8.1.2—Government failure

Government failure occurs when intervention creates a larger welfare loss than the market problem it was intended to correct, or fails to improve the outcome at reasonable cost.

Causes include imperfect information, administrative cost, unintended incentives, regulatory capture, political short-termism, rent-seeking and weak enforcement. Compare the policy outcome with the realistic counterfactual, not with a perfect textbook market.

A subsidy intended to reduce pollution may increase output if it is poorly targeted, while a regulation that is cheap to comply with may deliver little environmental benefit because firms can evade it.

Government failure does not prove markets are always efficient; both the original market failure and the feasible intervention must be assessed.