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Market Failure and Government Intervention

By attempting such complete control, the Russian government also took the complete blame for what occurs to the economy.  It is much easier to allow the private sector to handle the intricacies of the market and for government to step in whenever there are abuses.  Socialist and Communist governments throughout Europe and the Eastern block began a retreat toward reliance more on the private sector.  Specifically, many government industries are being sold to the private sector in a move called privatization.

D.  Information

The government should attempt to make more information available to allow markets to work competitively and efficiently.  However, under government auspices firms can often cooperate and prevent outsiders from getting information about the cooperative effort.  For example, when firms get together to lobby for a particular price control ceiling, or target price for protectionism, they may exclude other participants in the market who would be hurt by the policy.  Under the guise of national security, the government may withhold information about projects that it undertakes with firms; such insulation from public scrutiny prevents the forces of competition from controlling prices and costs. Ultimately whenever the government allows one firm in a market to gain a relative advantage in the acquisition of information, it prevents the competitive market from working efficiently.

E. Equity

Government must often define as well as find policies to achieve equity among the members of society.  Typically the government tries to use taxes and subsidies as a means for correcting inequities.  However, such policies may result in their own inequities.

When the government attempts to make transfers itself by taxing on the one hand and subsidizing on the other it faces substantial incentive problems.  First of all, the bureaucracy needed to administer such transfers is expensive and adds to the government deficit.  Secondly, the government finds it easier to disperse money than to collect it which means there tends to be a bias for the government to run a deficit.  Thirdly, the government's policies are likely to decrease private market incentives.  When the government taxes it inevitably penalizes earners.  Implicit in any tax policy is a marginal rate of taxation which indicates how much of every extra dollar earned is actually received as after tax income.  Instead of receiving a dollar for every dollar earned, individuals may receive only eighty cents which means there is a marginal tax rate of 20%.  High marginal taxation lessens the incentive for people to earn money.  Governments therefore face a tradeoff between equitable transfers and efficient incentives.

The analogy between the government and firms fails to account for the government's ability to tax.  Nevertheless, the fact that so many experienced business leaders believe in this analogy- whether right or wrong- means that larger government deficits trigger fears of inflation, higher interest rates, and heavy debt burdens for future generations.  These fears surface in market reactions to government financial data and attempts by the business community to reform government.

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