Unit 1 Micro Revision

1. Government Failure
AS Microeconomics

2. Intervention in the market-place
Government intervention
• Markets fail and the government
intervenes - but there is always the risk
of government or regulatory failure!

3. What is government failure?
• Government failure occurs when a policy
intervention leads to a deepening of the market
failure or even worse a new failure may arise
• In other words – intervention creates further
inefficiencies and a loss of welfare
• (1) Policies may have damaging long term
consequences for the economy or society
• (2) Policies may be ineffective in meeting aims
• (3) Policies may create more losers than winners

4. Some causes of government failure
1. Decisions made because of political self interest
2. Low value for money from public sector investment
3. Policy short-termism
4. Regulatory capture
5. Disincentives arising from specific policies
6. Information failures at government level
7. The “law of unintended consequences”
8. The costs of regulation may outweigh the benefits

5. Self interest
• Government may be
influenced by lobbying
from interest groups
• Examples?
– Farm support policies
– Reaction to swine flu risks
– Government failures to
reform the banking system
– Transport investment (power
of the road / air lobby)
– Caps on inward migration

6. Value for money issues
• What is the social benefit of public sector spending?
• Is the government getting value for money?
• Good grounds for thinking that public goods can be
provided efficiently – e.g. Economies of scale
• But there are risks
1. Over-staffing in public sector industries
2. Relatively low productivity compared to market sector
3. Excessive costs of bureaucracy
• Note though – waste is not the preserve of
government – there are plenty of examples of private
sector waste

7. Value for money is a key issue
Value for money is a crucial issue when discussing
government spending - many projects utilise economies of
scale but there may be inefficiencies too

8. More value for money issues
The costs of public sector investment projects often over-run
And many interventions do not meet set targets

9. Policy myopia and quick-fixes
• Politicians have a tendency to look for short term
solutions or “quick fixes” to problems
• They favour short term initiatives rather than fully
thought-through policies for the long term
• Examples?
– Road widening to cut traffic congestion
– ASBOs for young offenders
– Offering surgery on the NHS to combat obesity
– Zero-tolerance and visible anti-crime measures like CCTV

10. Legislative diarrhoea?
Government is less responsive than market signals
Too much legislation creates extra costs and uncertainty

11. Regulatory capture
• This is when the industries
under the control of a
government agency appear
to operate in favour of the
vested interest of producers
rather can consumers
• Examples:
– Allowing self-regulation on
alcohol prices
– Over-supply of C02 emissions
permits to industries as part of
the EU emissions trading
scheme

12. Does red tape strangle efficiency & enterprise?

13. Disincentives
• Where policy interventions lead to a loss of incentives either
for consumers or producers
• Free market economists argue that attempts to redistribute
income and & wealth can damage work incentives
• Examples:
– Higher rates of income tax?
– The poverty trap facing low income families
Government failure can happen if a policy decision fails to
create enough of an incentive to change behaviour

14. Information failures
• Has there been government
policy failure over swine flu?
• In the emergency last summer
the government contracted to
buy 120 million jabs from the
two manufacturers, GlaxoSmith
Kline and Baxter, but then
reduced the order to just 44
million as the emergency petered
out. Only 6million of those have
actually been used, nearly 4
million are being given to the
World Health Organisation for
use in Africa, leaving 34 million
on the shelf.

15. Law of unintended consequences
• Policy interventions have effects that are
unanticipated or unintended. Particularly when
people do not act in the way that the economics
textbooks would predict
• Remember – economics is a social science!
• Well-intentioned legislation often act against the
interests of those it is intended to serve
This law is crucial to understanding government failure – not
all of the unintended consequences are negative!

16. Negative unintended consequences
• Higher capital gains tax – reduces new house building -
worsens housing shortages /affordability
• Bank bail-outs – raises the problem of moral hazard
• Bio-fuel subsidy – causes food price inflation and hits the
poorest in society
• Smoking ban – increases demand for and use of energy
inefficient patio-heaters
• Windfall tax on North Sea oil and gas companies led to a
huge fall in investment and exploration – just years
before oil prices surged
• Tariffs on steel – hits domestic car and construction firms
• Targets for treating patients – leads to reduction in the
quality of care e.g. Staffordshire General scandal

17. Unintended consequences

18. Providing health care
• “20% of visits to GPs are
for coughs and common
colds. This costs the NHS
£2bn a year, without
making any difference to
people’s health. The NHS
has become a victim of
demand-led culture….
£10 per visit should be
enough to deter people
with sniffles.”
Incentives?
“In Dundee, smokers are being
offered £12.50 a week by the NHS if
carbon monoxide testing shows they
have quit. In Essex, pregnant women
can claim a £20 food voucher from
the NHS after stopping smoking for
one week, £40 after four weeks and
another £40 at the end of a year if
they have still quit. Brighton offers
children £15 for quitting smoking for
28 days, while overweight patients in
Kent are also being offered incentives
for losing weight.”

19. A bright idea?
• In 2008 the Government ordered
the big energy companies to
invest in measures for improving
energy efficiency and cutting fuel
poverty.
• The result is that 12 million low-
energy light bulbs were posted to
households over Christmas by an
energy company as part of its
legal obligation to cut carbon
emissions, despite government
advice that many would never be
used. Over 180 million light bulbs
have been issued most are
gathering dust in our drawers.

20. Market forces?
• Many questions refer to the ongoing debate about
free market forces versus government intervention
• Markets are hugely powerful:
– As drivers of innovation
– In finding solutions to long term problems
• The price mechanism performs several key functions
– Rationing
– Allocation
– Signalling
• Smart interventions can enhance the market, poorly-
judged interventions can make things much worse

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