- A failure of the free market and the price mechanism to deliver an allocatively efficient allocation of scarce resources is normally regarded as justification for government intervention.
- This intervention is designed to correct for instances of market failure and achieve an improvement in economic and social welfare.
- But what if intervention leads to further inefficiencies? What if government policies prove to be costly to implement but ineffective in achieving their desired outcomes? What happens if intervention distorts markets still further leading to a further loss of efficiency?
- The government can tax, control and regulate but the outcome may be a deepening of the market failure or even worse a new failure may arise.
Government intervention and evasion
A decision by the government to raise taxes on de-merit goods such as cigarettes might lead to an increase in attempted:
- Tax avoidance
- Tax evasion
- Smuggling and the development of black markets where trade takes place between consumers and suppliers without paying tax
The Law of Unintended consequences
- The law of unintended consequences is that actions of consumer and producers — and especially of government—always have effects that are unanticipated or "unintended."Particularly when people do not always act in the way that the economics textbooks would predict.
- The law of unintended consequences is often used to criticise the effects of government legislation, taxation and regulation. People find ways to circumvent laws; shadow markets develop to undermine an official policy; people act in unexpected ways because of ignorance and / or error.
- Unintended consequences can add hugely to the financial costs of some government programmes so that they make them extremely expensive when set against their original goals and objectives.
Costs of administration and enforcement
Government intervention can prove costly to administer and enforce. The estimated social benefits of a particular policy might be largely swamped by the administrative costs of introducing it.
Key points about government failure
- Free market economists are distrustful of intervention They believe that the price mechanism should be given freedom to operate
- Often we can accuse the government of policy failure only with the benefit of hindsight
- Limited information - no government has the resources and information available to it to make fully-informed, objective judgements. That is the nature of politics.
- Government failure is most likely to occur when decisions are made in the vested interest of special interest groups, at the expense of other groups (the result is a loss of equity)