Government failure occurs when intervention in markets leads to inefficient outcomes or a net welfare loss. This page explores real-world examples and practical evaluation.
Understanding government failure in practice
Government intervention is usually motivated by the desire to correct market failures, such as externalities, under-provision of public goods, or asymmetric information. However, these interventions do not always result in improved outcomes. In some cases, government policies lead to inefficiencies, misallocation of resources, or unintended consequences that reduce total economic welfare. This is referred to as government failure.
Unlike theoretical discussions, real-world examples of government failure help to illustrate how well-intentioned policies can backfire. This section focuses on three major sectors—housing, energy, and healthcare—and explores how government involvement has sometimes worsened outcomes. Students should be able to analyse and evaluate these examples in the context of the Edexcel A-Level syllabus.
Government failure in the housing market
Rent controls and unintended shortages
Rent controls are a common form of price ceiling, where the government sets a maximum allowable rent below the market equilibrium. This policy is intended to make housing more affordable, especially in expensive urban areas. While the objective may be well-meaning, setting a rent below equilibrium price (Pmax < Pe) distorts the market mechanism and leads to a number of negative consequences.
Effects of rent controls
Excess demand: The artificially low price increases quantity demanded while discouraging landlords from supplying rental properties. This creates a housing shortage.
Quality deterioration: Landlords receive less income, which reduces their incentive to maintain or upgrade properties, resulting in poorer living conditions.
Misallocation of housing: Long-standing tenants might occupy properties larger than their needs due to low costs, preventing new entrants from accessing appropriate accommodation.
Black markets: Illegal subletting or 'key money' payments may emerge, where tenants pay bribes to access rent-controlled housing.
Reduced investment: Property developers and investors may be discouraged from building new rental housing, exacerbating long-term supply problems.
Real-world example: Sweden
Sweden operates a rigid rent control system, particularly in cities like Stockholm. As a result:
Waiting lists for rental accommodation exceed ten years.
The secondary market for rental contracts has become widespread, often involving informal payments.
New housing construction is limited due to capped rental returns, deterring developers.
Rent control, although politically popular, can lead to severe under-provision of housing in the long term. This undermines affordability and availability—ironically worsening the problem it was intended to solve.
Evaluation: Government failure arises here because intervention creates welfare losses, both through allocative inefficiency (resources not used where most valued) and productive inefficiency (properties not maintained or improved). Despite this, in cases of severe affordability crises, some short-term controls may be justified to protect vulnerable renters.
Government failure in the energy market
Energy subsidies, overconsumption, and environmental degradation
Governments often subsidise energy production or consumption to:
Support low-income households.
Promote industrial growth.
Protect consumers from volatile prices.
Subsidies are financial supports that reduce the cost of energy, shifting the supply curve rightward. While they may help address poverty or inequality, subsidies frequently result in overconsumption and resource misallocation, particularly when poorly targeted.
Problems associated with energy subsidies
Overuse of fossil fuels: Lower prices encourage consumption of energy-intensive goods, leading to increased greenhouse gas emissions and pollution.
Inefficient pricing: Artificially low prices prevent the internalisation of negative externalities, such as carbon emissions.
Strain on public finances: Large subsidy programmes can cost billions, limiting the government’s ability to fund education, health, or infrastructure.
Wealthy benefit more: As higher-income groups consume more energy, untargeted subsidies disproportionately benefit those least in need.
Real-world example: India
India historically provided substantial subsidies on diesel, electricity, and kerosene.
Diesel subsidies: Encouraged private transport over public transport, worsening traffic congestion and emissions.
Electricity subsidies: Led to excessive groundwater extraction by farmers using free or low-cost electric pumps, resulting in falling water tables.
Kerosene subsidies: Fuelled black markets and smuggling, as subsidised fuel was sold at higher prices illegally.
In 2014, the Indian government initiated reforms, removing some fuel subsidies and introducing direct benefit transfers to low-income households. This improved targeting and reduced fiscal burden.
Evaluation: While subsidies may address equity concerns, their implementation often leads to allocative inefficiency and environmental degradation, illustrating government failure. Well-designed reforms can mitigate these effects by replacing broad subsidies with means-tested support and green energy incentives.
Government failure in the healthcare sector
Inefficiency in public health systems
Healthcare is often provided or heavily regulated by governments to address market failure arising from information asymmetry, under-consumption of merit goods, and equity concerns. While universal access to healthcare can improve social welfare, public provision is prone to certain types of government failure.
Key issues in public healthcare systems
Excessive waiting times: Free healthcare at the point of use increases demand, often beyond the system’s capacity, leading to delays.
Bureaucratic inefficiency: Decision-making may be slow due to layers of administration, resulting in waste and slow adoption of innovation.
Limited responsiveness: Without competitive pressure, healthcare providers may be less responsive to patients’ needs.
Resource misallocation: Central planning may allocate too many resources to low-priority services or regions.
Real-world example: NHS in the United Kingdom
The NHS provides free-at-point-of-use healthcare funded by taxation.
Long wait times for operations, diagnostic services, and GP appointments are common.
Budget constraints limit access to newer treatments and advanced technologies.
Staff shortages and burnout have affected service quality and employee retention.
Despite significant spending, some health outcomes (e.g. cancer survival rates) in the UK lag behind those in systems with more mixed provision, such as Germany or the Netherlands.
Evaluation: The inefficiencies in public healthcare represent government failure. However, these failures must be compared to private healthcare markets, which may exclude low-income patients, overcharge for services, or promote unnecessary treatments. Therefore, a mixed system with both public provision and private options, supported by performance management and funding reform, may reduce inefficiencies while maintaining equity.
Evaluating government involvement vs market failure
Not all government failure implies that intervention is worse than no action. In many cases, market failure itself is more damaging, and some form of intervention is necessary. The key is to design policies that minimise unintended consequences and adjust dynamically over time.
When government involvement worsens outcomes
Distortion of price signals: Price ceilings and subsidies can mislead consumers and producers, causing overuse or underproduction.
High enforcement and administrative costs: Regulatory interventions can be costly to implement and monitor.
Unintended side effects: For example, rent controls may increase homelessness or drive up housing costs in uncontrolled markets.
Regulatory capture: Industries may influence policy to benefit themselves, e.g. oil companies lobbying for continued fuel subsidies.
When intervention is still justified
Severe inequality or exclusion: Markets often fail to provide essential goods to the poor (e.g., healthcare, education).
Non-excludable public goods: Markets fail to supply these at all due to the free rider problem (e.g., national defence).
Merit goods: Services like vaccinations or education have wider benefits that consumers may undervalue.
Systemic externalities: In cases like climate change, failure to act could impose costs far exceeding those of intervention.
Even when flawed, intervention may reduce the harm caused by unregulated markets. The challenge is to improve government effectiveness, not necessarily to eliminate intervention.
Reducing government failure: policy design and analysis
Good policy design is essential to reduce the risk of government failure. This includes:
Using evidence-based approaches.
Applying cost-benefit analysis.
Designing adaptive and targeted interventions.
Monitoring outcomes continuously.
Principles of effective intervention
Targeted policies: Rather than blanket subsidies or controls, policies should focus on specific groups or problems.
Temporary measures: Policies should be reviewed regularly and withdrawn if no longer effective.
Incentive alignment: Policies should encourage behaviour that aligns with societal goals (e.g., congestion charges to reduce road usage).
Simplicity: Complex schemes are harder to implement and more prone to misuse or fraud.
Role of cost-benefit analysis
Cost-benefit analysis (CBA) evaluates whether the expected benefits of a policy outweigh the costs, including both direct and indirect effects. For example:
In evaluating a pollution permit system, CBA would consider the environmental benefit against the cost to industry and enforcement costs.
In education spending, it would consider long-term productivity gains against current expenditure.
Real-world example: Energy reform in Indonesia
Indonesia reformed its energy subsidy system in 2015:
Eliminated many fuel subsidies.
Replaced with direct cash transfers to low-income households.
Redirected savings to infrastructure, health, and education.
This reform:
Reduced the budget deficit.
Cut energy waste and smuggling.
Promoted long-term sustainability.
The Indonesian case shows how well-designed policies, based on data and consultation, can overcome previous failures and create lasting improvement.
FAQ
Governments often persist with energy subsidies despite their inefficiencies because of political, social, and practical considerations. Subsidies are highly visible and popular, particularly among consumers and industries that benefit directly from lower energy prices. Removing subsidies can provoke strong political backlash, civil unrest, or public discontent, especially in low- and middle-income countries where energy costs represent a larger share of household expenditure. In some cases, governments fear that removing subsidies could hurt national competitiveness, increase production costs, or harm the most vulnerable populations. Additionally, energy industries may lobby to maintain subsidies, especially where regulatory capture exists. There may also be a lack of administrative capacity or infrastructure to implement targeted alternatives like cash transfers. Lastly, subsidies can be a short-term tool to stabilise inflation or respond to global energy price shocks. Therefore, the continuation of such policies often reflects a compromise between economic efficiency and political and social stability.
Information failure within government institutions occurs when decision-makers lack accurate, timely, or complete data to design effective policies. This can lead to poorly targeted interventions, inefficient allocation of resources, or misjudged market responses. For example, if a government overestimates the income level of a region, it may underprovide support, exacerbating inequality. In the context of housing, inaccurate data on rental market conditions might lead to inappropriate rent control levels, worsening shortages. In healthcare, misreporting of waiting times or demand projections could cause bottlenecks or underfunding. Information asymmetries also occur between central and local authorities, limiting effective implementation. Furthermore, without reliable feedback mechanisms, policymakers may be unaware of a policy’s actual impact or fail to adjust it. Bureaucratic inertia and lack of transparency can compound the issue, delaying necessary reforms. In short, when governments act on flawed information, even well-intentioned interventions can fail to achieve desired outcomes, resulting in reduced welfare and wasted resources.
Yes, behavioural economics offers valuable insights into why government policies may fail in practice. Policymakers, like consumers, are subject to cognitive biases, limited rationality, and decision-making under uncertainty. One key concept is bounded rationality, where policymakers make decisions based on simplified models or heuristics due to limited information or cognitive capacity. For instance, a government may overestimate the effectiveness of a subsidy without fully considering behavioural responses, such as increased energy consumption. Overconfidence bias can also lead to excessive faith in regulatory solutions without proper evaluation or consultation. Status quo bias may explain why ineffective policies, like outdated subsidies or price controls, persist despite evidence of failure. Additionally, voters' short-term preferences may lead governments to prioritise visible benefits over long-term efficiency, known as present bias. This can result in politically expedient but economically harmful policies. Recognising these behavioural influences can improve policy design by incorporating nudges, pilot testing, and iterative feedback loops.
Special interest groups can significantly contribute to government failure by distorting the policy-making process in favour of their own agendas rather than the broader public interest. These groups—such as industry associations, unions, or large corporations—often exert influence through lobbying, political donations, or campaign support. This may result in regulatory capture, where the agencies intended to regulate industries act in the interests of those they regulate rather than the public. For instance, fossil fuel companies may pressure governments to maintain energy subsidies, even when these are economically and environmentally damaging. Similarly, property developer lobbies may resist zoning reforms needed to address housing shortages. The influence of these groups can lead to inefficient, poorly targeted, or protectionist policies that hinder competition and innovation. Moreover, they may contribute to excessive red tape or favour incumbents over new market entrants. Ultimately, special interest lobbying can undermine economic efficiency, reduce trust in public institutions, and deepen inequality.
Pilot programmes are small-scale, trial versions of policy initiatives implemented to test their effectiveness before a full rollout. They are a powerful tool to reduce government failure by allowing policymakers to evaluate outcomes, identify unintended consequences, and adjust the policy based on real-world feedback. For example, if a government is considering a new housing subsidy, a pilot scheme in a single city can reveal whether it genuinely increases access or simply inflates rents. Pilots allow for controlled experimentation, where different approaches can be compared, such as varying subsidy amounts or eligibility criteria. They also help estimate costs, understand administrative challenges, and gauge public response. Importantly, pilot schemes foster evidence-based policymaking, encouraging decisions rooted in data rather than assumptions. By identifying weaknesses early, governments can avoid widespread implementation of ineffective or harmful policies. In sectors like healthcare, education, and environmental policy, pilot programmes can improve policy design, enhance efficiency, and build public confidence.
Practice Questions
Evaluate whether government intervention in the housing market, such as rent controls, leads to more harm than good.
Rent controls, a form of price ceiling, are aimed at improving affordability. However, when set below equilibrium, they often cause excess demand and housing shortages. Landlords may withdraw properties from the market, reducing supply and quality. Black markets can emerge, distorting outcomes further. Despite these failures, rent controls may still protect vulnerable tenants in high-cost areas, preventing homelessness. Overall, while there are significant unintended consequences, in cases of severe housing inequality, some short-term intervention may be justified. Effectiveness depends on implementation, complementary policies like housing subsidies, and market conditions.
Explain how government subsidies in energy markets can lead to government failure.
Energy subsidies reduce costs for consumers, but often cause overconsumption, misallocation, and environmental degradation. By distorting price signals, they encourage excessive use of fossil fuels, increasing pollution and carbon emissions. Fiscal costs can be high, diverting funds from sectors like health or education. Poor targeting means higher-income households, who use more energy, gain the most. In some cases, subsidies lead to black markets or corruption. Therefore, although intended to promote equity and affordability, such interventions may create welfare losses, illustrating government failure. Better targeting and green alternatives could reduce these negative outcomes.
