Government Failure (Edexcel A Level Economics A)

Government Failure

• Government failure occurs when the government intervenes in a market to correct market failure, but the intervention results in a net welfare loss of resources from society's point of view

  • This results in even greater welfare loss

  • Usually represents poor value for money

  • May have long term consequences

Causes of government failure

• Distortion of Price Signals

  • The signaling function of the price mechanism is artificially altered

  • For example, 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 i.e. inefficient allocation of resources

    • In demerit markets, higher prices seem to be sending the message to increase supply (e.g. minimum price on alcohol). If producers do that, they will make greater losses. They often have to reduce supply

  • Price intervention may help solve one problem but creates others

• Unintended Consequences

  • 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

• Excessive Administrative Costs

  • Regulation or administration costs can be expensive

  • The costs can sometimes be greater than the savings in social welfare

• Information Gaps

  • Government decision making is subject to the same information gaps and cognitive biases (e.g. anchoring) that consumers face

  • Decision makers do not have perfect information

  • Decision makers are subject to political pressure

Government Failure in Various Markets

Environment agency - regulatory failure

• The Environment Agency is responsible for regulating major industry, waste, and treatment of contaminated land, water quality and resources

• According to the BBC, in 2021 there were more than 375,000 instances of raw sewage pumped into England's rivers

UK energy market - regulatory failure

• The UK energy market was privatised between 1986 and 1990

• Ofgem, the energy market regulator in the UK sets a maximum price on energy costs

• In 2021, British Gas (owned by Centrica) profits were £948m

• In 2022, Ofgem raised the maximum price by 53%

  • Unable to afford the increased payments, some pensioners ride on buses in the winter to stay warm

Smoking ban - unintended consequence

• In July 2007 an indoor smoking ban was implemented in the UK

• Unintended consequences of this policy included:

  • Congestion around office & restaurant doorways

  • Increased use of outdoor patio heaters, thus increasing CO₂ emissions

  • Increased cigarette stump littering

Illegal markets

• The introduction of minimum prices on alcohol in Scotland has increased the amount of cross-border driving to Carlisle and other northern parts of England to purchase alcohol

• In 2017, a report found that the illegal trade in drugs was worth £10bn.

Badly executed policies - information gaps

• Defence Information Infrastructure, a secure military network owned by the United Kingdom's Ministry of Defence (MOD), cost £7.1bn to create compared to the original budget of £2.8bn. (and it did not meet most of the operational targets that the MOD had originally envisaged)

• NHS National IT Programme. Abandoned in 2013 after more than £10bn was spent on it. It never worked