Market Failure and Government Failure in Europe - Essay Example

Market Failure and Government Failure in Europe Introduction For several decades, a debate has been raging in development economics on the relative virtues of the free market as opposed to state intervention. With the help of analytical models of a market economy, the interventionists have demonstrated what they have considered as serious instances of market failures. That is to mean, the inability of a market economy to reach certain desirable outcomes in resource use. The protagonists of the free market on the other hand, compile impressive lists of ill-covered and counterproductive policy measures implemented by the governments of different nations at different times. As a result, there has been serious wastage of resources in the economies of these countries. This debate has inevitably remained inconclusive. The analytical results on market failure do not disappear in the face of the evidence that most governments have performed rather badly. In cases where there appears to be scope for improvement over the market outcome, the search for corrective measures continues. Some protagonists of government failure tend to question the significance of such market failures. Some have voiced skepticism about the ability of governments to take any action in the economy which is not counterproductive. However, none of them has been able to explain why less developed European countries failed to grow during the first half of the 20th century. By documenting the performance of the government and how it should be improved to save the market situation, this essay will base its discussion on how government failure can lead to market failure in European nations and the other way round. Government failures Government’s intervention in solving market failures in some cases can fail when it fails to achieve a socially efficient allocation of resources. By definition, government failure is a situation the government’s intervention in an economy to correct market failures results into inefficiency leading misallocation of the scarce resources. Cases of government failure would include the government awarding subsidies to firms which would protect inefficient firms from completion. Protecting inefficient firms results in creating barriers to entry for new firms since prices are always kept lower than the standard set. Subsidies and other forms of assistance offered by the government lead to the moral hazard problem. Similarly, high taxation on goods and services leads to an artificial increase in prices which can distort the efficient operations of the market. Additionally, high taxes on incomes tend to create a disincentive effect therefore discouraging people to work harder. Information failure is still an issue for the government. The issue results from the government’s inability to know enough that would enable it make sober decisions concerning the best way of allocating scarce resources. Many economists have had a strong belief in the efficient market hypothesis. The hypothesis assumes that the market always contains more information than any person or the government. It therefore implies that market movements and market prices should not be interfered with since the markets can not be improved by individuals or the government (Halkier and Danson 197). Excessive bureaucracy to some extent is also one of the potential government failures. It results from the public sector’s trials to solve the main-agent problem. The government needs to appoint bureaucrats for it to ensure its objectives are pursued by organizations’ managers in the public sector. Market failure Market failure is a situation whereby there is inefficient allocation of goods and services by the free market. That is to say, there is another convincible outcome involving the market participants being better-off without disadvantaging others. In such a case, the outcome is not the Pareto optimal. A market failure is viewed as a scenario where the pursuit of an individual on self-interests leads to inefficient results. The inefficient results can be improved upon from a societal point of view. In most cases, market failures in European nations are associated with information asymmetries, principal-agent problems, time-inconsistent preferences, public goods, or externalities. The existence of market failures is the main reason for governments, supra-national institutions, or self-regulatory organizations. Economics are always concerned with the market failures and have been seeking for the possible ways of solving the problem for many years. Such analysis plays a crucial role in most types of the public policy decisions (Halkier and Danson 200). However, a good number of government policy decisions such as subsidies, taxes, wage and price controls, bailouts, may lead to inefficient allocation of resources. Comparing market failure to government failure When the performance of an industry in the private sector is effective or efficient, a market failure is said to exist. Then economists and other stakeholders in the economy will recommend for government actions such as taxation to reduce pollution and to combat this failure. The diagnosis of a market failure to some extent may be accurate, but calling government involvement in such a crisis may be inappropriate and naïve. The reason is that governments do not make an effort of doing what economists want them to do since there is still government failure and market failure. Before giving an opinion on what the government needs to do to correct market failure, one has to consider whether the actual government policies would worsen instead of improving the outcomes of the private sector. Since many factors contribute to a considerable market failure, putting into consideration such failure is equally important and not just a theoretical point (Halkier and Danson 202). Considering for example, consumers are not always well vast with qualities and other related aspects of the products they purchase. However, before advocating for different ways in which the government can protect the consumers, it is important to note that voters are often far more ignorant of political candidates. Therefore, consumers are victims of what they purchase. The reason here is that consumers suffer directly when they make wrong choice because of their ignorance. On the other hand, individual voters have less influence over most of the political outcomes. Therefore, voters are less motivated to know much about different political candidates and the positions they are vying for, and the repercussions of the mistakes they make are caused by others. Monopolies in most cases arise in the private sector. For example, Microsoft previously had monopoly over the personal computer operating systems while IBM had monopoly over computers. In addition, manufacturers try to form cartels and raise their prices by restricting entry of new companies in the industry. However, monopolies still exist in the political sector and tend to be even more pervasive. An industry that has only two firms is considered as a duopoly and the firms raise prices considerably about competitive levels. On the other hand, a political process that is entirely dominated by two political parties is considered as duopolies, such as the Republican and Democratic parties in some of the European countries. Additionally, when companies owned by the government gain monopoly powers, such as the national oil and the British Postal Service, they succeed in restricting entrance of private competitors. Contrary to that, private monopolies are always temporary, as seen in the erosion of dominance by Microsoft and IBM (Halkier and Danson 203). Actions taken by the government not only sometimes fail to combat failure but instead worsen it. For example, Freddie Mac and Fannie Mae were formed as quasigovernmental institutions that would help in encouraging mortgages in the residential housing market in the U.K due to the belief that there were no enough mortgages being provided by the private sector, more so to low income families. However, these companies misused their privileged positions. They took excess risks and insured large number of mortgage loans that should not have been made. In addition, European regulators have attacked Intel, Microsoft, Google, General Electric, and other companies they allege to have anti-competitive policies. In such cases, especially in many antitrust cases brought about by regulators in the United Kingdom, such the objection to the merge between T-Mobile and AT&T, the motivation is to protect competitors of these companies. Unfortunately, the motivation is not to improve the outcomes to consumers (Halkier and Danson 202). Policies to correct market failures Economic theory identifies many situations where a market failure may arise and suggests how the government could correct the failure and improve economic efficiency. In practice, potential market failures such as such as market power and imperfect information do not appear to create large efficiency losses to an economy. However, market failures arising from externalities such air and water pollution, traffic congestions, and hazardous wastes impose significant social costs that government policies could reduce efficiently (Halkier and Danson 205). Based on the assessment by Halkier and Danson, government policy to correct market failures is typically characterized by two major flaws; that is, government failures that cost countries hundreds of billions of dollars yearly. First, government policy has created lots of economic inefficiencies where significant market failures do not appear to exist, such as with economic regulation and antitrust laws that have raised the cost of firms and generated economic rents for various interests at the expense of consumer’s welfare. Antitrust enforcement is trying to deter anticompetitive behavior, especially collusion. However, this potentially important benefit is yet to be verified empirically. Information policies have also raised consumer prices and the cost of firms. A possible benefit of such intervention is that harmful products, such as harmful drugs, may have been prevented from appearing the on the market. However, potentially important benefits still have to be verified by empirical evidence (Halkier and Danson 206). Secondly, in situations where market failures do not exist, government policy has either achieved expensive success by combating these failures in a way that has sacrificed substantial net benefits or reducing social welfare. Government policy has wasted a lot of its resources by applying command-to-control policies to correct externalities, especially in safety, health and environmental policy. Using tradeable permits and efficient pollution taxes can reduce air and water pollution, automobile emissions, airplane noise at a much lower cost than the current policies. Secondly, researchers are yet to determine whether public financing of transportation and other services generates greater welfare than would privatization of these activities. However, it is clear that investment, public sector pricing, and production policies have failed to improve externalities traffic and airport congestions. These congestions have led to poor service delivery and have resulted in large subsidies that need to be financed by taxes. In turn, these taxes create additional inefficiencies such as the cost of raising public funds (Halkier and Danson 209). Conclusion Both market failure and government failure in most of the European nations have a negative impact on the economy of a given country. In the process of trying to balance the economic scales for the interest of everybody, economic mistakes usually arise leading to errors that result in the two economic issues. The solution to these issues found by recognizing that the economic scale is out of balance and taking necessary actions to bring it back to back for the benefit of everyone. Work cited Halkier, Henrik and Mike Danson. Regional Development Agencies in Europe. East Sussex: Psychology Press, 2002. Print Read More