Government failure versus market failure
A lot of economists in Australia like to talk about ‘market failure’ and ‘externalities’. But there is another side that needs to be weighed up and quantified, that of ‘government failure’. To justify government intervention, not only do policymakers need to show that there’s a market failure, they also need to show that government intervention would produce better results. This is indeed very difficult to show, and people tend to skip over this step.
The following is a classic exposition of government failure, taken from Milton Friedman’s Free to Choose. I have numbered the items serious economists should quantify under the heading ‘Possible costs of government failure’ when proposing policy:
Almost everything we do has some third-party effects, however small and however remote. In consequence, [this may] appear to justify almost any proposed government measure. But there is a fallacy. Government measures also have third-party effects. ‘Government failure’ no less than ‘market failure’ arises from ‘external’ or ‘neighbourhood’ effects. And if such effects are important for a market transaction, they are likely also to be important for government measures intended to correct the ‘market failure’…
[1.] If it is difficult for private parties to identify who imposes costs or benefits on whom, it is difficult for government to do so. As a result a government attempt to rectify the situation may very well end up making matters worse rather than better – imposing costs on innocent third parties or conferring benefits on lucky bystanders…[Would government intervention make matters worse?]
[2.] To finance its activities it must collect taxes, which themselves affect what the taxpayers do – still another third-party effect. [What would be the unintended consequences or deadweight costs of taxation to finance this government progam?]
[3.] In addition, every accretion of government power for whatever purpose increases the danger that government, instead of serving the great majority of its citizens, will become a means whereby some of its citizens can take advantage of others. [Would government agencies charged with implementing the programme get captured by vested interests?].
[4.] We should develop the practice of examining both the benefits and the costs of proposed government interventions and require a very clear balance of benefits over costs before adopting them. This course of action is recommended not only by the difficulty of assessing the hidden costs of government intervention but also by another consideration. Experience shows that once government undertakes an activity, it is seldom terminated. The activity may not live up to expectation but that is more likely to lead to its expansion, to its being granted a larger budget, than to its curtailment or abolition. [Is this the sort of program that is likely to be able to be terminated if it does not perform well? Or would it become too politicised?]
The lesson from this is ‘not that government intervention is never justified, but rather that the burden of proof should be on its proponents‘. This is commonsense. If you want the rest of the population to suffer higher taxes to pay for your grand public health schemes, public universities, etc you had better prove that it works, and that it works well. Unfortunately, the evidence points in the opposite direction. Most government programs never achieve their intended objectives. Even supporters of public health acknowledge it has poor outcomes. But their solution is usually to throw more money at the problem! We would be better off having lower tax, eliminating the churning, and paying for services ourselves.
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