Government Failure

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    Markets may fail to allocate resources efficiently, for example in the case of externalities, a monopoly, public goods and/or asymmetric information. Market failure means the government must intervene to correct the market failure. However, government failure could also occur. Government failure occurs when government intervention leads to an inefficient allocation of resources and a welfare loss.

    Reasons for government failure:

    1) Administrative Costs.

    The administrative costs (salaries, monitoring equipment, surveys etc.) of correcting a market failure may outweigh the benefits of correcting the market failure. Society is worse off because there is a net welfare loss.

    2) Imperfect Information.

    Information could be misleading, conflicting or missing. If there is imperfect information the government will make mistakes and set the wrong policies.

    3) Market Distortions.

    The government may correct a market failure but inadvertently create another market failure in the process. For example, a minimum wage raises income for those in work but firms may fire workers because costs are higher, so unemployment rises.

    4) Conflicting Objectives.

    The government may want to spend more on education but this may mean they have to increase taxes. Maybe the welfare gain from spending more on education is less than the welfare loss of increasing taxes. So society becomes worse off after spending rises and taxes increase.

    5) Political Myopia.

    Government decisions may not be independent of politics. The government may make shortterm decisions that benefit the electorate who vote for them even if that decision leads to a lower long-term social welfare than another policy option. For example, even if a new road will increase the economy’s productivity, the government may decide not to build the new road because it will create noise pollution in an area largely consisting of its electorate. The government fails in its economic policy response because it seeks to appease its supporters. As a whole, society is worse off.

    6) Corruption.

    Corrupt government officials could be bribed by special interest groups to carry out political favours. Government officials then make decisions based on maximizing their own benefit and the benefit of special interest groups rather than the benefit of society.

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