carry out their actions in favour of producers over consumers. For example, Common  Agricultural Policy

• Lack of information-­ if policy makers have a lack of accurate information about the market situation, government failure is likely to arise

In the previous unit (1.3.8), the advantages and disadvantages of government intervention policies were  discussed.  All of the disadvantages could be arguments for the existence of government failure.

It is important to note that even if the intervention does not worsen the situation, if the government had to spend money to intervene, the intervention could be seen as a waste of taxpayers’ money which could be better used elsewhere. So government failure

Examples of Government Failure

National Minimum Wage

If NMW is set above the free market equilibrium, there will be an excess supply of labour-unemployment. There are also other disadvantages of NMW, as described in Unit 1.3.6.

Road Pricing

Road congestion charges are often implemented to reduce external costs such as congestion, air pollution and noise pollution. However, if charges are set too high, then there could be an under-utilisation of road space. It may also be unfair to low‐income drivers who cannot afford to pay the congestion charge. Moreover, congestion charges may reduce business trade within the congestion charge zone. Therefore, the socially optimum quantity of traffic may not be consumed.

Subsidies to Bus Transport

Subsidies to reduce prices of bus tickets or to increase quality of bus travel could be a waste of taxpayers’ money. This is because bus travel is not a very close substitute to car travel, so it is unlikely that consumers will switch from using their car to using buses. Moreover, bus travel is generally seen as an inferior good, so it is unlikely that people will switch to using it if they can afford their own car. Hence, the government expenditure on subsidies is a waste, with opportunity costs arising.

Buffer Stock Schemes and Minimum Prices

The disadvantages of these schemes, such as the wastage of food or waste of taxpayers’ money, are discussed in detail in the ‘Unit 1.8.8’. All of these disadvantages contribute to government failure.

Allocation of Fish Quotas

The European Commission is responsible for ensuring a sustainable level of fishing in the North Sea. To do this, they have allocated fish quotas for each commercial fishing boat. There are advantages to the scheme: it is legally enforceable and the quotas are tradable, so a new market is created.

However, there are many disadvantages which lead to market failure:

• Wealthy fisherman can buy quotas, so can continue to overfish
• Extra costs are passed onto consumers in the form of higher prices
• Extra costs result in businesses going bankrupt
• Fish quotas are often set at too high a level, so they have little effect
• Fishing boats have to throw dead fish back overboard to keep within their quota
• Fish catches are not monitored very well, so the quotas are not enforced strongly enough.

Environmentalists argue that other strategies could be used to reduce fishing. For example, each boat could be given a limited time period in which they could fish. In this time period, they could fish as much as they like. This would increase quality of life for fisherman, reduce pollution (because ships are out for less days) and would reduce labour costs for fishing firms.

Common Agricultural Policy (CAP)

The EU gives special attention to farming markets to protect farmers.

Farmers suffer from three potential problems:

1. Farm incomes have fallen because of increasing global food production, and higher yields following the application of new technology
2. Farmers’ incomes are extremely unstable, largely because of random supply shocks, such as poor weather and disease.
3. Farmers and growers have lost power to the large supermarket chains, which can exert their monopoly power in pushing farm prices down.

Through CAP, farmers and growers receive subsidies and minimum price guarantees from the EU. This ensures that food production is maintained at a secure level, to prevent risk of food shortages.

However, there are many disadvantages associated CAP which lead to market failure:

Productive Inefficiency

Minimum prices, buffer stock schemes and subsidies have led to farmers producing excess food because they know they are protected under CAP. This over­‐production is a mis­‐allocation of scarce resources. In fact, much of the price support goes to farmers who need it least. Because most support is production-based, the bulk of it goes to the larger, often richer, farms able to exploit the market.

Fall in consumer welfare

CAP concentrates mainly on producers, and not consumers. Consumers are often faced with  high food prices due to the minimum prices set, whilst the policy means farmers have less incentive to improve quality of foods. The higher food prices hit poor families hard because food is an inelastic good.

Environmental Concerns

Subsidies and minimum prices have lead to farmers producing excess food, as explained above. This leads to an over­‐use of fertilisers, which has implications for the environment.

Government Spending

There is an opportunity cost to spending on CAP. This is especially significant because CAP is a very expensive policy which requires high levels of government spending.

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