8.1.1—Policies for market failure

Governments may address market failure with taxes, subsidies, regulation, tradable permits, direct provision, information, competition policy or assignment of property rights.

Choose the instrument by asking what is missing: a tax can internalise a cost, a subsidy can encourage an external benefit, information can reduce asymmetric knowledge, and competition policy can limit market power. Estimate implementation and enforcement costs.

A pollution tax aims to move private cost toward social cost; if emissions are difficult to monitor, a standard or permit system may be more practical than a perfectly calibrated tax.

“Government intervention” is not a cure by definition: policy can overshoot, be captured or cost more than the welfare gain.