This article outlines a theory of government failure that parallels the more well-established theory of market failure. It builds on the work of the public choice school concerning the behaviour of governments under the assumption that all relevant agents pursue their selfinterest. It examines the theoretical consequences for efficiency and equity of three kinds of government activity: provision, subsidy and regulation. The conclusion is reached that all three may create inefficiency and inequity, but that the form and magnitude of the failure will differ with the type of activity; hence it is important that the three are distinguished. It is also emphasised that the extent of government failure in each case (and whether it is greater or smaller than the corresponding areas of market failure) is ultimately an empirical question, not a theoretical one.
1 Wolf, Charles Jr, ‘A Theory of Nonmarket Failure’, Journal of Law and Economics, 22 (1979), 107–39.
2 Wolf, Charles Jr, Markets or Governments: Choosing Between Imperfect Alternatives (Cambridge, Mass.: MIT Press, 1988).
3 Mueller, D. C., Public Choice II (Cambridge: Cambridge University Press, 1989); McLean, I., Public Choice: An Introduction (Oxford: Basil Blackwell, 1987).
4 As indicated in the previous footnote, such reviews exist elsewhere. The most comprehensive, and one which has greatly facilitated the writing of this article, is Mueller, , Public Choice II. However, this is quite technical in places. McLean, , Public Choice, is a good non-technical introduction to the literature. Also useful is Bosanquet, N., After the New Right (London: Heinemann, 1983), particularly for the discussions of authors ignored by the other two, such as Hayek and Milton Friedman.
5 For a fuller exposition of the theory of market failure and its application that is accessible to non-specialists, see Le Grand, J., Propper, C. and Robinson, R., The Economics of Social Problems, 3rd edn (London: Macmillan, 1991). For those with a little more economics training, another useful text is Barr, N., The Economics of the Welfare State (London: Weidenfeld and Nicolson, 1987).
6 There are of course other social objectives or values against which market performance can be judged, such as the preservation of liberty or the promotion of a sense of community. Welfare economics textbooks usually give these even less attention than equity; a limited exception is LeGrand, Propper and Robinson, The Economics of Social Problems. An important recent discussion of the ability of markets to attain a broader set of social objectives can be found in Miller, D., Markets, State and Community (Oxford: Oxford University Press, 1989). See also some of the contributions to Le Grand, J. and Estrin, S., eds, Market Socialism (Oxford: Oxford University Press, 1989), particularly those by Millerand R. Plant.
7 Strictly, this second definition of allocative efficiency is equivalent to ‘potential’ Pareto efficiency whereby an allocation of resources is efficient if it is impossible for the gainers from any change potentially to compensate the losers and still remain better off. For further discussions of different definitions of economic efficiency (including Pareto-efficiency) and of the values they imply, see Le Grand, J., ‘Equity vs Efficiency: The Elusive Trade-off’, Ethics, 100 (1990), 554–68, reproduced as chap. 3 in Le Grand, J., Equity and Choice (London: Harper Collins, 1991).
8 Although these are the sources of market failure that are currently receiving most attention in the welfare economics literature, there are others that have attracted attention in the past and are still of considerable practical relevance. For example, one that will be familiar to anyone who has encountered elementary economics texts is the ‘corn’ or ‘hog’ cycle: the tendency of markets with long production times, such as those for agricultural commodities, to be unstable, with continuous under- and over-shooting of the efficient level of production.
9 If insurance companies had sufficient information concerning the patient's condition, they could control the moral hazard problem by determining the efficient level of treatment beforehand and only re-imbursing up to that level. However, they have difficulty doing this precisely because of the information difficulties associated with medical care.
10 There are some notable exceptions, reviewed in Le Grand, , Equity and Choice.
11 Wolf, , Markets or Governments, pp. 63–4.
12 For information concerning charges in Britain and a discussion of their role, see Rose, R., ‘Charges as Contested Signals’, Journal of Public Policy, 9 (1989), 261–86.
13 Wolf, , Markets or Governments, p. 66.
14 Niskanen, W. A. Jr, Bureaucracy and Representative Government (Chicago: Aldine Atherton, 1971).
15 Wolf, , Markets and Governments, p. 67.
16 Wolf, , Markets and Governments, p. 77.
17 These changes and their implications for the efficiency and equity of government policy on the area concerned are examined in Le Grand, J., Quasi-Markets in Social Policy: Studies in Decentralisation and Quasi-Markets No. I (Bristol: University of Bristol, School for Advanced Urban Studies, 1990).
18 Borcherding, T. E., Pommerehne, W. W. and Schneider, F., Comparing the Efficiency of Private and Public Production: The Evidence from Five Countries (Zurich: University of Zurich Institute for Empirical Research in Economics, 1982).
19 Millward, R., ‘The Comparative Performance of Public and Private Ownership’, in Roll, E., ed., The Mixed Economy (London: Macmillan, 1982).
20 Vickers, John and Yarrow, George, Privatization: An Economic Analysis (Cambridge, Mass.: MIT Press, 1988), pp. 39–43.
21 Barr, N., Glennerster, H. and Le Grand, J., Reform and the National Health Service, STICERD Welfare State Programme Discussion Paper No. 32 (London: London School of Economics, 1988).
22 The theory of the budget-maximizing bureaucrat was developed by Niskanen, in Bureaucracy and Representative Government. Its theoretical basis has been challenged by a number of authors: see, for example, Dunleavy, P., ‘Bureaucrats, Budgets and the Growth of the State’, British Journal of Political Science, 15 (1985), 299–328; Goodin, R., ‘Rational Politicians and Rational Bureaucrats in Washington and Whitehall’, Public Administration, 60 (1982), 23–41; Cullis, J. G. and Jones, P. R., Micro-Economics and the Public Economy: A Defence of Leviathan (Oxford: Basil Blackwell, 1987).
23 Hayek was perhaps the first to draw attention to the importance of prices and information: see, for example, Hayek, F. A. ‘The Use of Knowledge in Society’, American Economic Review, 35 (1945), 519–30. It should be remembered that at times prices convey the wrong information. Many of the instances of market failure – especially those concerned with externalities and imperfect information – arise because of the failure of prices to provide appropriate information.
24 The median voter theorem has its origins in Hotelling, Harold's ‘Stability in Competition’, Economic Journal, 39 (1929), 41–57. Since then, of course, it has been extensively developed, as well as subject to empirical tests; a useful review of the relevant literature can be found in Mueller, Public Choice II.
25 The possibility that majority rule can lead to cycles in this way was first discussed (in recent times) by Black, Duncan in ‘The Decisions of a Committee Using a Special Majority’, Econometrica, 16 (1948), 245–61. It also forms an important part of Arrow, Kenneth's ‘Impossibility Theorem’ in his Social Choice and Individual Values (New York: John Wiley and Sons, 1951; revised edition, 1963).
26 See, for example, Buchanan, J. M. and Tullock, G., The Calculus of Consent (Ann Arbor, Michigan: University of Michigan Press, 1962).
27 See Downs, A., ‘Why the Government Budget Is Too Small in a Democracy’, World Politics, 12 (1960), 541–63.
28 See, for example: Peltzman, S., ‘The Growth of Government’, Journal of Law and Economics, 23 (1980), 209–87, reprinted as chap. 1 of Stigler, G. J., ed., Chicago Studies in Political Economy (Chicago: University of Chicago Press, 1988); Le Grand, J. and Winter, D., ‘The Middle Classes and the Defence of the British Welfare State’, chap. 8 in Goodin, R., Le Grand, J. et al. , Not Only the Poor: The Middle Classes and the Welfare State (London: Allen & Unwin, 1987); Pampel, F. C. and Williamson, J. B., Age, Class, Politics and the Welfare State (Cambridge: Cambridge University Press, 1989); Le Grand, J., ‘The State of Welfare’, chap. 10 in Hills, J., ed., The State of Welfare (Oxford: Oxford University Press, 1990). Peltzman and Pampel and Williamson provide useful references to some of the rest of the literature, as does Mueller, , Public Choice II, chap. 17.
29 I am grateful to Anthony King for this point.
30 Again a useful review can be found in Mueller, , Public Choice II, especially chap. 13. Aspects of the economic theory of regulation are discussed in Vickers, and Yarrow, , Privatization, chap. 4, and in Part 2 of Stigler, , ed., Chicago Studies in Political Economy.
31 See Mueller, , Public Choice II, chap. 13, Part B, and the references therein; Stigler, , ed., Chicago Studies in Political Economy, Part 3; Vickers, and Yarrow, , Privatization, Part II.
32 See Deacon, A. and Bradshaw, J., Reserved for the Poor: The Means Test in British Social Policy (Oxford: Basil Blackwell and Martin Robertson, 1983).
33 Yet another potential problem concerns means-test ‘creep’ over time, whereby means-tested services are metamorphosed into universal ones. See Goodin, R. and Le Grand, J., ‘Creeping Universalism in the Welfare State: Some Evidence from Australia’, Journal of Public Policy, 6 (1986), 255–74, reprinted as chap. 6 in Goodin, , Le Grand, et al. , Not Only the Poor.
34 See Stigler, G. J., ‘Director's Law of Public Income Redistribution’, Journal of Law and Economics, 13 (1970), 1–10, reprinted in Stigler, , ed., Chicago Studies in Political Economy; Le Grand, J., The Strategy of Equality (London: Allen and Unwin, 1982); Goodin, , Le Grand, et al. , Not Only the Poor; Bramley, G., Le Grand, J. and Low, W., ‘How Far is the Poll Tax a Community Charge? The Implications of Service Usage Evidence’, Policy and Politics, 17 (1989), 187–205. See also George, V. and Wilding, P., The Impact of Social Policy (London: Routledge and Kegan Paul, 1984); Ringen, S., The Possibility of Politics (Oxford: Oxford University Press, 1987); Pampel, and Williamson, , Age, Class, Politics and the Welfare State.
35 See Le Grand, J., ‘Measuring the Distributional Impact of the Welfare State: Methodological Issues’, chap. 2 in Goodin, , Le Grand, et al. , Not Only the Poor.
* School for Advanced Urban Studies, University of Bristol. While writing this article I was supported by the Economic and Social Research Council under the Functioning of Markets Initiative, Grant No. W 102251016. I am grateful to Ray Robinson, Robert Goodin, David Miller, Carol Propper, an anonymous referee and the co-editor of this Journal, Anthony King, for helpful comments.
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