- Government failure
- Government failure is government intervention that itself results in an inefficient allocation of resources, such as a subsidy for a polluting good or regulation that causes shortages.
- Market failure
- Market failure is a situation where the free market, left to its own devices, is unable to achieve optimal economic efficiency.
Types of government failure
Can you name the five types of government failure?
Each is a way an intervention meant to fix a market can leave resources worse allocated.
Regulatory capture is when the industry being regulated comes to exercise influence over its regulators, so the rules serve the industry rather than the public.
Can you think of an example?
A rail regulator hires its senior staff from the train companies, and relies on those companies for its figures. Over time its rules protect the companies' profits rather than passengers, who get higher fares and late trains.
A distortion of price signals is when a tax, subsidy or price rule changes prices so that they no longer reflect true costs and benefits.
Can you think of an example?
A subsidy for producing a good that causes high levels of pollution keeps its price low, so buyers and firms are told to make and use more of it than society should.
Unintended consequences are effects of a policy that its makers did not plan, as people respond in unexpected ways that undermine the policy's intent.
Can you think of an example?
A rent cap meant to help renters leads landlords to take flats off the market, so fewer are rented. Those who cannot find a flat bear the cost, but nobody can say who they are.
An information gap is when the government lacks what it needs to know, such as the true external cost, and sets a policy at the wrong level.
Can you think of an example?
A government taxes plastic bags at 50p each to cut litter, guessing the damage. If the real damage is 10p a bag, the tax cuts bag use well below the social optimum.
Excessive administrative costs are when running an intervention uses up more resources than it saves, often because a tax-funded agency with no competitors has little pressure to cut costs.
Can you think of an example?
A grant scheme hands out £2 million a year but costs £3 million to run in staff, checks and paperwork. A firm with costs like that would lose customers to rivals; a government department has no rivals, so it carries on.