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Introduction to Government Failures

January 9, 2013

Economists often discuss market failures, which occur when market outcomes do not correspond to perfect competition. There are also government failures of a similar type, when government agencies do not create the result which would occur under perfectly competitive markets. Most people focus on market failures without even addressing government failures, despite, in my opinion, government failures being more severe and pervasive.

Preference Bundling
When markets are used to allocate resources, each person can match their purchases to their own preferences. For example, if I go to the grocery store, I can buy apples and someone else can buy oranges without either of us harming the other. Each of us gets the particular good we want and prices adjust to reflect how much resources society uses for each of the goods. If oranges are out of season and require expensive greenhouses to grow, the price of oranges will rise. Even the producers’ preferences are reflected in the market price. Government choice, on the other hand, necessarily imposes one option on everyone, hurting those whose preferences are different from the faction which controls the government. At best, you have a democracy so at least half the population is satisfied with a choice, but that’s a far cry from a market where everyone can follow their perferences.

The Median Voter Theorem
Most choices that are made by governments are not stark “A or B”; they are picking a position along a contiuum of policy options. According to the median voter theorem, the policy which is popular with the median voter will be implemented. So, suppose you have 100 possible policies, ranked from most conservative to most liberal. If one politican advocates #60 and the other advocates #45, the one advocating #45 will win, because they’ll get the 45 lower plus 7 middle voters closer to 45 than to 60 and wind up with 52% of the vote. Under the median voter model, well over half of the population could hate the policy, but it will still get passed, because compromise pushes policy toward the middle.

Median_voter_model

Representation
If people could pick policy by policy, they could get a situation where each policy was approved by around 50% of the population, but when policies are instead chosen by one representative, you could wind up at a situation far from even that low bar. All a politican has to do to win election is be better than the other candidates. In many cases, the result boils down to only a few key issues people care a lot about. If elections were perfectly competitive, the winner would be fairly close to the median voter. However, there are only a few candidates in elections and people often vote based on a candidate’s appearance or personality, not on the issues. Furthermore, voters might be rationally ignorant of the optimal policies, not having the time or the inclination to carefully evaluation which candidate is actually better.

Special Interests
Special interests often change policy to benefit themselves to the detriment of the rest of society. Firms may lobby the government to lower their taxes, which pushes the burden of the cost of government to others. Governments may place tariffs on specific goods, which helps particular firms by limiting competition from abroad, but at the cost of higher prices for consumers. But how do these policies come about? If they hurt the median voter, should the majority be able to block them? Beneficiaries of the policies are often well organized and highly motivated to lobby, but the costs are dispersed over many poorly-motivated victims. Special interests can ally themselves with a more sympatheic group. So the cannonical example is that both bootleggers and Baptists are in favor of prohibition. The bootleggers want it because it raises their profits and the Baptists want it for moral reasons. Whatever the tactic, special interests often get their way in politics to the detriment of the masses.

Lack of Market Institutions
The free market is an incredible institutions for solving problems which relies on incentives, information, prices, and property rights to function properly. Governments often do not use market prices to allocate resources; they allocate by fiat in an inflexible way. When a law is passed, prices and circumstances might be different than when it is implemented resulting in inefficient behavior. This problem is exacerbated by price controls, which destroy the ability of supply and demand to function. Fortunately, most governments have given up on price controls as a way to direct economic behavior. Government agencies are rarely run for profit, which means that managers are not rewarded for improving efficiency or customer satisfaction. While inefficient firms can go out of business, inefficient agencies can blunder about for decades after they have lost any ability to improve societal outcomes. Finally, it is very rare for government run institutions to have any competition whatsoever. All the problems of monopoly as a failure apply whether that monopoly is government or privately run. Monopoly is certainly not an exclusively “market” phenomenon, given that many monopolies today have explicit governmental support. Governmental organizations can often not rely on market institutions to ensure efficient functioning.

Conclusion
The exclusive focus on market instead of governmental failures is misleading. Government organizations are often just as “failed”, if not more, that market ones and suffer from their own set of problems. If society is to improve, both types of failures need to be understood and accounted for.

A Note:
James M. Buchanan died today. He was one of the two founders of the public choice school of economics, which studied government failures. Buchanan described his field as “politics without romance”.

Further Reading:
Arrow’s Impossibility Theorem
Garett Jones on Buchanan on Arrow
Wikipedia on Government Failure

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5 Comments leave one →
  1. January 9, 2013 1:08 pm

    “For example, if I go to the grocery store, I can buy apples and someone else can buy oranges without either of us harming the other.”

    How about an apples-to-apples comparison ;-). What if both people want apples, but there is only one apple left? Then I suppose they could bid on it. But that would cause the price to rise, and what if one of the people is poor and starving? Then I would find the the richer person bidding up the price of the apple to be morally suspect. The free market system seems to fail here to me.

    • January 9, 2013 1:59 pm

      The price will be bid up, but only along the supply curve. In theory, anyone willing to pay a premium of a single cent would be able to buy all the apples they wanted. How many times in your whole life has a grocery store been out of apples? If you assume a fixed supply by fiat, government control over the supply does nothing to aleviate the shortage. It’s just that the person with more political power will get the apple instead of the one who pays more for it.

      People don’t starve to death in a free market. There would be something that the poor person could trade for food, if only their labor. People starve to death all the time in countries with government run agriculture because food is allocated politically instead of by willingness to pay.

      • January 9, 2013 5:40 pm

        “People don’t starve to death in a free market” Let us not veer into hyperbole here. You know this statement can’t possibly represent the truth. I might accept that FEWER people will starve to death in a free market, but not zero people.

  2. January 9, 2013 9:07 pm

    While individuals may involuntarily starve in free market societies, famines don’t occur. Maybe I was exaggerating a bit, but not much. How many people are able to make it to a grocery store, and yet starve to death in America? Or any OECD country for that matter? I’m guess less than a handfull a year.

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