What is government failure? • Government failure occurs when a policy intervention leads to a deepening of a market failure or even worse a new failure may arise • In other words – intervention causes a loss of allocative efficiency and a loss of welfare • (1) Policies may have damaging long term consequences for the economy and/or society • (2) Policies may be ineffective in meeting aims • (3) Policies may create more losers than winners
www.tutor2u.net
1
Microeconomics ‐ Government Failure
May 2011
Root causes of government failure 1. 2. 3. 4. 5. 6. 7. 8.
Decisions made in political self interest Low value for money from public sector investment Policy myopia – short‐termism Regulatory capture / failure arising from lobbying Disincentive effects arising from specific policies Information failures / failures to use proper trials The “law of unintended consequences” Costs of regulation may outweigh the benefits
Political self interest • Government may be unduly influenced by lobbying from interest groups • Examples – EU farm support policies – Import protectionism – Failures to reform / overhaul the banking system – Transport investment (power of the road / air lobby) – Caps on inward migration
www.tutor2u.net
2
Microeconomics ‐ Government Failure
May 2011
Protectionism and government failure
Value for money issues • What is the social benefit of public sector spending? • Is the government getting proper value for money? • Good grounds for thinking that public goods can be provided efficiently – e.g. Economies of scale • But there are risks 1. Over‐staffing in public sector industries 2. Relatively low productivity compared to market sector 3. Excessive costs of bureaucracy • Note though – waste is not the preserve of government – there are plenty of examples of private sector waste
www.tutor2u.net
3
Microeconomics ‐ Government Failure
May 2011
Value for money issues (2)
The costs of public sector investment projects often over‐run And many interventions do not meet set targets
Policy myopia and quick‐fixes • Politicians have a tendency to look for short term solutions or “quick fixes” to problems • Especially when elections are on the horizon! • They favour short term initiatives rather than fully thought‐through policies for the long term • Examples? – – – –
www.tutor2u.net
Road widening to cut traffic congestion ASBOs for young offenders Offering surgery on the NHS to combat obesity Zero‐tolerance and visible anti‐crime measures like CCTV
4
Microeconomics ‐ Government Failure
May 2011
Legislative diarrhoea?
Government is less responsive than market signals Too much legislation creates extra costs and uncertainty
Regulatory capture / regulatory failure • Where an agency acts in the interest of the industry it was established to regulate • Regulators often trust information provided by the industry over that contributed by the public • Examples: – Allowing self‐regulation within drinks industry on alcohol prices – Over‐supply of C02 emissions permits to industries as part of carbon trading – 2008 financial crisis caused by banking regulators who were captured by the financial services industry and failed to spot trouble on the horizon
www.tutor2u.net
5
Microeconomics ‐ Government Failure
May 2011
Does red tape strangle efficiency & enterprise?
Disincentives • Where policy interventions lead to a loss of incentives either for consumers or producers • Free market economists argue that attempts to redistribute income and & wealth can damage work incentives • Examples: – Higher rates of income tax – The poverty trap facing low income families
Government failure can happen if a policy decision fails to create enough of an incentive to change behaviour
www.tutor2u.net
6
Microeconomics ‐ Government Failure
May 2011
Information failures • Has there been government policy failure over swine flu? • In the emergency in 2010, the UK government contracted to buy 120 million jabs from the two manufacturers, Glaxo‐Smith‐Kline and Baxter, but then reduced the order to just 44 million as the emergency petered out. Only 6million of those have actually been used, nearly 4 million are being given to the World Health Organisation for use in Africa, leaving 34 million on the shelf.
Law of unintended consequences • Policy interventions have effects that are unanticipated or unintended. Particularly when people do not act in the way that the economics textbooks would predict • Remember – economics is a social science! • Well‐intentioned legislation often act against the interests of those it is intended to serve This law is crucial to understanding government failure – but not all of the unintended consequences are negative!
www.tutor2u.net
7
Microeconomics ‐ Government Failure
May 2011
Examples of unintended consequences • Higher capital gains tax – reduces new house building ‐ worsens housing shortages /affordability • Tuition fees – reaction of universities when setting fees • Bank bail‐outs – raises the problem of moral hazard • Bio‐fuel subsidy – higher food prices + hits poorest in society • Smoking ban – increases demand for and use of patio‐heaters • Windfall tax on North Sea oil and gas companies led to a huge fall in investment and exploration • Tariffs on steel – hits domestic car and construction firms • Targets for treating patients – reduction in the quality of care • Waterbed effect: where regulation to limit or cut charges such as minimum banking charges for going overdrawn, or roaming charges set by mobile phone operators leads suppliers to raise prices elsewhere to by‐pass the effects of regulation.
Unintended consequences (3)
www.tutor2u.net
8
Microeconomics ‐ Government Failure
May 2011
Sub‐prime carbon trading?
Windfall taxes on oil and gas companies
www.tutor2u.net
9
Microeconomics ‐ Government Failure
May 2011
Inefficiency in providing health care Incentives “In Dundee, smokers are being offered £12.50 a week by the NHS if carbon monoxide testing shows they have quit. In Essex, pregnant women can claim a £20 food voucher from the NHS after stopping smoking for one week, £40 after four weeks and another £40 at the end of a year if they have still quit. Brighton offers children £15 for quitting smoking for 28 days, while overweight patients in Kent are also being offered incentives for losing weight.”
• “20% of visits to GPs are for coughs and common colds. This costs the NHS £2bn a year, without making any difference to people’s health. The NHS has become a victim of demand‐led culture…. £10 per visit should be enough to deter people with sniffles.”
A bright idea? • In 2008 the Government ordered the big energy companies to invest in measures for improving energy efficiency and cutting fuel poverty. • The result is that 12 million low‐ energy light bulbs were posted to households over Christmas by an energy company as part of its legal obligation to cut carbon emissions, despite government advice that many would never be used. Over 180 million light bulbs have been issued most are gathering dust in our drawers.
www.tutor2u.net
10
Microeconomics ‐ Government Failure
May 2011
A move towards market forces? • Many questions refer to the ongoing debate about free market forces versus government intervention • Markets can be hugely powerful: – As drivers of innovation and invention – In finding solutions to long term problems
• The price mechanism performs several key functions – Rationing – Allocation – Signalling
• Smart interventions can enhance the market, poorly‐ judged interventions can make things much worse • Increasing interest in behavioural economics / nudges
Tutor2u Keep up‐to‐date with economics, resources, quizzes and worksheets for your economics course.
