2.11 - Government failure and policy choice

Identifying government failure

Government failure occurs when intervention causes or worsens a misallocation of resources, reducing welfare relative to an appropriate feasible alternative.

The alternative may be no intervention, a better-designed intervention or another instrument. A programme missing its stated target is evidence to investigate, but not automatic proof of government failure: it could still create worthwhile net benefits. Equally, meeting an output target is not proof of success if the resources used would have produced larger benefits elsewhere. Ask what changes because of the policy, whose benefits and costs count, and what would otherwise happen.

Suppose an illustrative pollution programme produces benefits worth £120,000 and uses £90,000 of resources, including administration. Its net benefit is £30,000 compared with doing nothing, if those figures include all relevant consequences. An alternative feasible programme produces £100,000 of benefits for £40,000, a net £60,000. The first programme can improve on no action yet still use resources less well than the alternative. Money estimates may omit health or environmental effects, so the arithmetic supports rather than replaces judgement.

Government failure is not identical to market failure. Market failure identifies why private choices may misallocate resources; government failure identifies problems caused by the attempted response. Both can coexist. The existence of one does not establish that the other must be larger or smaller.

Information and targeting errors

Intervention can misallocate resources when policymakers misunderstand the size, location or cause of a market failure.

An authority setting a pollution tax needs evidence about damage, responses and enforcement. A rate below relevant marginal damage may leave excessive emissions; a rate above it may discourage units whose benefit exceeds their social cost. Measuring damage is difficult, and firms have incentives to present selective cost information. This does not mean every uncertain estimate is useless: a range can improve a decision, and the cost of waiting for perfect knowledge may be substantial.

A subsidy intended to increase preventive care may pay people who would have used it anyway if the true barrier for others is distance rather than price. Output can rise little despite high spending. A buffer-stock authority can also choose a floor too high, encouraging persistent surpluses and using storage resources. Mistargeting wastes scarce resources and may worsen the original distortion.

Improvement can involve trials, independent evidence, targeting the observed barrier and revising policy as results become available. Yet a pilot may not transfer to a national scheme, and measurements of uptake alone may miss health benefits or displacement of another service. Evaluate both the relevance of information and the consequences of errors: a small reversible subsidy and an irreversible harmful project warrant different tolerances for uncertainty.

Incentives and unintended effects

People and firms adapt to policy rules, so the intended direct effect may be offset by changes in behaviour elsewhere.

A price ceiling below equilibrium can make a product cheaper for successful buyers but reduce supply and create shortages. Queuing, poor quality or an illegal resale market can replace price rationing. A reusable-container rule may reduce discarded containers yet increase washing energy or encourage purchases from uncovered sellers. A subsidy can reward output without rewarding quality, so providers concentrate on measurable units rather than the outcomes the policy intended.

These are consequences to analyse, not a reason to assume every policy fails. A ceiling combined with public construction may expand housing supply over time, while well-targeted standards and monitoring can reduce avoidance. The relevant question is how large the offsetting response is and whether design can address it at reasonable cost.