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Market Failure and Government Intervention

Perhaps the greatest evidence of the government’s failure to think through the basis for its tax and subsidy policies are the contradictions between its taxes and subsidies.  Tobacco is a classic case.  While consumption of cigarettes is heavily taxed due to the negative consumption externalities on health, for a very long time, the government also subsidized tobacco farmers.  Similarly, while the government has provided indirect subsidies through protection to the steel industry it has taxed and regulated the asbestos pollution caused by mining iron.  While subsidizing medical education, the government will heavily tax doctors’ services and institute malpractice regulations and billing requirements that are highly punitive and discouraging.

F.  Lags and Dynamic Government Failure

As in the private market, lags can play a destabilizing role in the government's interaction with markets.  There are four basic lags between the time that a problem arises and the time that the government does something about it:

(1)  Recognition lag.  Between the time a problem occurs and the time it is recognized as a problem by a government there is a recognition lag.  

(2)  Response lag.  Between the time a problem is recognized and the time that a decision is made about what to do there is a response lag.  

(3)  Implementation lag.  Between the time a problem is responded to and the time that action is taken, there is an implementation lag.  

(4)  Impact lag.  Between the time of implementation and the time when the final impact is felt, there is an impact lag.  

If the pollution problem of ozone were to progressively deteriorate the above schedule could be far too slow to take care of the problem. The government would always be responding with too little action, too late and there would be clear government failure.  

Government involvement is no guarantee that a market failure can be corrected.  In evaluating whether or not a government should intervene in the market, the problems of government failure must be weighed against the problems of market failure.  Unless the government can clearly and efficiently correct a market failure it should generally not interfere.  When it does have to interfere, then it should do so with the minimum restraint that is necessary.

The problem of deciding whether or not the government should intervene reduces to a problem of weighing market failures against government failures.  As shown in Table 17-5, there are many market failures (left hand column)  that might justify government intervention (middle column).  However, the government failures (right hand column) may potentially be worse than the market failures that are to be corrected.  The political process must be relied upon to weigh government failure and market failure before the government intervenes.  As part of this process,

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