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Government Failure
Definition of government failure:
This occurs when government intervention in the economy causes an inefficient allocation of resources and a
decline in economic welfare.
Reasons for government failure
Lack of incentives: In the public sector, there is limited or no profit motive. Because workers and
managers lack incentives to improve services and cut costs it can lead to inefficiency. For example, the
public sector may be more prone to over-staffing. The government may be reluctant to make people
redundant because of the political costs associated with unemployment.
Poor information, politicians may have poor information about the type of service to provide. Politicians
may not be experts in their department, but concentrate on their political ideology.
Political interference e.g. politicians may take the short term view rather than considering long term
effects
Administration cost of government bureaucracy in running public services
Moral hazard. The government may offer a guarantee to all bank deposits to protect financial system,
but this could encourage banks to take risks because they know they can be bailed out by the
government.
Overcoming government failure
There are various things the government can try and do to overcome government failure
Give performance targets / profit incentives
Competitive tendering where public sector bodies face competition from the private sector for the right
to run a public service.
Employing outside private sector consultants to make decisions about how to cut costs.
See also: How to overcome government failure
Evaluation
It should be remembered many public services are not subject to the same profit goals. It is difficult to give a
profit motive in health or education because the goal is not profit but quality of service.
Related
Market Failure
Definition of Market Failure This occurs when there is an inefficient allocation of resources in a free market.
Market failure can occur due to a variety of reasons, such as monopoly (higher prices and less output), negative
externalities (over-consumed) and public goods (usually not provided in a free market)
Types of market failure:
1. Positive externalities Goods / services which give benefit to a third party, e.g. less congestion from
cycling
2. Negative externalities Goods / services which impose cost on a third party, e.g. cancer from passive
smoking
3. Merit goods People underestimate the benefit of good, e.g. education
4. Demerit goods People underestimate the costs of good, e.g. smoking
5. Public Goods Goods which are non-rival and non-excludable e.g. police, national defence.
6. Monopoly Power when a firm controls the market and can set higher prices.
7. Inequality unfair distribution of resources in free market
8. Factor Immobility E.g. geographical / occupational immobility
9. Agriculture Agriculture is often subject to market failure due to volatile prices and externalities.
10. Information failure where there is lack of information to make an informed choice.
Key Terms in Market Failure
Externalities: These occur when a third party is affected by the decisions and actions of others.