Government Failure

Government failure occurs when government intervention leads to economic inefficiency, and therefore a net loss of
economic welfare.

Lack of market information:

a. Setting tax levels to low, his will lead to the externality not being internalised and MSC will not equal MSB.
b. Setting tax levels to high will cause excessive costs to business or consumers, damaging markets. e.g.
the fuel tax protests in 2000
c. Subsidy of merit goods will lead to over consumption, for instance health care.
d. Provision of public goods, amount of these goods provided is often a value judgement (politically based).
However, under-provision can lead to external costs, such as crime or road accidents.

Distortion of market forces

i. Farm subsidies or minimum prices, can lead to over-production, heavy tax burden on
consumers and other businesses and external costs such as pollution and storage. An
example of market failure in this area is the Common Agricultural Policy (CAP)
ii. Prohibition: An attempt to prevent consumption of a demerit good by declaring it illegal. Ac
a result of prohibition prices are driven up. And since illegal drugs are addictive there is no
guarantee that consumption will fall, so externalities remain. Prohibition risks criminalizing
people that otherwise would not be so. Increase costs of policing and imprisonment.
Creates criminal gangs and often encourages farmers to grow illegal crops because they
can earn a lot more than form legitimate crops.
iii. The National Minimum Wage (NMW): If the NMW is set to high, it may reduce poverty
amongst those who keep their jobs, but at the cost of some of them becoming unemployed.
If it set too low it will have little impact on poverty.
iv. Income and corporation tax level: The higher rates are set the greater the disincentive to
work and the more tax avoidance becomes.
v. Benefits: If unemployment is set at too high a level it becomes a disincentive to work. Job
Seekers Allowance is credited with reducing unemployment because the payment of
benefits is dependent on the unemployed actively looking for work.
vi. Maximum rent controls: Keeping rental costs for housing below the market price will lead
to a shortage of affordable housing. This incurs external costs such over-crowding, poor
quality housing and homelessness.

Conflicts in government Policy

Economic efficiency versus equity: Often the government must attempt to correct cases in which it
considers the market to create inequality. Such as rent controls, the national minimum wage and the
free provision of education and health.
Economic efficiency versus the environment: Sometimes the government considers managing the
environment more important than the free working of the market. Such as tax on fuel, tradable permits
or refusing planning permission for new roads or airports.

Very often the government is slow to identify market failures, because of time lags. Often various time consuming
and expensive enquiries have to take place before new laws or building projects are given the go-ahead.

Also markets change very quickly (dynamically) because of the effect of globalisation and technology, that
governments find hard to respond to.