Government failure

1
Lecture 7

• Government failure
• Readings T. Besley, Principled Agents?, chapter 2

2
Government intervention

• Scope for government intervention in the economy
  exists when individuals fail to reach a good
  outcome on their own (when there is a market
  failure)
• We analyzed mechanism of collective decision
  making

3
Government intervention

• Mechanisms of collective decision making
• the government can take an action maximising
  some social welfare function (i.e. a function
  that gives a precise weight to each individual in
  the society
• political mechanism, like majority voting to
  decide

4
Government intervention and efficiency

• Do governments solve market failures?
• Government failures?
• Some welfare criteria to judge government
  intervention
• Pareto-inefficiency
• Distributional failures
• Wicksellian failures

5
Pareto-inefficiency

• Remember that market failure is defined as
  situation where the market fails to achieve an
  outcome on the utility possibility frontier
• In an analogous way, we will say that there is a
  government failure when the government fail to
  achieve policies resulting in outcomes on the
  utility possibility frontier
• Criticism a very unequal outcome chosen by a
  dictator would satisfy Pareto-efficiency

6
Distributional failures

• Distributional concerns may be very important
  when we consider public policies
• Example of policies raising distributional
  concerns
• subsidies to particular sectors
• Provision of goods targeted to particular regions
• Policies favouring some particular lobby group or
  region may be Pareto-efficient, yet they may
  result in very unequal distribution of resources

7
Distributional failures

• How can we judge government intervention on
  distributional grounds and assess whether there
  is a case of distributional failure?
• We need some kind of distributional metric
  Social Welfare Function
• Does the government maximise a Social Welfare
  Function?
• Problem the choice of the function is arbitrary
  and any allocation might be affected by
  distributional failure or might be considered
  distributionally efficient depending on the
  Social Welfare Function used as benchmark!

8
Distributional failures

• Alternative criterion if utility is transferable
  (ex utility linear in money) so that there is a
  way to redistribute resources from winners to
  losers, then social surplus maximisation could be
  an alternative criterion.
• Hence, if a policy maximises Social Surplus
  there is not policy change in which the gainers
  can compensate the losers
• On the other hand, if a policy does not maximise
  social surplus, than moving toward social surplus
  maximization will guarantee that gainers from the
  policy change can compensate losers

9
Wicksellian failures

• Policy outcomes and political decisions should
  lead to outcome that Pareto dominate what would
  have been achieved without government
  intervention
• Hence, whenever the government does not achieve
  an outcome that Pareto dominate the status quo
  (i.e. what would have been achieved without
  government this could be for example the market
  outcome) the government intervention is affected
  by a Wickesellian failure

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Utility possibility frontier (UPF)
UB
Social preferences
A social welfare function maximisation point
(distributional and Pareto efficient) B Pareto
efficient but not distributionally efficient
A


B
UA
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Utility possibility frontier (UPF)
UB
Mstatus quo Pareto-inefficient A Pareto and
Wickesell efficient B Pareto-efficient but
Wickesell- inefficient C Wicksell-efficient but
Pareto-inefficient

A

C

M

B
UA
12
Majority voting and efficiency

• Does majority voting deliver outcomes satisfying
  any of the above criteria of efficiency?
• Example Public Good Provision
• Public good g can be provided at a cost C(g) that
  is equally shared among N individuals (N odd)
• Each individual indexed by j derives from the
  public good provision the following utility

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Majority voting and efficiency

• The most preferred level of public good for each
  individual is obtained equating the marginal
  benefit to the marginal cost
• Assume that the utility and cost associated to
  the public good provision are such that if there
  is no government intervention, individuals would
  not voluntarily contribute to the public good
  provision and therefore g0
• If the government intervenes, the provision of g
  depends on the mechanism of collective decision
  making
• Suppose that government chooses the quantity of
  public good that is preferred by the majority.
• Given that preferences are single peaked the
  median voter results applies. Therefore, among
  the possible g, the most preferred outcome of the
  median voter is selected and lets denote it by

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Majority voting and efficiency

• Is the median voter outcome Pareto-efficient?
• Suppose that the outcome preferred by the median
  voter (that is a Condorcet winner), is not
  Pareto-efficient. In this case there must be
  another outcome that must be preferred by
  everybody. But if this is the case, the outcome
  preferred by the median voter cannot be a
  Condorcet winner (because it could not beat any
  other outcome in any pair wise comparison)

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Majority voting and efficiency

• Wicksell efficiency?
• Status quo policy g0
• Government policy gm
• For the median voter clearly
• However, for individuals with preferences
  sufficiently distant from the median voter, the
  status quo, although Pareto-inefficient, may be
  preferred to the median voter most preferred
  policy

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Ranking of most preferred outcomes
gj

• Individuals whose most preferred policy is closer
  to the status quo policy g0 than to the outcome
  implemented by majority voting gm are worse off
  if the government intervenes
• Hence, majority voting does not satisfy Wicksell
  efficiency
• Similar concerns can be raised if we judge
  majority voting according to distributional
  efficiency (tyranny of the majority)
• Hence, public policies chosen by majority voting
  satisfy Pareto- efficiency only

g0 status quo
gm
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Questions

• Explain the difference between Pareto efficiency,
  Wicksell-efficiency and distributional efficiency
• Do governments choosing policies preferred by the
  majority of the population achieve efficient
  outcomes? Explain carefully your answer
  specifying the notion of efficiency you are using
• Consider the example of public good provision
  provided in the lecture. Does majority voting
  deliver the same outcome of the Samuelson rule
  (remember public good provision of lecture 3)?