Government failure and unintended consequences

Government failure and unintended consequences

We have already seen that unregulated markets have a tendency to “fail” by not achieving an allocation of resources that best satisfies societies needs and wants (allocative efficiency).  As a consequence, governments frequently intervene to alter how resources are used within an economy with the intention of improving overall living standards.  However, government intervention frequently comes with unintended consequences that, on balance, potentially leads to a less efficient allocation of resources and reduces overall living standards.

Governments intervene in many ways such as indirect tax (excise tax on fuel, alcohol and tobacco), subsidy (solar panels) and government regulation (E10 fuel/ energy markets via RET/minimum wage/ plain packaging laws) and advertising to educate (e.g. sunscreen and smoking) with the intention of improving how efficiently and effectively resources are used.  However, given that there are typically a variety of potential solutions to overcome the “misallocation of resources” that frequently occurs in unregulated markets, any policy response runs the risk of decreasing economic efficiency and creating ‘government failure’.  This will occur if the costs of the intervention outweigh any intended benefits from the intervention, such that overall living standards fall as a consequence of the intervention.  It can also be argued that government failure occurs if the costs of any given government intervention are greater than they could otherwise be (i.e. the opportunity cost of government intervention is not minimised).  For example, if it is accepted that pricing carbon is the ‘best’ way to tackle climate change, then the adoption of any other policy solution could be considered an example of government failure (even if it does manage to reduce carbon emissions) given that the opportunity costs attached to this intervention are not minimised).

Examples of possible government failures or at least policies that unintentionally have a negative impact on efficiency in the allocation of resources includes the provision of government subsidies that have been designed to protect Australian industries and/or promote employment.  For example, subsidies given to companies like Alcoa enable it to artificially keep its prices lower than otherwise, which grants the company relatively more power to compete, or bid for resources against other (unprotected) Australian producers.  In addition, the subsidised companies will be somewhat shielded from the rigours of international competition, and this shielding has the potential to create complacency and cause management to be less proactive in seeking efficiency gains, for example via reform or restructure.  Inevitably, this can result in a slowdown in productivity growth, adding unnecessarily to production costs and reducing technical efficiency.  As a consequence, the allocation of resources (in the economy) will be suboptimal in the sense that too many resources are being allocated to those industries in which Australia does not have a competitive advantage.

Another example relates to the government subsidies provided to private vocational colleges and students [e.g. under the federal government’s now defunct VET FEE-HELP scheme].  The subsidies allowed these colleges to effectively receive thousands of taxpayer dollars per student enrolled, which created huge incentives for the colleges to enrol excessive numbers of students in courses (many of which were either sub-standard or virtually useless) that provided students with very little education and/or skills development.  The private colleges were effectively ‘rorting the taxpayer’, attracting huge amounts of scarce government revenue that could have been put to much more effective use elsewhere in the economy.  This, in itself, is an example of government failure given that the subsidy support came at huge opportunity costs and effectively reduced social welfare.  [In addition, the fact that numerous students have been left with worthless qualifications increases the likelihood that future students will avoid vocational education altogether, afraid of amassing debts to complete courses that might provide no economic benefit.  This is inefficient because well targeted vocational education is actually in the national interest and the failure to allocate an appropriate amount of resources to this sector is allocatively inefficient.]

There are numerous other possible examples to focus upon, including:

  • The negative impact on equity (unintended consequence) related to the imposition of a number of indirect taxes (e.g. excise on alcohol and tobacco) and their regressive effects
  • The increased excise on tobacco and the effects on black market activity
  • The effect of indirect taxes and the possibility of resources being allocated to other (more?) harmful goods (e.g. alcopops tax, sugar tax overseas)
  • The National Broadband Network investment and the possible misallocation or resources
  • The negative consequences associated with minimum wages laws and the impact on unemployment.
  • The state government debacle in relation to the payment of approximately $1B as a result of the decision to scrap the East West Link contract
  • The privatisation of airports and ports and the effects on prices as a result of monopoly status
  • The heavy subsidisation of renewable sector and the implications for energy supply (shortages over summer?)
  • Direct action initiatives that involve subsidies for activity that would have ordinarily occurred
  • Unfair dismissal laws and the effects on efficiency
  • Guarantees provided to the banking system
  • Subsidies for biofuels and the impact on consumer demand for (unwanted) premium fuels and technical efficiency as imported biofuels pay an excise and are relatively more expensive