Government failure occurs when possible interventions are not
analyzed before action is taken regarding market inadequacies.
LEARNING OBJECTIVE [ edit ]
Analyze situations in which the government has failed to act in an economically optimal way
KEY POINTS [ edit ]
Government failure, also known as non­market failure, is the public sector version of market
failure.
Government failures can occur in relation to both supply anddemand within a market.
Economic crowding out occurs when the government expands its borrowing to pay for
increased expenditure or tax cuts. The expanded borrowing is in excess of its revenue.
Inefficient government regulation contributes to market and government failure.
TERMS [ edit ]
expenditure
Act of expending or paying out.
arbitrage
Taking advantage of a price difference between two or more markets: striking a combination of
matching deals that capitalize upon the imbalance; the profit made between price differences.
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Government Failure
Government failure, also known as non­market failure, is the public sector version of market
failure . The market fails and government intervention causes a more inefficient allocation of
goods and resources than would occur without the intervention. It occurs when the market
inadequacies are not compared and
analyzed against possible interventions
before action is taken. Government failure
can be described as providing "only
limited help in prescribing therapies for
government success. "
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The Public Sector
This graph shows the layers of the government. The government is tied directly to the public sector.
Government failure is an analogy made by the public sector when market failure occurs.
A government failure is not the failure of the government to enact a solution to a failure, but
rather it is a systematic problem that prevents an efficient government solution to the
problem. Government failures can occur in relation to both supply and demand within a
market. Demand failures are the result of preference/revelation problems and the imbalance
of voting and collective behavior. Supply failures are usually the result of principal­agent
problems. In this case, the failure occurs in trying to get one party (agent) to work in the best
interest of another party (principal).
Economic Crowding Out
There are specific scenarios that are directly associated with government failure. Economic
crowding out occurs when the government expands its borrowing to pay for increased
expenditure or tax cuts. The expanded borrowing is in excess of its revenue which crowds out
private sector investmentdue to higher interest rates. Government spending also crowds out
private spending.
Government Regulation
When analyzing government failure, inefficient regulation contributes to market failure. The
are three specific regulatory inefficiencies:
Regulatory arbitrage occurs when a regulated institution takes advantage of the
difference between its real risk and the regulatory position.
Regulatory capture occurs when regulatory agencies co­opt whether its the members or
the entire regulated industry. Mechanisms that allows regulatory capture include rent
seeking and rational ignorance.
Regulatory risk is a risk faced by private sector firmswhen there is a chance that
regulatory changes will negatively affect their business.
Recent evidence has suggested that even when democracies are economically stable,
transparency, media freedom, and a larger government all contribute to increased
government corruption. Government corruption leads to both market and government
failure.