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Government Failure versus Market Failure

Government Failure versus Market Failure: Microeconomics Policy Research and Government Performance

Clifford Winston
Copyright Date: 2006
Pages: 130
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  • Book Info
    Government Failure versus Market Failure
    Book Description:

    When should government intervene in market activity and when is it best to let market forces take their natural course? How does the existing empirical evidence about government performance guide our answers to these questions? In this clear, concise book, Clifford Winston offers his innovative analysis -shaped by thirty years of evidence -to assess the efficacy of government interventions. Markets fail when it is possible to make one person better off without making someone else worse off, thus indicating inefficiency. Governments fail when an intervention is unwarranted because markets are performing well or when the intervention fails to correct a market problem efficiently. Winston concludes from existing research that the cost of government failure may actually be considerably greater than the cost of market failure: "My search of the evidence is not limited to policy failures. I will report success stories, but few of them emerged from my search." The prevalence of market failure is due to a lack of conviction in favor of markets, the inflexibility of intervening government agencies, and political forces that enable certain interest groups to benefit at the expense of society as a whole. Winston suggests that government policy can be improved by making greater use of market-oriented solutions that have already produced benefits in certain situations.

    eISBN: 978-0-8157-9391-5
    Subjects: Business

Table of Contents

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  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Foreword
    (pp. ix-x)
    Robert W. Hahn and Robert E. Litan

    How can economists help improve public policy? One way is by taking a serious look at the effectiveness of different kinds of policy interventions. That is exactly what Clifford Winston does in this important book assessing market failure and government failure. Winston’s careful and comprehensive analysis of the empirical evidence on the economic impact of government policies to correct market failures leads to some troubling insights. He finds that government interventions frequently occur when no significant market failure exists. In addition, many policies aimed at addressing market failures that do exist could have corrected them at significantly lower cost. Winston...

  4. Acknowledgments
    (pp. xi-xii)
  5. 1 Introduction
    (pp. 1-6)

    Shortly after he took office, President George W. Bush nominated Harvard professor John D. Graham to head the Office of Information and Regulatory Affairs within the Office of Management and Budget. Graham was known to be a strong advocate of using cost-benefit analysis to assess and reform environmental, health, and safety regulation. If, for example, the Environmental Protection Agency (EPA) proposed a regulation that saved 100 lives but at a cost of $1 billion per life, Graham would oppose the regulation and encourage the EPA to craft an alternative that could save these lives at a much lower cost that...

  6. 2 Methodological Perspective
    (pp. 7-12)

    Economists began systematically using the tools of applied welfare economics, also known as cost‒benefit analysis, as early as the 1960s to empirically assess government policies designed to correct market failures. Harberger (1971) gave applied welfare economics a theoretical framework that was distilled into three postulates: benefits and costs to consumers should be calculated using consumer surplus; benefits and costs to producers should be calculated using producer surplus; benefits and costs accruing to each group should normally be added without regard to the individual(s) to whom they accrue.

    Although Harberger’s framework has been refined, many empirical assessments of public policies calculate...

  7. 3 Market Power: Antitrust Policy and Economic Regulation
    (pp. 13-26)

    In the textbook model of perfect competition, firms earn a normal market rate of return in the long run. Of course, some firms may have superior technologies and management, which enable them to earn an above-normal rate of return for an indeterminate length of time. But when a firm attempts to capture consumer surplus by engaging in illegal conduct to monopolize a market or by abusing its market power, government policy, as codified in the antitrust laws, can improve consumer welfare by stopping these actions and discouraging other firms from engaging in such behavior.

    A market’s technological characteristics may give...

  8. 4 Social Regulation: Imperfect Information and Externalities
    (pp. 27-60)

    Competitive markets are an essential step toward efficient resource allocation, but efficiency also requires that buyers and sellers be fully informed and that their actions do not affect the welfare of others. Market participants can adjust their behavior to reduce the social cost of imperfect information and of consumption and production externalities, but information and externality policies may raise social welfare further. In theory, these so-calledsocial regulationsseek to protect public health, safety, and the environment by encouraging consumers and producers to take account of the effect of their actions on others’ utility.¹ In practice, the economic policy issue...

  9. 5 Public Production
    (pp. 61-72)

    A private firm will provide a good or service if it can earn a normal profit. Market failure occurs when a socially desirable service (that is, one whose social benefits exceed social costs) is not privately offered because it is unprofitable. Market failure also occurs when a service is undersupplied because it is a public good and susceptible to the free rider problem. A pure public good—defense and fresh air are probably the only examples—is nonrivalrous (nobody’s consumption lowers anybody else’s benefits) and nonexcludable (it is infeasible to prevent those who do not pay for the good from...

  10. 6 Policies to Correct Market Failures: Synthesis and Assessment
    (pp. 73-86)

    Economic theory identifies many situations where a market failure may arise and suggests how the government could correct the failure and improve economic efficiency. In practice, potential market failures such as market power and imperfect information do not appear to create large efficiency losses to the U.S. economy. However, market failures arising from externalities such as air and water pollution, hazardous wastes, and traffic congestion do impose significant social costs that government policy could reduce efficiently.

    Based on the assessments discussed here and summarized in table 6-1, government policy to correct market failures is characterized by two major flaws—that...

  11. 7 Market Failure and Social Goals Policies: Common Failures and Conflicts
    (pp. 87-92)

    Thus far, I have confined my assessment to policymakers’ efforts to improve U.S. microeconomic efficiency by correcting market failures. However, American society, like any society, seeks to solve other social problems. U.S. policymakers have therefore enacted an array of social goals policies that can be categorized broadly as attempting to reduce poverty, ensure fairness in labor markets, and provide merit goods.¹

    Although these policies redistribute resources from one group of citizens for the benefit of another group of citizens, I do not believe that they conflict with efficiency to such an extent that policymakers and citizens must resign themselves to...

  12. 8 Policy Recommendations Motivated by Policymakers’ Learning
    (pp. 93-102)

    The ultimate purpose of this assessment is to identify ways that market failure policies can be improved. But unless policymakers have shown that they are capable of improving these policies, it is naïve to believe that any policy recommendations will have a constructive effect. My static assessment has identified few policy successes, but, in fact, policymakers have learned from counterproductive policies in certain areas and appropriately reformed their policies to varying degrees. I draw on these improvements to suggest other plausible ways in which policymakers could enhance the efficiency of market failure policies.

    It is as difficult to offer a...

  13. 9 Microeconomics Policy Research and the Policy Community
    (pp. 103-108)

    Economists who conduct theoretical or empirical studies of policy issues undoubtedly wish to have an impact beyond the academic community. Microeconomics policy research can contribute and has contributed to policy formation by attracting the attention of government staff members who are trained in economics and can distill the essential ideas for policymakers. For instance, according to Derthick and Quirk (1985), economic deregulation would never have occurred if microeconomists had not generally supported it through their research. DOJ’s and FTC’s approach to antitrust policy and FTC’s approach to information policy have benefited from economists’ greater understanding of market behavior. Notwithstanding these...

  14. References
    (pp. 109-124)
  15. Index
    (pp. 125-130)
  16. Back Matter
    (pp. 131-133)