Government failure

Government failure is a situation where government intervention in a market – often to correct a market failure – results in an inefficient allocation of scarce resources.

For example, the government may intervene in the market for healthcare by providing services which are free at the point of consumption, or need. The case for such intervention is strong given that healthcare is a merit good.

Merits goods will tend to be under-consumed in a ‘free’ market where consumer’s pay a price based on the true costs of supply, including a normal profit.

The under-consumption will come from two sources:

  1. Firstly, information will be imperfect, with the perceived ‘cost’ of treatment (from the individual’s point of view) exceeding the perceived benefit. The actual benefit will include the external benefits of remaining healthy, but individuals – acting ‘selfishly’ – are unlikely to take these external benefits into account.
  2. Secondly, only those who can afford to pay for treatment will demand it.

Intervention by government, therefore, including subsidising healthcare to make it free at the point of consumption, or through other intervention, appears the ‘rational choice’ for an efficient supply of, and consumption of healthcare.

Moral hazard

However, such intervention can create failures – notably the problem of moral hazard. This means that doctors’ waiting rooms may be full of what are often called the ‘worried well’, or those who have minor complaints and who do not need the intervention of a doctor. In this case, the fact that treatment is ‘free’ at the point of consumption can act as an incentive to visit a doctor when treatment may not be required. This is why hospitals have triage systems to screen out the minor from the major ailments to make a more rational use of the hospital’s time and resources.

Moral hazard can also result from the provision of welfare benefits to the poor or unemployed, creating ‘welfare and unemployment’ traps. In this case, the welfare benefit acts as a disincentive to find paid work.

Of course, once government failures are identified, improvements can be made to systems to reduce failures and inefficiencies.