Government failure occurs when the intervention in the free market by the government does not correct market failure but leads to inefficiency. The intervention fails to correct inefficiency in the market and creates problem or economic welfare loss. The reasons for government failure are explained below.
Government may not have the adequate information to determine the appropriate amount of subsidies and taxes required to ensure the consumption of adequate amount of goods in the economy. It has to value both external benefits and external costs from information it gathers from different sources. This information may not be readily available. There may also be uncertainty about the consequences (positive or negative) of its policy intervention in the economy.
Disincentive of taxation
Progressive taxation, which is often used to redistribute income, may discourage hard-work since the higher the income the higher the tax rate. Indirect taxes, that are meant to reduce consumption of demerit goods, will reduce supply and raise prices. This will create a welfare loss (deadweight loss) because the desired production and consumption will not take place.
The government sometimes takes decisions based on political considerations rather than economic considerations. It tries as much as possible to implement policies that are unpopular with the populace even if they are the most appropriate ones. The reason is to avoid being voted out of power in the next election. Therefore, the intervention does not correct the problem but leads to inefficient use of scarce resources.
The lengthened administrative procedures in government make decision-making slow. The circumstances might have changed by the time the policy is approved and implemented. Bureaucratic bottlenecks make it hard for the government to respond to changes in a timely manner. It ends up implementing outdated policies that could worsen the situation.
Frequent changes in government policies
Frequent changes in government policies may create business uncertainty as firms cannot easily plan based on prevailing policies on taxation, price controls, subsidies and other areas of the economy. This affects the effectiveness of policies in tackling market failure.
Disincentive of subsidies
Many loss-making and inefficient businesses are subsidised at tax payers” expense. Subsidies give the recipient firms unfair advantage over competitors because their prices are much lower. Over-reliance on government subsidies breeds inefficiency as firms do not attempt to cut costs and improve supply on their own. Without subsidies, the firms could reallocate resources to areas where they are needed more.
Disincentive of welfare benefits
The payment of benefits to the poor and the unemployed, in a bid to reduce inequality, will reduce their effort to improve their skills and get a good job. They may also engage in risky behaviour, such as smoking, if they enjoy free healthcare from the government.
Government intervention may produce undesirable outcomes that were not anticipated when the policies were designed. Therefore, the policies may fail to correct the market failure they were intended to correct and create additional problems.
The government may use a short-term solution for an issue that requires a long-term solution. The policy provide a temporary solution which does not address the underlying problem. The policy may be hurriedly designed and not well-thought out. It may provide a short-lived reprieve before a total collapse is experienced. This leads to government failure. Short-termism is also called policy myopia.
This occurs when the government officials start working for the interests of the firms they are supposed to regulate but not the interests of the members of the public. The regulators build relationship with the firms over time and start supporting their actions instead of serving the interests of the consumers. In other words, they are not totally independent and could be pressurised to work in favour of the industry they are regulating. The regulators may also succumb to pressure to act in such a way that will further the political interests of the government in power; this may result in misallocation of resources.