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. However, while market failure has been widely studied, government failure has only recently come into common usage as the lenses of Public choice theory and New Institutional Economics (NIE) or Transaction Cost Economics (TCE) have begun to explore the problems. 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 principle/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).
• 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, and the benefits to doing so is limited, voters will not necessarily obtain all of the information necessary to make an informed decision on a subject on which they may nonetheless cast a vote. This is true of both legislators and private citizens.
• Rent seeking - The tendency by interest groups to lobby for laws and regulations that provide them a guaranteed benefit (rent). There are three main classes of rent-seekers: legislators, administrators, and regulated entities. Legislators will try to change laws to ensure their continued incumbency, such as gerrymandering. Administrators (bureaucrats) may seek to advance their power and budget authority. Regulated entities may seek to obtain barriers to entry or other special provisions of the law that reduce competition, increase subsidization, or both.
• Short time horizons - The tendency to fixate on short term fixes and to ignore large, complex problems. This may be driven to the election cycle. See, for example, "Political cycles in nontraditional settings: theory and evidence from the case of Mexico", Grier and Grier, JLE vol. XLIII (April 2000), p. 239.
• Licensing and permits - High costs of obtaining a license or permit from government to practice an activity beneficial to society, such as practicing medicine or starting a business, can reduce the availability of certain goods and services.
• Taxes - high taxes can reduce, halt, or reverse economic expansion
• Subsidies - government subsidies provided to particular businesses or industries.

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)

See also

• iron triangle
• regulatory capture

References

• Weimer and Vining, Policy Analysis and Concepts 4th edition (2004) p. 206
• Grier, Robin M. and Grier, Kevin B., "Political cycles in nontraditional settings: theory and evidence from the case of Mexico", JLE vol. XLIII (April 2000), p. 239
• Kolko, Gabriel (1977), The Triumph of Conservatism, The Free Press, ISBN 0-02-916650-0
• Kolko, Gabriel (1977), Railroads and Regulation, 1877-1916, Greenwood Publishing Company, ISBN 0-8371-8885-7
• Niskanen, William (1967), The peculiar economics of bureaucracy, Institute for Defense Analyses, Program Analysis Division (1967), ASIN B0007H5TBG
• Niskanen, William (1971), Bureaucracy and Representative Government, Aldine, Atherton, ISBN 0-202-06040-3