government failure essay

Examples of how government intervention can cause government failure

Explanation of why government intervention to try and correct market failure may result in government failure.

Market failure is a socially inefficient allocation of resources in a free market. Market failure can occur for various reasons

• Externalities
• Demerit/merit goods
• Public goods
• Monopoly power

Government failure occurs when government intervention results in a more inefficient and wasteful allocation of resources. Government failure can occur due to:

• Poor incentives in public sector
• Lack of information
• Bureaucracy and administration costs higher in public sector
• Decisions taken for political reasons

Example of government intervention in transport

Transport is prone to market failure as it is a good with significant externalities. For example, driving a car into a city causes congestion and pollution – two negative externalities. Therefore, we get a social inefficient allocation of resources – congestion and time wasted by business and commuters.

The free market output is at Q1, but social efficiency is at Q2.

To respond to this problem, the government may try to intervene in the economy. For example, it could raise taxes and build a new highway, which travels into the city. In theory, this should reduce congestion and help solve the market failure. However, in building a new inter-city highway, there may be government failure.

Unintended consequences . As a result of building the new highway, it may encourage more people to buy a car and live further out of the city. In this case, increasing supply has an effect on increasing demand in the long-term. After 5 or 10 years, the levels of congestion can end up being as bad as before the government spent all the money in building the new road. But, in addition to the failure to solve congestion, the government have increased levels of pollution and wasted public funds on a scheme that has failed to tackle the problem.

The government may undertake such a scheme due to poor planning. A new highway may be a popular political idea in the short-term by residents keen to beat traffic jams. However, the politicians fail to explain the potential drawbacks of more congestion in the long-term.

Example of Subsidy for loss-making firm

The government may be worried that if a large steel plant closes down, it will result in unemployment. This unemployment will be a type of market failure as the unemployed steelworkers may struggle to gain employment in new areas. As a result, the government uses public funds to give a subsidy to the steel plant and keep the firm in business.

However, government subsidies to failing business can lead to government failure.

If firms become used to receiving a government subsidy, they may feel fewer incentives to cut costs and transform the business – they become reliant on subsidies and the government ends up wasting public funds on supporting inefficient firms. In the long-run, consumers end up paying higher taxes and higher prices for steel

Example of Market failure in agriculture – CAP

Minimum price caused supply to be greater than demand. The EU had to buy the surplus Q3-Q1

Governments often intervene in agricultural markets. The argument is that agriculture is prone to market failure. Supply can be volatile and in certain years farmers are left with lower incomes. Therefore, to stabilise food supply and farm incomes, the government have intervened. The EEC implemented a Common Agricultural Policy (CAP) which involved guaranteeing a minimum price for agricultural produce.

However, this also required import tariffs to keep the minimum prices protected from international competition.

The problem with this policy is that it had unintended consequences. As farmers had a guaranteed minimum price, it created an incentive for them to produce as much as possible. It was guaranteed the government would buy any surplus.

• Farmers started using more artificial fertilisers to maximise yields.
• The EU had to keep buying more an more surplus food, which was stored in big depositories (known as wine lakes, butter mountains)
• The food was either destroyed or dumped on world markets (causing lower income for farmers in developing economies)

Therefore, in order to overcome the market failure of volatile prices for farmers, the EU created a system where:

• The price of food was higher than it should have been.
• Tax revenue was used to buy surplus food that was not needed.
• The environment was damaged by farmers trying to maximise yields.
• The EU experienced retaliatory tariffs from other countries in response to high agricultural tariffs on food.
• At its peak the CAP took 70% of the EU budget – money that could have been better spent elsewhere.

Example Monopoly

Monopoly leads to market failure because firms are in a position to increase prices at the expense of the consumer and be more inefficient. To prevent an increase in Monopoly power, the Competition Commission can block mergers; however, some mergers could have benefits e.g. economies of scale and more research and development. If the government blocked all mergers this may be harmful to the economy

 Further reading

• How can the government avoid government failure?
• Government failure
• Market failure

What Is Government Failure?

The phrase “government failure” as a term of art originated in the critique of government regulation that emerged in the 1960s. This critique premised that “market failures” were the only legitimate rationale for regulation. Although the phrase is a popular currency in scholarship and politics, people attribute to it different values. As a result, all seem to expect the government to fail, many believe that government inaction cannot constitute a failure, and alleged failures tend to be disputed. This essay seeks to establish a coherent meaning for the term “government failure” and its relatives (e.g., “government breakdown,” “regulatory failure”).

I. Introduction

In Capitalism and Freedom , Milton Friedman explained why “the scope of the government must be limited.” 1 1. Milton Friedman, Capitalism and Freedom 2 (1962). “The existence of a free market,” Friedman wrote, “does not . . . eliminate the need for government. On the contrary, government is essential both as a forum for determining the ‘rules of the game’ and as an umpire to interpret and enforce the rules decided on. What the market does is . . . minimize the extent to which the government need participate directly in the game.” 2 2. Id. at 15. Friedman firmly believed that it was not “an accident that so many . . . government reforms [go] awry.” 3 3. Id. at 196. The “central defect” of regulatory measures, he argued, is that “they seek through government to force people to act against their own immediate interests in order to promote a supposedly general interest.” 4 4. Id. Under this thesis, the government is likely to fail whenever it interferes with the freedom of choice. Thus, since “pretty much all law consists in forbidding [people] to do some things that they want to do,” 5 5. Adkins v. Children’s Hospital, 261 U.S. 525, 568 (1923) (Holmes, J., dissenting). the failure is inevitable.

The concept of “government failure” is somewhat peculiar. People and institutions may fail in their actions, but they may also fail by not taking action. The phrase “government failure,” however, as it is commonly used, connotes ineffective government action, implying that less government action is necessarily better. 6 6. See generally Peter L. Kahn, The Politics of Unregulation: Public Choice and Limits on Government , 75 Cornell L. Rev. 280 (1990). In Milton Friedman’s words: “[T]he government solution to a problem is usually as bad as the problem and very often makes the problem worse.” 7 7. Milton Friedman, An Economist’s Protest 6 (1975). See also Milton Friedman, Why Government is The Problem (1993).

The phrase “government failure” emerged as a term art is in the 1960s with the rise of intellectual and political criticism of regulation. 8 8. See, e.g. , Roland N. McKean, The Unseen Hand in Government , 55 Am. Econ. Rev. 496 (1965); Charles Wolf, Jr., A Theory of Nonmarket Failure: Framework for Implementation Analysis , 22 J. L. & Econ. 107 (1979). See also Barry Goldwater, Consciences Of A Conservative (1960) (introducing a general critique of government regulation). Building on the premise that the only legitimate rationale for government regulation is market failure, 9 9. See Francis M. Bator, The Anatomy of Market Failure , 72 Q.J. Econ. 351 (1958). Executive Order 12,866 states that “material failures of private markets to protect or improve the health and safety of the public, the environment, or the well-being of the American people” may establish a “compelling public need” for regulation. Exec. Order No. 12,866 § 1. economists advanced new theories explaining why government interventions in markets are costly and tend to fail. This line of literature supposedly established the theoretical foundations of the phrase “government failure.”

Despite their growing popularity, the phrase “government failure” and its relatives ( e.g. , “government breakdown,” “regulatory failure”) do not have any clear meaning. 10 10. See generally Cary Coglianese ed., Regulatory Breakdown: The Crisis Of Confidence In U.S. Regulation (2012). Some use these phrases to describe government intervention in the private domain that results in undesirable outcomes. For others, these phrases may also mean lack of or inadequate government regulation. Yet, many identify a government failure in any perceived societal problem. Thus, people who use the phrase “government failure” often disagree with each other about what a failure means. Neither the prevalence of studies of government failures nor the use of the phrase “government failure” necessarily says much about the standards of “failure.”

This essay intends to clarify the general meaning of the term “government failure” by focusing on a few properties of failures.

[Figure 1: omitted] 11 11. For the methodology and its limitations, see Jean-Baptiste Michel et al., Quantitative Analysis of Culture Using Millions of Digitized Books , 331 Sci. 176 (2011).

II. Inaction as a Failure

Can government inaction ever be a failure? A byproduct of the controversy over regulation is an artificial distinction between action and inaction. 12 12. The analysis of the distinction is of course rather old. For example, Thomas Aquinas distinguished between sins of commission and sins of omission, arguing that the latter are “less grievous” than sins of commission, but stressed that inaction may constitute a sin. Thomas Aquinas, 1 The Summa Theologica 316-20 (Fathers of the English Dominican Province trans., 1981). On one side of the controversy, people see over-regulation. On the opposite side, people observe insufficient regulatory safeguards―too little regulatory action or frequent inaction. 13 13. See generally Nicholas Bagley & Richard L. Revesz, Centralized Oversight of the Regulatory State , 106 Colum. L. Rev. 1260 (2006). These opposite perspectives delineate the approaches to government inaction. Some posit that inaction cannot be scrutinized, let alone considered a failure, 14 14. See, e.g. , Heckler v. Chaney, 470 U.S. 821, 831-32 (1985): The reasons for (the general unsuitability for judicial review of agency decisions to refuse enforcement) are many. First, an agency decision not to enforce often involves a complicated balancing of a number of factors which are peculiarly within its expertise. (T)he agency must . . . assess whether a violation has occurred, . . . whether agency resources are best spent on this violation or another, whether the agency is likely to succeed if it acts, whether the particular enforcement action requested best fits the agency’s overall policies, and (other factors). . . . In addition(,) . . . when an agency refuses to act it generally does not exercise its coercive power over an individual’s liberty or property rights, and thus does not infringe upon areas that courts often are called upon to protect. . . . while others maintain that similar rules should apply to action and inaction. 15 15. See, e.g. , Bagley & Revesz, supra note 35.

Superficially, both positions may appear plausible. Indeed, both positions have strong expressions in the case law of the U.S. Supreme Court, 16 16. See, e.g. , DeShaney v. Winnebago County Dept. of Soc. Servs., 489 U.S. 189 (1989) (holding in a 6-3 decision that a local social service worker’s failure to prevent child abuse did not violate the Due Process Clause although the social worker “had reason to believe” abuse was occurring.); Massachusetts v. EPA, 549 U.S. 497 (2007) (holding in a 5-4 decision that the EPA’s denial of a petition for rule making was “arbitrary, capricious, or otherwise not in accordance with law”); Caperton v. A.T. Massey Coal Co., Inc., 556 U.S. 868 (2009) (holding in a 5-4 decision that a judge’s failure to recuse, when a “probability of actual bias” exists, may make him subject to disqualification). and in the academic literature. 17 17. See, e.g. , Lisa Schultz Bressman, Judicial Review of Agency Inaction: An Arbitrariness Approach , 79 N.Y.U. L. Rev. 1657 (2004); William N. Eskridge, Jr., Interpreting Legislative Inaction , 87 Mich. L. Rev. 67 (1988); Kahn, supra note 8; Peter H.A. Lehner, Judicial Review of Administrative Inaction , 83 Colum. L. Rev. 627 (1983); Ronald M. Levin, Understanding Unreviewability in Administrative Law, 74 Minn. L. Rev. 689 (1990); Glen Stazsewski, The Federal Inaction Commission , 59 Emory L.J. 369 (2009); David A. Strauss, Due Process, Government Inaction, and Private Wrongs , 1989 Sup. Ct. Rev. 53 (1989); Cass R. Sunstein, Reviewing Agency Inaction After Heckler v. Chaney , 52 U. Chi. L. Rev. 653 (1985). Several legal standards—such as standing, 18 18. See, e.g. , Allen v. Wright, 468 U.S. 737 (1984) (denying standing to petitioners who sought to challenge agency inaction, specifically the agency’s failure to adopt standards for denying tax exemptions from racially segregated private schools); Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992) (denying standing to petitioners that sought to challenge agency inaction—the Secretary of Interior’s refusal to enforce certain requirements of the Endangered Species Act); Massachusetts v. EPA, 549 U.S. 497 (granting standing to petitioners that that sought to challenge agency inaction— The EPA’s refusal to regulate greenhouse gas emissions). the interpretation of legislative inaction, 19 19. See Eskridge, supra note 37. Justice Scalia articulated the strongest opposition against giving any meaning to legislative inaction. See, e.g. , Johnson v. Transp. Agency, Santa Clara Cnty., Cal., 480 U.S. 616, 672 (1987) (Scalia, J., dissenting) (“vindication by congressional inaction is a canard”). and the un-reviewability presumption 20 20. The unreviewability presumption supposedly shields agencies’ inaction from judicial review. See Heckler v. Chaney, 470 U.S. 821, 832-33 (1985) (holding that an administrative agency’s decision not to take action is “presumptively unreviewable; the presumption may be rebutted where the substantive statute has provided guidelines for the agency to follow in exercising its enforcement powers.”) In Massachusetts v. EPA , the Court clarified—effectively narrowed—the presumption, distinguishing rulemaking denials from decisions not to enforce and holding that the former are subject to judicial review. Massachusetts v. EPA, 549 U.S. 497 (2007). — frequently serve as tools for dismissing critique of inaction.

But distinction is artificial and analytically flawed. Values and other preferences often shape views regarding its relevance. For example, consider action and inaction of individuals. Assume an individual can take an action that would prolong her life, but some individuals do not take such action. Should the state require action? In Cruzan v. Missouri , Justice Antonin Scalia was willing to “acknowledge that the distinction between action and inaction has some bearing.” 21 21. Cruzan by Cruzan v. Dir., Missouri Dep't of Health, 497 U.S. 261, 296 (1990). “It would not make much sense”, he explained, “to say that one may not kill oneself by walking into the sea, but may sit on the beach until submerged by the incoming tide; or that one may not intentionally lock oneself into a cold storage locker, but may refrain from coming indoors when the temperature drops below freezing.” 22 22. Id. Justice Scalia, therefore, argued that the distinction between action and inaction might be utterly irrelevant. 23 23. Id. at 296-97.

In National Federation of Independent Business v. Sebelius (“ NFIB ”), the Court considered a similar issue: the validity of the so-called “individual mandate,” a minimum coverage of health insurance policy. Writing for the Court, Chief Justice John Roberts declared that “[t]o an economist, perhaps, there is no difference between activity and inactivity[, but] the distinction between doing something and not doing nothing would not have been lost on the Framers, who were ‘practical statesmen,’ not metaphysical philosophers.” 24 24. National Federation of Independent Business v. Sebelius, 132 S.Ct. 2566, 2589 (2012). In NFIB , Justice Scalia agreed with the Chief Justice on this point.

Moreover, government inaction means, among other things, accommodation of externalities. The underlying logic of exempting government inaction from scrutiny is that “government actions can violate the Constitution, but government failures to act against private wrongdoers cannot.” 25 25. David A. Strauss, Due Process, Government Inaction, and Private Wrongs , 1989 Sup. Ct. Rev. 53, 53 (1989). See also David A. Strauss, Why Was Lochner Wrong? , 70 U. Chi. L. Rev. 373 (2003). Under this premise, for example, environmental regulation violates polluters’ constitutional rights, while government inaction on environmental issues does not violate the rights of those affected by pollution. Similarly, gun control measures abridge Second Amendment rights, but government inaction concerning gun control does not abridge victims’ rights. Or, restrictions on tobacco sales infringe constitutional rights of businesses, whereas inaction on tobacco does not infringe the public rights. 26 26. See, e.g. , Walgreen Co. v. San Francisco, 185 Cal. App. 4th 424 (2010) (addressing San Francisco’s ban on sales of tobacco products in pharmacies). And so on.

In sum, the distinction between action and inaction is often a matter of framing, and cannot be depicted as substantive. When applied to the government, the distinction narrows the government’s fundamental duty to “restrain men from injuring one another.” 27 27. See, e.g. , Thomas Jefferson, Inaugural Address, 10 Annals Of Cong. 763, 765 (1801) (“(A) wise and frugal Government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned.”). If government inaction cannot constitute a failure, than people are free to harm each other, including by imposing one’s costs on society.

III. Imperfection as a Failure

What degree of imperfection defines a government failure? Thomas Aquinas taught believers that “[t]o sin is to fall short of a perfect action” 28 28. Aquinas, supra note 14, at 138. and that “sinning is . . . a deviation from that rectitude which an act ought to have.” 29 29. Id. at 312. Today, people understand that the pursuit of perfection is impractical. 30 30. See, e.g. , Herbert A. Simon, Models of Man 198 (1957) (“The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world.”). For example, in corporate law, fiduciary duties and the business judgment rule emphasize that officers and directors can make mistakes. 31 31. See, e.g. , In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996); In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del. Ch. 2009); Stone v. Ritter, 911 A.2d 362 (Del. 2006); In re Walt Disney Co. Derivative Litigation, 907 A.2d 693 (Del. Ch. 2005); Brehm v. Eisner, 906 A.2d 27 (Del. 2006). Yet, people sometimes perceive deviations of public policies from ideal norms or theoretical solutions as government failures. Such perceptions, the so-called nirvana fallacy, 32 32. Harold Demsetz, Information and Inefficiency: Another Viewpoint , 12 J. L. & Econ. 1, 1 (1969) (criticizing the “nirvana approach” to public policy). are common among both critics and advocates of regulation. In effect, they reflect unrealistic demands for perfection in the spirit of Thomas Aquinas. 33 33. See Barak Orbach, What Is Regulation? , 30 Yale J. Reg. Online 1, 6 (2012) (defining “regulation” as “state intervention in the private domain, which is a byproduct of our imperfect reality and human limitations.”).

In this spirit, many critics of regulation focus on ideal norms of liberty and freedom, and believe that most regulatory measures are imperfect and fail society; that is, “government is the problem.” 34 34. President Ronald Reagan’s Inaugural Address, 127 Cong. Rec. 715, 716 (1981). Likewise but with different values, many advocates of regulation are troubled by “problems”—imperfections in our world—and believe that society can address such problems with regulations.

The references to the invisible hand and the precautionary principle as plausible guidelines for public policies illustrate these perspectives. Invisible hand arguments ordinarily propose that markets are generally efficient and government actions burden and disrupt them. 35 35. For discussions of several aspects of the invisible hand thesis see Barak Orbach, Invisible Lawmaking , 79 U. Chi. L. Rev. Dialogue 1 (2012); Barak Orbach, Regulation: Why And How The State Regulates 144-55 (2012); Adrian Vermeule, The Invisible Hand in Legal and Political Theory , 96 Va. L. Rev. 1416 (2010). The precautionary principle prescribes that activities that pose certain risks to the environment or human lives should be banned until safety is established. 36 36. See, e.g. , Douglas A. Kysar, Regulating From Nowhere: Environmental Law and the Search for Objectivity (2010). San Francisco supposedly expressly endorsed the Precautionary Principle. See San Francisco, Resolution No. 129–03 (Mar. 13, 2003); San Francisco Environment Code and Precautionary Principle Policy, Ordinance No. 171–03 (July 3, 2003). Similarly, the 1957 Delaney Clause effectively adopted this principle. The Delaney Clause banned all food additives having the potential of “induc(ing) cancer in man or animal.” 21 U.S.C. § 348(c)(3). See Less v. Reilly, 968 F.2d 985 (9th Cir. 1992). Both concepts offer reliance on simplistic frameworks that never have proved themselves, or more precisely, have proved their ineffectiveness. 37 37. For the invisible hand see, for example, The Financial Crisis and the Role of Federal Regulators: Hearing Before the H. Comm. on Gov’t Oversight and Reform , 110th Cong. 17 (Oct. 23, 2008) (testimony of Alan Greenspan, Former Chairman of the Federal Reserve) (stating that “those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself included) are in a state of shocked disbelief. . . . The whole intellectual edifice . . . collapsed.”); Joseph Stiglitz, Regulation and Failure , in New Perspectives On Regulation 11, 17-18 (David Moss & John Cisternino eds., 2009) (“the primary reason for the government failure (that led to the Great Recession) was the belief that markets do not fail, that unfettered markets would lead to efficient outcomes, and that government intervention would simply gum up the works.”); Henry T.C. Hu, Efficient Markets and the Law: A Predictable Past and Uncertain Future , 4 Ann. Rev. Fin. Econ. 179 (2012); Carmen M. Reinhart & Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly (2009); Steven G. Medema, The Hesitant Hand (2009); Robert J. Shiller, Irrational Exuberance (2d ed. 2005). For the precautionary principle see generally Cass R. Sunstein, Laws of Fear: Beyond the Precautionary Principle (2005); Cass Sunstein, Irreversibility , 9 Law, Probability & Risk 227 (2010). Proponents of these concepts will always identify government failures. Under invisible hand theories, government regulation is unwarranted intervention in markets. Under the precautionary principle, the government is unlikely to do enough to prevent all activities that pose risks to lives and the environment.

Imperfection is not all about the degree of government conduct; it may also be about the form. Two general forms of imperfections are commonly used to define government failures: a deviation from adequate cost-benefit analysis and a mismatch between normative expectations and public policies. 38 38. See, e.g. , Bus. Roundtable v. S.E.C., 647 F.3d 1144, 1148-49 (D.C. Cir. 2011): (The SEC) acted arbitrarily and capriciously for having failed once again . . . adequately to assess the economic effects of a new rule. Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters. Com. v. Wasson, 842 S.W.2d 487, 501 (Ky. 1992): By 1974 (when Kentucky enacted its anti-sodomy law) there had already been a sea change in societal values insofar as attaching criminal penalties to extramarital sex. The question is whether a society that no longer criminalizes adultery, fornication, or deviate sexual intercourse between heterosexuals, has a rational basis to single out homosexual acts for different treatment.

Cost-benefit analysis as a standard for government failures underscores the inability to define ex ante precise criteria for government failures and potential misuse of hindsight. 39 39. See, e.g. , John F. Morrall III, A Review of the Record , 10(4) Reg. 25 (1986); John Morrall III, Saving Lives: A Review of the Record , 27 J. Risk & Uncertainty 221 (2003). For a discussion of the controversy over cost-benefit analysis, see Orbach, Regulation, supra note 40, at 113-18. For the hindsight bias, see Scott A. Hawkins & Reid Hastie, Hindsight: Biased Judgments of Past Events after the Outcomes Are Known , 107 Psych. Bull. 331 (1990); Kim A. Kamin & Jeffrey J. Rachlinski, Ex-Post ≠ Ex Ante , 19 L. & Human Behavior 89 (1995); Jeffrey J. Rachlinski, A Positive Psychological Theory of Judging in Hindsight , 65 U. Chi L. Rev. 571 (1998). When undesirable outcomes materialize, we can supposedly employ a Learned-Hand-like formula (or a more sophisticated analysis) to examine whether the government adequately invested in precautions to address the risk. 40 40. United States v. Carroll Towing Co., 159 F.2d 169 (2d Cir. 1947) (Hand, J.). See generally Mark Grady, Untaken Precautions , 18 J. L. Stud. 139 (1989); Allan M. Feldman & Jeonghyun Kim, The Hand Rule and United States v. Carroll Towing Reconsidered , 7 Am. L. & Econ. Rev. 523 (2005). Such inquiries do not account for budgetary constraints, ex ante knowledge of risks, and available precautions. Therefore, such inquiries may be reasonable for certain domains but not for others.

Mismatches between normative expectations and public policies may also establish perceptions of government failures. Examples of such perceptions may include the inability of the federal government to address child labor until 1938, 41 41. The 1938 Fair Labor Standards Act was the first federal legislation that set limit on child labor that survived scrutiny of the Supreme Court. Hammer v. Dagenhart, 247 U.S. 251 (1918) (holding that the Keating-Owen Child Labor Act of 1916 that restricted child labor was unconstitutional); The Child Labor Tax Case, 259 U.S. 20 (1922) (invalidating a federal tax imposed on goods produced with child labor); United States v. Darby, 312 v. 100 (1941) (upholding the constitutionality of the Fair Labor Act). For the history of the child labor debate, see Hugh D. Hindman, Child Labor: An American History (2002); Kriste Lindenmeyer, A Right to Childhood: The U.S. Children’s Bureau and Child Welfare, 1912–1946 (1997). the endorsement of eugenics and the maintenance of eugenics programs until 1974, 42 42. North Carolina, the last state to engage in eugenics, sterilized people “for the best interest of their mental, moral or physical improvement” until 1974. N.C. Ch. 1281 § 35-36 (1973). See The Governor’s Task Force to Determine the Method of Compensation for Victims of North Carolina’s Eugenics Board: Final Report (Jan. 2012); Kim Severson, Thousands Sterilized, a State Weighs Restitution , N.Y. Times, Dec. 10, 2011, at A1. See also Buck v. Bell, 274 U.S. 200 (1927) (Holmes, J.) (“It is better for all the world, if instead of waiting to execute degenerate offspring for crime, or to let them starve for their imbecility, society can prevent those who are manifestly unfit from continuing their kind.”). and the choice to ignore irrational exuberance during the housing bubble of 2000s. 43 43. See National Commission On The Causes Of The Financial And Economic Crisis In The United States, The Financial Crisis: Inquiry Report (final report, Jan. 2011). The existence of a mismatch implies that the underlying normative expectation is not in consensus. For some portion of the public there is no mismatch. 44 44. Lawrence v. Texas stands for the potential normative mismatch that the majority may have to tolerate. Lawrence v. Texas, 539 U.S. 558, 577 (2003) (“(T)he fact that the governing majority in a State has traditionally viewed a particular practice as immoral is not a sufficient reason for upholding a law prohibiting the practice.”). But those, whose normative views clash with existing public policies, may perceive the contrast as a government failure. Normative contrasts of this type begin with the general controversy over regulation: For some a government failure is a consequence of too much regulation, while for others it is a result of too little regulation. 45 45. See supra Section I; Orbach, What Is Regulation? , supra note 35.

In sum, every government failure represents some imperfection in government performance, but not every imperfection in government performance is a failure. Although we often “see” government failures, threshold standards that separate tolerable imperfections from government failures do not exist. In corporate law, only extreme situations of improper intent, conflict of interest, carelessness, and inattention or a failure to be informed of all facts material to a decision may result in liability for decisions made or not made. 46 46. See supra note 33. By contrast, under some theories, the government fails whenever it acts because of the inevitable imperfections. Such theories are impractical.

IV. Defining Failure

What government’s actions and inaction ought be considered government failures? When “bad things” happen, such as a natural disaster hits a major city, a financial bubble bursts, or a Ponzi scheme unravels, a government failure is often declared. 47 47. See, e.g. , Hurricane Katrina Lessons Learned, Staff, The Federal Response to Hurricane Katrina: Lessons Learned (Feb. 2006); National Commission on the Causes of the Financial and Economic Crisis in the United States (final report, Jan. 2011) (hereinafter, Inquiry Report); U.S. Senate Permanent Subcommittee on Investigation, Committee on Homeland Security and Governmental Affairs, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse (Apr. 13, 2011); U.S. S.E.C. Office of Investigations, Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme (Aug. 2009). The reasoning for such public verdicts is that “the public stewards . . . ignored warnings and failed to question, understand, and manage evolving risks . . . to the well-being of the American public.” 48 48. Inquiry Report, at xvii. Such failures supposedly refer to substantial imperfections in government performance.

Designed by humans for a complex reality, regulations tend to be imperfect. Government failures, including a lack of, or inadequate regulation, merely reflect the imperfect nature of regulation. Indeed, the phrase “government failure” as a term of art was born in critique of regulation.

“Government failure” as a concept in regulation refers to substantial imperfection in government performance. Such imperfections are comprised of inadequate actions and unreasonable inactions. The scope of the imperfection is related to the level of a disregarded risk, inadequacy of cost-benefit analysis, deviation from popular normative expectations, and magnitude of misallocated resources. In essence, government failures are accidents that cannot be eliminated, but their costs can be reduced.

Barak Orbach is a Professor of Law at the University of Arizona College of Law. www.orbach.org. This is the second essay in the Series “What Is . . . ?” that explores the meaning of basic terms in regulation. See Barak Orbach, What Is Regulation? , 30 Yale J. Reg. Online 1 (2012). I thank Paul Connell and Sivan Korn for comments and suggestions.

What Is Government Failure?

30 Yale Journal on Regulation Online 44 (2013)

Arizona Legal Studies Discussion Paper 13-10

13 Pages Posted: 17 Feb 2013 Last revised: 6 Jun 2013

Barak Orbach

University of Arizona

Date Written: May 15, 2013

The phrase “government failure” as a term of art originated in the critique of government regulation that emerged in the 1960s. This critique premised that “market failures” were the only legitimate rationale for regulation. Although the phrase is a popular currency in scholarship and politics, people attribute to it different values. As a result, all seem to expect the government to fail, many believe that government inaction cannot constitute a failure, and alleged failures tend to be disputed. This essay seeks to establish a coherent meaning for the term “government failure” and its relatives (e.g., “government breakdown,” “regulatory failure”).

Keywords: government failure, regulatory failure, regulation, market failure

Suggested Citation: Suggested Citation

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University of arizona ( email ).

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Understanding Government Failure

Peter h. schuck.

To create better solutions to today’s problems, policymakers must analyze government’s successes and failures.

Public discontent over many of the federal government’s domestic policy efforts has reached alarming proportions. In my recent book, Why Government Fails So Often: And How It Can Do Better , I entertain a number of possible causal explanations, but I focus on the most straightforward one: across many different policy domains, the public perceives poor governmental performance – and generally speaking, the public is correct in this view.

This explanation is buttressed by social scientists who have reviewed and assessed federal domestic programs in great detail, producing many data points that in a large number of cases indicate government failure, defined as cost-ineffectiveness. This failure is evident even though the government allocates a vanishingly small percentage of its budget to assessing how effective the vast majority of its spending is in achieving its putative purposes. These failures, I argue, are structural and recurrent in nature, and each chapter in my book analyzes in depth a different set of structural causes, which I outline here.

But let me first very briefly explain what impelled me to write this book and the challenges that I encountered when I did so. I have long been intrigued by the central questions surrounding federal domestic regulation, some of which include:

• What conditions justify regulation in the first place?
• How do the specific features of particular markets affect the regulation that seeks to re-shape them?
• Which of the many regulatory forms, techniques, and procedures should be employed under what circumstances?
• Which political economy and other factors determine regulation’s consequences?
• How should regulatory effectiveness be assessed?

But regulation is only one policy instrument among many, and Why Government Fails So Often is concerned with policies’ failure and success regardless of the forms that those policies take. The research literature that I found contains many excellent studies of one or another policy, but very few look across the numerous discrete policy areas to identify the recurrent, systemic, structural determinants and patterns of federal policy performance. Even fewer bring the discipline of peer-reviewed and other authoritative social science data to bear on the vital question of governmental performance.

My book attempts to fill this gap.  Why Government Fails So Often begins with a chapter introducing some important themes: the striking success of American society along many (but not all) dimensions; the growing public dissatisfaction with the federal government and possible reasons for this trend; the challenge of defining policy failure and success; the high social stakes in improving government performance; an introductory thumbnail sketch of the social science evidence demonstrating widespread failure; the difference between optimists and realists about government performance; and a preface to markets that cast such long shadows across all policymaking that seeks to control them.

Chapter 2 defines success, failure, and in-between assessments and defends a criterion of cost-effectiveness, rightly understood and suitably qualified. Chapter 3 describes the functions, processes, missions, instruments, and institutions of policymaking, and Chapter 4 analyzes the main elements of the political culture that shape and constrain it: constitutionalism; decentralization; protection of individual rights; interest group pluralism; acceptance of social and economic inequality; religious and political moralism; social diversity; populist suspicion of technical expertise and official discretion; public opinion; and civil society.

The next six chapters constitute the heart of my causal analysis of government performance and of the social science evidence on which this analysis is based. These chapters focus on incentives and collective irrationality (Chapter 5); information, inflexibility, incredibility, and mismanagement (Chapter 6); markets (Chapter 7); implementation (Chapter 8); the inherent limits of law, the almost universal policy tool (Chapter 9); and the federal bureaucracy (Chapter 10). Chapter 11 considers a dozen policy success stories, attempting to distill why they worked. Chapter 12 presents my proposed remedies, which are limited to those that can cut across all policy domains and which are sub-constitutional and relatively incremental in nature. Chapter 13 presents a summary conclusion and exhortation that we come to accept the brutal “facts of public life” and think more realistically about what government can accomplish.

Participants in the  The Regulatory Review  series discussing my book this week, as well as readers of the book, will of course address whichever issues they find most interesting. But in the interest of provoking the discussion, here are some issues that I posed previously at a Notre Dame conference organized around the book. I have classified them as descriptive, normative, prescriptive, and political questions.

Descriptive : How accurate is the book descriptively? How representative are its examples, and how accurate are the data on which it relies? How applicable are its analysis and findings to state and local governments?

Normative : In the analysis of performance, does the analysis neglect relevant values other than cost-effectiveness, and if so which ones? Is my approach too technocratic?

Prescriptive : Are my proposed remedies politically feasible? Are they equal to the nature and magnitude of the policy problems to which they are addressed? Are they too incremental? Is the bureaucracy on which reforms depend equal to the challenge of implementing them?

Political : Are the constitutional and cultural impediments to more effective government discussed in Chapter 4 too great? Is the public so disgusted and apathetic to be aroused to support targeted reforms (as distinct from its unfocused indignation)? Is the book (as one reviewer put it) “a gateway drug to libertarianism”? Are my moderate proposals doomed to failure in an increasingly polarized polity? Will those on the left likely to take my critique seriously?

These are vital questions both for public leaders and members of the public, and we need more analysis of them. I am therefore most grateful to Professor Cary Coglianese for organizing this  The Regulatory Review  series and to the several other participants in the recent Notre Dame conference on the book whom Coglianese has urged to participate in this online discussion. Only by understanding better the reasons for government failure can policymakers have any chance of making it succeed, at least in those ever-decreasing times when the conditions are right for its success.

This essay is part of  The Regulatory Review’s  seven-part series,  Is Government Prone to Fail?

Peter H. Schuck is the Simeon E. Baldwin Professor Emeritus of Law at Yale Law School  and the author of  Why Government Fails So Often: And How It Can Do Better (Princeton University Press), among many other books. His current project is a book tentatively entitled Five Hard Issues and How to Think About Them (Princeton University Press), analyzing the issues of immigration, affirmative action, poverty, campaign finance, and religious accommodation.

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Government Failure

Policies that cause a deeper market failure. Government failure may range from the trivial, when intervention is merely ineffective, to cases where intervention produces new and more serious problems that did not exist before.

Government failure refers to the situation where government intervention in the economy or in a specific market fails to achieve its intended goals or creates unintended negative consequences.

Government failure can occur when the government lacks the necessary information or expertise to effectively design and implement policies, or when the government creates incentives that are misaligned with its intended objectives.

Government failure can also occur when the government attempts to intervene in a market that is already functioning efficiently, disrupting the natural operation of the market and leading to negative outcomes. Examples of government failure include policies that create unintended incentives, such as subsidies that lead to overproduction or overconsumption of a particular good or service, or regulations that create barriers to entry that limit competition and lead to higher prices for consumers.

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Government failure

A) Understanding of government failure as intervention that results in a net welfare loss:

Government failure occurs when resource allocation in a given market is more inefficient then before the government intervened. As a result of this, the net welfare loss to society increases rather than decreases, which is the opposite of what the government aims to achieve when intervening in markets.

B) Causes of government failure:

Government failure exists due to a range of different factors. However, in all cases, the costs of the government intervening outweigh the benefits. This leads to even worse outcomes in the market and therefore the welfare loss to society increases. Government failure can be extremely costly to the government considering how much money is needed to intervene in the market e.g. through a subsidy. Therefore for it to lead to even worse outcomes then before is extremely wasteful.

Distortion of price signals

This can occur when the government gives out subsidies to firms. Information gaps can often lead to the government giving out subsidies to firms that are inefficient. This causes firms to become reliant on government subsidies rather than trying to cut down waste in order to become more competitive in the market. If it was left to the free market, inefficient firms wouldn’t survive in the market. However, government intervention has distorted these price signals as now subsidised firms have a higher level of revenue than if they weren’t subsided. This means that they achieve profit levels high enough to remain in the market. If the government hadn’t intervened then the firms would not be breaking even and therefore would be forced out of the market. Overall, this leads to an inefficient allocation of resources as a result of the price mechanism not being able to act freely.

Unintended consequences

Another example can often be seen when setting levels of regulation. The aim of this is too reduce the negative externalities that occur through overproduction. However, governments can often set regulation levels too high. This can cause a massive increase in the costs of production for firms. As a result of this, they are unable to make a profit in the market and therefore more inefficient firms will be forced out of the market. This is an unintended consequence of government intervention and will lead to outcomes that are much worse than before. The socially optimum level will actually be lower than before as fewer firms are in the market, causing overall output in the market to fall.

Subsidies can also be used an example of unintended consequences derived from government intervention. The aim of a subsidy is to increase the quantity of goods/services that a firm produces. However, subsidies can often be given to inefficient firms. As a result of this, these firms rely on the subsidy in order to survive in the market which is not the intended outcome when subsidising firms. If it was left up to the free market then inefficient firms wouldn’t be able to stay in the market as they’re not competitive enough. This can lead to the government spending lots of money on subsidies while not improving market conditions. As a result of this, government failure occurs.

Excessive administrative costs

A good example of this is when the government intervenes in a market where there is excessive pollution, implementing a trade pollution permit scheme. The cost of policing the pollution levels of firms involved can be extremely high. Therefore, in order for the intervention to be successful, the benefits have to be even higher than this. However, this is a more difficult outcome to achieve compared to other types of intervention which are less expensive. As a result of this, intervention through schemes such as tradable pollution permits are more likely to end up in government failure as the costs are more likely to outweigh the benefits.

Information gaps

Governments can often intervene in markets without having a perfect level of information about that market. Just like firms and consumers can have information gaps, so can the government. This leads them to making irrational decisions. For example, when implementing regulations to fix a market failure, if the government does not have perfect information then they are more likely to set regulations at a level different from the socially optimal level. Either too much regulation can be set, forcing firms out of the market, or too little regulation can be set, having minimal impact and therefore not solving the market failure. Overall, when taking into account the cost of the government intervening in the market, an outcome that does not fix the market failure will result in government failure.

C) Government failure in various markets

In 2008 Mexico extended a scheme using licence plates that required cars to stay off the road at least once a week to Saturdays also. Analysis indicated that doing so would result in a 16% decrease in nitrogen oxides and large particulates. The policy aimed at reducing pollution levels in Mexico City which are some of the worst in the world.

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Mild Government Failure

A relatively mild form of government failure - for example, bureaucrats can count but do not differentiate quality - can significantly affect the efficacy of industrial policy. We investigate this idea in the context of China's largest pro-innovation industrial policy using a structural model. We find that the return to the subsidy program is -19.7\% (but would be 7.8\% if the mild government failure can be removed). Furthermore, the welfare loss is exacerbated by patent trade.

We thank Daniel Xu, Nancy Qian, Ken Rogoff, Joe Stiglitz, Carlos Serrano and seminar and conference participants at the NBER Chinese Economy meeting, Columbia University, Emory University, World Bank, Asian Bureau of Financial and Economic Research (ABFER), and Asian Innovation and Entrepreneurship Association (AIEA) for their helpful comments and suggestions. All errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

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