Author: Geoff Riley Last updated: Sunday 23 September, 2012
Quick recap: Reasons for market failure
Positive & negative externalities
Short-term and long-term environmental concerns
Lack of public goods
Under-provision of merit goods
Over-provision of demerit goods
Information gaps and asymmetries
Abuse of monopoly power
High levels of relative poverty
Laissez faire economics
In a free market system, governments take the view that markets are best suited to allocating scarce resources and allow the market forces of supply and demand to set prices.
The role of the government is to protect property rights, uphold the rule of law and maintain the value of the currency.
Competitive markets often deliver improvements in allocative, productive and dynamic efficiency
But there are occasions when they fail – providing a case for intervention.
Intervention in the market
The main reasons for policy intervention are:
To correct for market failure
To achieve a more equitable distribution of income and wealth
To improve the performance of the economy
There are many ways in which intervention can take place – some examples are given below
Laws on minimum ages for buying cigarettes and alcohol
The Competition Act which penalizes businesses found guilty of price fixing cartels
Statutory national minimum wage
A new law in Scotland banning under-18s from using sun-beds
Equal Pay Act and acts preventing other forms of discrimination
Changes in the law on cannabis
Maximum CO2 emissions for new vehicles, laws which restrict flight times at night
Government appointed utility regulators who may impose price controls on privatized monopolists e.g. telecommunications, the water industry
The economy operates with a huge and growing amount of regulation. The government appointed regulators who can impose price controls in most of the main utilities such as telecommunications, electricity, gas and rail transport. Free market economists criticize the scale of regulation in the economy arguing that it creates an unnecessary burden of costs for businesses – with a huge amount of “red tape” damaging the competitiveness of businesses.
Regulation may be used to introduce fresh competition into a market – for example breaking up the existing monopoly power of a service provider. A good example of this is the attempt to introduce more competition for British Telecom. This is known as market liberalization.
Direct State Provision of Goods and Services
What is best provided by the market?
What might be more appropriately provided by the government sector of the economy?
Privatisation means the transfer of assets from the public (government) sector to the private sector.
In the UK the process has led to a sizeable reduction in the size of the public sector. State-owned enterprises now contribute less than 2% of GDP and less than 1.5% of total employment.
Privatisation has become a key micro reform in the transition economies of Eastern Europe.
Over the last few years privatisation in the UK economy has given way to a new wave of nationalisation including some high profile banks, building societies and transport services. Nationalisation has also happened in other Western European countries
The following businesses remain part of the public sector:
Network Rail - Network Rail is a "not for dividend" company that owns the fixed assets of the UK railway system that formerly belonged to British Rail, the now-defunct British state-owned railway operator. Network Rail owns the infrastructure itself, railway tracks, signals, tunnels, bridges, level crossings and most stations, but not the rolling stock. Network Rail took over ownership by buying Railtrack plc, which was in "Railway Administration", for £500 million from Railtrack Group plc.
East Coast Rail Line. In June 2009 the government announced that it was nationalising the East Coast rail line previously operated by National Express.
The Royal Mail - Royal Mail has been a state-owned company since 1969 and remains a public limited company wholly owned by the UK government. The Royal Maul is regulated by PostComm which has the power to grant licences to new competitors entering the deregulated market for household and business mail services. The market was opened up to full competition in 2006. The Royal Mail retains a universal service commitment.
The Tote – a betting business that remains in state ownership and has done since it was created by an act of parliament in 1928. The government has announced plans to privatise the business but this has not yet been completed in part because of difficult stock market conditions following the credit crunch and the recession.
Northern Rock - In the autumn of 2007 the government announced the nationalisation of Northern Rock - all shares in the business were handed over to the Treasury. The main justification for the decision was that Northern Rock's business model had failed but that the economic and social consequences of allowing the business to go bust were too severe - hence the need for government intervention. Weeks earlier Northern Rock ran into a financial crisis which led to the first run on a major UK bank since the nineteenth century. It was forced to ask the Bank of England for emergency funding. With nationalisation, the debts of the bank were taken onto the public sector finances.
Bradford and Bingley - In September 2008 the UK government nationalised Bradford and Bingley - it took control of the bank's £50bn mortgages and loans, while B&B's £20bn savings unit and branches was bought by Spain's Santander.
Royal Bank of Scotland: On the 13 October 2008 the UK government announced its plan to save the Royal Bank of Scotland from failing. It agreed a bail out of the bank in return for taking a seventy per cent stake in the business. The government also has a 43 per cent stake in Lloyds Banking Group.
State funding can also be used to provide merit goods and services and public goods directly to the population e.g. the government pays private sector firms to carry out operations for NHS patients to reduce waiting lists or it pays private businesses to operate prisons and maintain our road network.
Fiscal Policy Intervention
Fiscal policy can be used to alter the level of demand for different products and also the pattern of demand within the economy.
Indirect taxes can be used to raise the price of de-merit goods and products with negative externalities designed to increase the opportunity cost of consumption and thereby reduce consumer demand towards a socially optimal level
Subsidies to consumers will lower the price of merit goods. They are designed to boost consumption and output of products with positive externalities – remember that a subsidy causes an increase in market supply and leads to a lower equilibrium price
Tax relief: The government may offer financial assistance such as tax credits for business investment in research and development. Or a reduction in corporation tax (a tax on company profits) designed to promote new capital investment and extra employment
Changes to taxation and welfare payments can be used to influence the overall distribution of income and wealth – for example higher direct tax rates on rich households or an increase in the value of welfare benefits for the poor to make the tax and benefit system more progressive
Intervention designed to close the information gap
Often market failure results from consumers suffering from a lack of information about the costs and benefits of the products available in the market place. Government action can have a role in improving information to help consumers and producers value the ‘true’ cost and/or benefit of a good or service. Examples might include:
Compulsory labelling on cigarette packages with health warnings to reduce smoking
Improved nutritional information on foods to counter the risks of growing obesity
Anti-speeding television advertising to reduce road accidents and advertising campaigns to raise awareness of the risks of drink-driving
Information campaigns on the dangers of smoking addiction and binge-drinking
Businesses in England and Wales that allow under-18s to use sun beds can now be fined up to £2,000. The Sunbed (Regulation) Act 2010 stops young people using sun beds in places including salons, gyms and hotels.
These programmes are really designed to change the “perceived” costs and benefits of consumption for the consumer. They don’t have any direct effect on market prices, but they seek to influence “demand” and therefore output and consumption in the long run. Increasingly adverts are becoming more hard-hitting in a bid to have an effect on consumers.
Intervention and Stakeholders
As an economist, whenever you are required to discuss the costs and benefits of an example of government intervention it is worth asking yourself “who are the major stakeholders in this issue?”
A stakeholder is any person or organization that has a legitimate interest in a specific project or policy decision.
The decisions of government, businesses and other organisations inevitably affect different groups within society. Increasingly, many businesses are taking into account the effects of their actions not just on the value that such decisions create for shareholders – but also to a broader range of stakeholder groups.
Typically stakeholder issues come into play on major infrastructural projects where a cost benefit analysis might be undertaken to assess the likely social costs and benefits – it is important to bring as many stakeholders into the picture as possible – many people might be affected,
Stakeholders are affected by Legislation Direct government provision of merit & public goods Taxation Subsidies Tradable permits Extension of property rights Advertising to encourage or discourage consumption International cooperation among governments
Examples of stakeholders you might think of bringing into a discussion
Employees of a business / organisation (who may / may not be members of a union)
Communities where a business is located or affected directly by a decision
Suppliers to a particular business (e.g. back down the supply chain)
Shareholders and other investors / financiers
Creditors (people owed money)
Government (and through them – taxpayers)
Trade unions (and the workers they represent)
NGOs and other advocacy groups (i.e. World Bank, IMF, Pressure Groups)
Competitors within a market
Topical issues where the stakeholder concept might be considered important
Stakeholders affected by all kinds of issues including the following:
Increasing the national minimum wage
Rise in the London Congestion charge and expansion of the congestion charge zone
The building and opening of Heathrow Terminal 5
Government investment in wind farm technology
Reforms to the EU’s common agricultural policy
Possible introduction of a tax on aviation fuel for flights inside the EU
Key decisions on developing new towns to help meet the demand for housing
Food export bans and export taxes (e.g. India increasing the tax on exported rice)
Decisions to lower import tariffs on goods and services coming into the UK
Changes to rules on mortgage lending as a result of the credit crunch
Higher tuition fees for UK students at English universities