Compare the policy with the relevant alternative, not a perfect world.
Government failure occurs when intervention produces a worse resource allocation than the relevant no-intervention alternative. Inaccurate information, weak incentives, influence by organised groups or costly implementation can cause this. A policy falling short of the social optimum is not automatically worse than doing nothing; compare the improvement achieved with the new costs and distortions.
- Benchmark
- Government failure occurs when intervention makes resource allocation worse than the relevant no-intervention outcome. Compare the net results, not whether the policy is perfect.
- Causes
- Wrong estimates of harm, weak incentives to control costs, pressure from organised groups or costly enforcement can make a policy deliver less than it costs.
- Not perfection
- An incomplete correction can still be better than no policy. Compare the remaining allocation loss plus new real costs with the original loss.
Explain a cause, then compare outcomes
Information
A regulator may mismeasure harm, demand or costs and choose an unsuitable rate or scale.
Incentives and influence
Providers may have weak incentives to control costs, or organised beneficiaries may influence a decision towards their interests. Establish the mechanism rather than asserting all officials or firms behave this way.
Implementation
Monitoring and administration use real resources; evasion can reduce the intended gain. A delay can make the policy respond to an outdated problem.
Counterfactual
The counterfactual is what would realistically happen without the policy. Missing the ideal optimum is not enough to show government failure if the policy still improves on that alternative.
Worked example: An overcorrection that costs more than it gains
Unregulated output is 80. Social optimum is 60 and original welfare loss is $40 per day in the chapter's negative-externality model. A tax reduces output to 40, with remaining allocation loss $40 and additional administration cost $10 per day.
- At 40 units, the policy now prevents some units whose social benefits exceed their costs. It has exchanged overproduction for underproduction.
- The remaining allocation loss of $40 is as large as before; the $10 real administration cost adds to the loss.
- With no other effects, total loss is $50 rather than $40. That policy is worse than the stated alternative.
- By contrast, a policy leaving loss $10 with administration $5 would improve the outcome by $25 despite remaining imperfect.
Watch out for this
Any policy that fails to reach the exact social optimum is government failure.
Compare net outcomes. An incomplete correction can still improve welfare relative to no intervention.
Check your understanding
A policy reduces allocation loss from $80 to $30 but adds $10 of real administration costs. With no other effects, what is the change?
- A loss because some inefficiency remains.
- No change because government spends money.
- A net improvement of $40.