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Government failure

Government failure, in the context of public economics, is an economic inefficiency caused by a government intervention, if the inefficiency would not exist in a true free market.[1] It can be viewed in contrast to a market failure, which is an economic inefficiency that results from the free market itself, and can potentially be corrected through government regulation. The idea of government failure is associated with the policy argument that, even if particular markets may not meet the standard conditions of perfect competition required to ensure social optimality, government intervention may make matters worse rather than better.

As with a market failure, a government failure is not a failure to bring a particular or favored solution into existence but is rather a problem which prevents an efficient outcome. The problem to be solved need not be a market failure; governments may act to create inefficiencies even when an efficient market solution is possible.

Government failure (by definition) does not occur when government action creates winners and losers, making some people better off and others worse off than they would be without governmental regulation. It occurs only when governmental action creates an inefficient outcome, where efficiency would otherwise exist. A defining feature of government failure is where it would be possible for everyone to be better off (a Pareto improvement) under a different regulatory environment.

Examples of government failure include regulatory capture and regulatory arbitrage. Government failure may arise because of unanticipated consequences of a government intervention, or because an inefficient outcome is more politically feasible than a Pareto improvement to it. Government failure can be on both the demand side and the supply side. Demand-side failures include preference-revelation problems and the illogics of voting and collective behaviour. Supply-side failures largely result from principal–agent problem.[2]


The phrase "government failure" emerged as a term of art in the early 1960s with the rise of intellectual and political criticism of government regulations. Building on the premise that the only legitimate rationale for government regulation was market failure, economists advanced new theories arguing that government interventions in markets were costly and tend to fail.[3]

An early use of "government failure" was by Ronald Coase (1964) in comparing an actual and ideal system of industrial regulation:[4]

Contemplation of an optimal system may provide techniques of analysis that would otherwise have been missed and, in certain special cases, it may go far to providing a solution. But in general its influence has been pernicious. It has directed economists’ attention away from the main question, which is how alternative arrangements will actually work in practice. It has led economists to derive conclusions for economic policy from a study of an abstract of a market situation. It is no accident that in the literature...we find a category "market failure" but no category "government failure." Until we realize that we are choosing between social arrangements which are all more or less failures, we are not likely to make much headway.

Roland McKean used the term in 1965 to suggest limitations on an invisible-hand notion of government behavior.[5] More formal and general analysis followed[6] in such areas as development economics,[7] ecological economics,[8] political science,[9] political economy,[10] public choice theory,[11] and transaction-cost economics.[12]


Economic crowding outEdit

Crowding out is the displacement of private sector investment by way of higher interest rates, when the government expands its borrowing to finance increased expenditure or tax cuts in excess of revenue. Government spending is also said to crowd out private spending by individuals.[13]


Regulatory arbitrage is a regulated institution's taking advantage of the difference between its real (or economic) risk and the regulatory position.[14]

Regulatory capture is the co-opting of regulatory agencies by members of or the entire regulated industry. Rent seeking and rational ignorance are two of the mechanisms which allow this to happen.

Regulatory risk is the risk faced by private-sector firms that regulatory changes will hurt their business.[15]

Alexander Hamilton of the World Bank Institute argued in 2013 that rent extraction positively correlates with government size even in stable democracies with high income, robust rule of law mechanisms, transparency, and media freedom.[16]

See alsoEdit


  1. ^ Orbach, Barak (2013). "What Is Government Failure," Yale Journal on Regulation Online, 30, pp. 44-56.
  2. ^ Connolly, S. & Munro, A. (1999). 'Public Choice', Chapter 8 in Economics of the Public Sector, Pearson, Harlow, Essex.
  3. ^ Id.
  4. ^ Coase, Ronald (1964). "The Regulated Industries: Discussion," American Economic Review, 54(2), p. 195, as quoted in Oliver E. Williamson (2002), "The Lens of Contract: Private Ordering," American Economic Review, 92(2), pp. 438-443.
  5. ^ McKean, Roland N. (1965), "The Unseen Hand in Government," "American Economic Review," 55(3), pp, 496-506.
  6. ^ • Charles J. Wolf, (1979). "A Theory of Non-Market Failure," Journal of Law and Economics, 22 (1), pp. 107–139.
      • _____ (2003). Markets Or Governments: Choosing between Imperfect Alternatives, MIT Press. Description and chapter-preview links.
      • Mrinal Datta-Chaudhuri (1990). "Market Failure and Government Failure." Journal of Economic Perspectives, 4(3), pp. 25-39[dead link].
      • Aidan R. Vining and David L. Weimer (1990). "Government Supply and Government Production Failure: A Framework Based on Contestability," Journal of Public Policy Journal of Public Policy, 10(1), pp 1-22. Abstract.
      • Joseph E. Stiglitz (1998). "The Private Uses of Public Interests: Incentives and Institutions," Journal of Economic Perspectives, 12(2), pp. 3-22.
      • Richard O. Zerbe Jr. and Howard E. McCurdy (1999). "The Failure of Market Failure," Journal of Policy Analysis and Management, 18(4), pp. 558–578. Abstract. Reprinted in Economic Efficiency in Law and Economics," pp. 164-87.
      • Clifford Winston (2006).
    Government Failure versus Market Failure: Microeconomics Policy Research and Government Performance. Brookings Institution Press. Link. Archived 2011-04-29 at the Wayback Machine
  7. ^ Anne O. Krueger (1990). "Government Failures in Development," Journal of Economic Perspectives, 4(3), pp. 9-23.
      • Eduardo Wiesner (1998). "Transaction Cost Economics and Public Sector Rent-Seeking in Developing Countries: Toward a Theory of Government Failure," in E. Wiesner and R. Picciotto, ed. Evaluation and Development: The Institutional Dimension, pp. 108-23. World Bank.
  8. ^ Thomas Andersson (1991). "Government Failure – the Cause of Global Environmental Mismanagement," Ecological Economics, 4(3), pp. 215–236. Abstract.
  9. ^ Julian Le Grand (1991). "The Theory of Government Failure," British Journal of Political Science, 21(4), pp. 423-442.[permanent dead link]
      • Eduardo Wiesner (1998). "Transaction Cost Economics and Public Sector Rent-Seeking in Developing Countries: Toward a Theory of Government Failure," in E. Wiesner and R. Picciotto, ed. Evaluation and Development: The Institutional Dimension, pp. 108-23. World Bank.
  10. ^ Oliver E. Williamson (1995). "The Politics and Economics of Redistribution and Inefficiency," Greek Economic Review, December, 17, pp. 115-136, reprinted in Williamson (1996), The Mechanisms of Governance, Oxford University Press, ch. 8, pp. 195- 218.
       • Sturzenegger, Federico, and Mariano Tommasi (1998). The Polítical Economy of Reform, MIT Press. Description Archived 2012-10-11 at the Wayback Machine and links to chapter-previews and "failure".
       • Sharun W. Mukand (2008). "policy reform, political economy of," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
       • Buchanan James M. (2008). "public debt," The New Palgrave Dictionary of Economics , 2nd Edition The New Palgrave Dictionary of Economics (2008), 2nd Edition.Abstract.
  11. ^ • Buchanan James M. (1983). "The Achievement and the Limits of Public Choice in Diagnosing Government Failure and in Offering Bases for Constructive Reform," in Anatomy of Government Deficiencies, ed. Horst Hanusch (Berlin: Springer-Verlag, 1983), pp. 15–25.
      • Gordon Tullock et al. (2002), Government Failure: A Primer in Public Choice, Cato Institute. Description and scroll-down for preview.
  12. ^ Richard O. Zerbe Jr. and Howard E. McCurdy (1999). "The Failure of Market Failure," Journal of Policy Analysis and Management, 18(4), pp. 558–578. Abstract. Reprinted in Zerbe (2001), Economic Efficiency in Law and Economics," pp. 164-87.
  13. ^ Blanchard, Olivier Jean (2008). "crowding out," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
        • Shaghil Ahmed (1986). "Temporary and Permanent Government Spending in an Open Economy," Journal of Monetary Economics, 17(2). pp. 197–224)
  14. ^ Stephen Breyer (1979). "Analyzing Regulatory Failure: Mismatches, Less Restrictive Alternatives, and Reform," Harvard Law Review, 92(3), pp. 547-609[permanent dead link].
       • Joseph E. Stiglitz (2009). "Regulation and Failure," in David Moss and John Cisternino (eds.), New Perspectives on Regulation, ch. 1, pp. 11-23. Cambridge: The Tobin Project.
  15. ^ "Regulatory risk". Retrieved 2013-10-21.
  16. ^ Hamilton, Alexander J. (2013). "Small is Beautiful, at Least in High-Income Democracies: The Distribution of Policy-Making Responsibility, Electoral Accountability, and Incentives for Rent Extraction" (PDF). The World Bank Institute. Policy Research Working Paper 6305. This paper hopes to contribute towards an explanation of these empirical regularities by developing and testing a new contextually enriched career concerns model of the political economy of public policy-making. Cite journal requires |journal= (help)