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Government Failure

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Government Failure
Government failure refers to situations where allocative efficiency may have been reduced following government intervention in markets designed to correct market failure.

Copyright 2007 Biz/ed

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Government Failure
When does government step in? To correct shortages or surpluses To provide when the market does not or can not To regulate and correct where there is perceived inequality or inefficiency To protect individuals and groups in society and provide a safety net for those unable to help themselves To reduce poverty To influence property rights
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Government Failure
How does government intervene?
Taxation to redistribute and provide incentive or disincentive effects Subsidies to encourage production/consumption Regulation guides, codes of practice, legislation, independent regulators Identifying property rights ownership of property, e.g. intellectual property, granting of patents, etc. Direct provision of goods and services health, education, etc.
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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. The invisible hand may not work in the provision of public goods. 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?
Copyright: Stock.Xchng

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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.
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Government Policy
e.g. decisions made on genetically modified crops were they made on the basis of the public interest at large or to satisfy the farming lobby, the health lobby, the environmental lobby or the GM business lobby?

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Government Failure
Should taxes be raised extensively on tobacco? If so, what will the reaction of the tobacco industry be? Do they have sufficient power to influence decision making?

Image Copyright: Zaid Zolkiffli, Rosika Voermans (http://www.sxc.hu)

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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
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Government Failure
Disincentive Effects
High taxes hampering business expansion or enterprise Welfare benefits reducing the incentive to find work Short termism solving the hot topics of the day rather than the long term important issues e.g. ID cards versus pension crisis?
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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?

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Government Failure
Impact on the environment e.g. building new motorways rather than investing in public transport?

Is the real answer to road congestion building more motorways?


Copyright: Photolibrary Group

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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, http://www.sxc.hu

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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, http://www.sxc.hu

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