Government failure

This article is about an economic term. For another kind of failed government, see Failed state.

Government failure (or non-market failure) is the public sector analogy to market failure and occurs when a government intervention causes a more inefficient allocation of goods and resources than would occur without that intervention. Likewise, the government's failure to intervene in a market failure that would result in a socially preferable mix of output is referred to as passive Government failure (Weimer and Vining, 2004). Just as with market failures, there are many different kinds of government failures that describe corresponding distortions.

The term, coined by Roland McKean in 1965, became popular with the rise of public choice theory in the 1970s. The idea of government failure is associated with the policy argument that, even if particular markets may not meet the standard conditions of perfect competition, required to ensure social optimality, government intervention may make matters worse rather than better.

Just as a market failure is not a failure to bring a particular or favored solution into existence at desired prices, but is rather a problem which prevents the market from operating efficiently, a government failure is not a failure of the government to bring about a particular solution, but is rather a systemic problem which prevents an efficient government solution to a problem. The problem to be solved need not be a market failure; sometimes, some voters may prefer a governmental solution even when a market solution is possible.

Government failure can be on both the demand side and the supply side. Demand-side failures include preference-revelation problems and the illogics of voting and collective behaviour. Supply-side failures largely result from principal/agent problems.

Examples

Legislative

• Crowding out - Crowding out occurs when the government expands its borrowing more to finance increased expenditure or tax cuts in excess of revenue crowding out private sector investment by way of higher interest rates. Government spending is also said to crowd out private spending (Shaghil Ahmed, “Temporary and Permanent Government Spending in an Open Economy,” Journal of Monetary Economics, Vol. 17, No. 2 (March 1986), pp. 197–224).
• Horse trading/Logrolling - The process by which legislators trade votes
• Pork barrel spending - The tendency by legislators to encourage government spending in their own constituencies, whether or not it is efficient or even useful. Senior legislators, with greater status and ability to "bring home the bacon", may be reelected for this reason, even if their policy views are at odds with their constituency.
• Rational ignorance - because there are monetary and time costs associated with gathering information

Administrative

• Self-interested administrators Anthony Downs argues that administrators are self-interested, wanting to build their own power and prestige.
• Public Monopolies Government operates like a monopoly because it does not have to face market competition. (Milton Friedman, Capitalism and Freedom
• Multiple, conflicting goals Government administration is often asked to meet conflicting goals. (Jonathan Rauch)

Regulatory

• Regulatory arbitrage - Where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory position.
• Regulatory capture - The co-opting of regulatory agencies by members of or the entire regulated industry. Rent seeking and rational ignorance are two of the mechanisms which allow this to happen.
• Regulatory risk - A risk faced by private-sector firms that regulatory changes will hurt their business.
• Rent seeking - see above.

Information assessment

• Environmental impact - Public support for roads lowers the cost of operating a vehicle; farm subsidies and programs like the Soil Conservation program encourage farmers to use fields which require more intense application of fertilizer and irrigation. Both of these have an adverse impact on the environment.
• Imperfect information - Especially in Pigouvian application, gathering sufficient information is no easier for the regulatory agency than for individual actors
• Market distortion
  • By tax structures - by organizing taxation in a particular way, investments may be directed so as to avoid those taxes even though the investments are inferior
  • By regulatory ordering - mandating a particular solution may prohibit all other solutions, some of which may be superior
  • By subsidization - by subsidizing particular goods, these may force other, nonsubsidized, but superior substitutes from the market
  • Risk assumption - by promising to relieve risk-takers, the government encourages risk-taking whose benefits accrue to a minority while spreading the assumption of that risk across the populace. The Savings and Loan crisis of the 1980s is one example; federal assumption of responsibility for the Mississippi River levee system. See also moral hazard
• Unintended consequence - An unintended consequence comes about when a mechanism that has been installed with the intention of producing one result is used to produce a different (and often conflicting) result. (e.g. rent control leads to shortages in housing)

References

• Aidt, Toke S. (2003). "Economic Analysis of Corruption: A Survey," Economic Journal, 113(491), Features, pp. F632-F652.
• Andersson, Thomas (1991). "Government Failure — the Cause of Global Environmental Mismanagement," Ecological Economics, 4(3), pp. 215–236. Abstract.
• Becker, Gary (1958) "Competition and Democracy," Journal of Law and Economics, 1, pp. 105-109.
• _____ (1983). "A Theory of Competition among Pressure Groups for Political Influence," Quarterly Journal of Economics, 98(3), pp. 371–400.
• Buchanan, James M. (1983). "The Achievement and the Limits of Public Choice in Diagnosing Government Failure and in Offering Bases for Constructive Reform," in Anatomy of Government Deficiencies, ed. Horst Hanusch (Berlin: Springer-Verlag, 1983), pp. 15–25.
• Datta-Chaudhuri, Mrinal (1990). "Market Failure and Government Failure." Journal of Economic Perspectives, 4(3) , pp. 25-39.
• Dollery, Brian, and Andrew Worthington (1996). "The Evaluation of Public Policy: Normative Economic Theories of Government Failure," Journal of Interdisciplinary Economics, 7(1), pp. 27-39.
• Grier, Robin M. and , Kevin B. Grier "Political cycles in nontraditional settings: theory and evidence from the case of Mexico", JLE vol. XLIII (April 2000), p. 239
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• Kolko, Gabriel (1977), Railroads and Regulation, 1877-1916, Greenwood Publishing Company, ISBN 0-8371-8885-7
• Krueger, Anne O. (1990). "Government Failures in Development," Journal of Economic Perspectives, 4(3), pp. 9-23.
• Le Grand, Julian (1991). "The Theory of Government Failure," British Journal of Political Science, 21(4), pp. 423-442.
• The New Palgrave Dictionary of Economics, 2nd Edition, 2008 with Table of Contents/Abstract links:
      Backhouse, Roger E., and Steven G. Medema, "laissez-faire, economists and."
      Buchanan, James M., "public debt."
      Lohmann, Susanne, "rational choice and political science."
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• Niskanen, William (1967), The Peculiar Economics of Bureaucracy, Institute for Defense Analyses, Program Analysis Division (1967), ASIN B0007H5TBG
• _____ (1971), Bureaucracy and Representative Government, Aldine, Atherton, ISBN 0-202-06040-3
• Stiglitz, Joseph E. (1998). "The Private Uses of Public Interests: Incentives and Institutions," Journal of Economic Perspectives, 12(2), pp. 3-22.
• Tullock, Gordon et al. (2002). Government Failure: A Primer in Public Choice. Cato Institute. Scroll down for preview.
• Weimer and Vining, Policy Analysis and Concepts 4th edition (2004) p. 206
• Wiesner, Eduardo (1998). "Transaction Cost Economics and Public Sector Rent-Seeking in Developing Countries: Toward a Theory of Government Failure," in E. Wiesner and R. Picciotto, ed. Evaluation and Development: The Institutional Dimension, pp. 108-23. World Bank.
• Winston, Clifford (2006). Government Failure versus Market Failure: Microeconomics Policy Research and Government Performance. Brookings Institution Press. Link.
• Wolf, Charles J. (1979). "A Theory of Non-Market Failure," Journal of Law and Economics, 22 (1), pp. 107–139.
• Zerbe Jr., Richard O., and Howard E. McCurdy (1999). "The Failure of Market Failure," Journal of Policy Analysis and Management, 18(4), pp. 558–578. Abstract. Reprinted in Economic Efficiency in Law and Economics," pp. 164-87.