Government Failure (AQA A Level Economics)

Cause

Explanation

Example

Inadequate information

• Governments and regulators do not have perfect information or they often do not understand the market they are trying to regulate
  
  
• Government decision making is subject to the same information gaps and cognitive biases (e.g. anchoring) that consumers face

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• Many financial markets are fast moving and incredibly complex
  • Government regulators find it difficult to keep pace with the change of products

Conflicting objectives

• The implementation of one policy can come at the expense of achieving another
  
  
• The government has to make a trade-off that it believes will maximise social welfare
  
  • Governments often face a trade-off between achieving long term and short term policy objectives

• The government may want to achieve both economic growth and environmental protection
  
  
• These goals may be in conflict
  • E.g In the UK there is much debate about the issuing of new offshore gas drilling licences. They will generate economic growth but lead to environmental degradation

Administrative costs

• Regulation or administration costs can be expensive
  
  
• The costs of intervention can sometimes be greater than the savings in social welfare, leading to a worsening of allocation of resources

• The cost of recruiting and paying staff to ensure firms are adhering to regulation may exceed the size of the external cost from the market failure 

Market distortions

• Price intervention may help to solve one problem but creates others by distorting price signals
  
  
• The signalling function of the price mechanism is artificially altered
  
  
• This can lead to an inefficient allocation of resources, surpluses and shortages

• A minimum price sends a signal to producers to supply more
  • In agricultural markets this has often resulted in an excess of perishable products which end up going to waste 
• A maximum price sends a signal to producers to supply less
  • In pharmaceutical markets, this has led to excess demand of products

Unintended consequences

• Consequences that are unforeseen may occur
• Producers and consumers aim to maximise their self interest
  • This often leads them to look for legal or illegal loop holes to bypass government intervention
  • This result creates unintended consequences such as the creation of illegal markets and/or illegal production/consumption

• Reduced consumption of alcohol due to minimum pricing, may lead to an increase in consumption of more harmful intoxicants as they become relatively cheaper 

Regulatory capture

• Regulatory capture occurs when firms influence the regulators to change their decisions/policies to align more with the interests of the firm
  • Firms spend millions lobbying regulators or politicians who can issue instructions to the regulatory
• Some lobbying activity is corrupt, and there is a fine line between influencing activity and bribing

• In 2021 the former UK Prime Minister, David Cameron, was caught in an embarrassing case of lobbying for a failed financial venture by a firm called Greensill Capital