Government failure

In public choice theory and welfare economics, a government failure is the creation of economic inefficiency by government intervention; a situation in which government action in the economy yields a worse allocation of resources than an available alternative. It is the analytical counterpart to market failure: as markets fail to allocate resources efficiently, government action intended to correct them may itself fall short. A government failure occurs when costs of an intervention outweigh its benefits, leaving society worse off that it would be under a different policy, or none at all.

Like market failure, government failure does not refer to the absence of a preferred outcome, but to the prevention of an efficient one, and can arise even where an efficient market solution was available. It is defined by inefficiency, rather than distribution: creating winners and losers doesn't by itself is a government failure. The defining feature of a government failure is the availability of an unrealised Pareto improvement—a change that could make everyone better off in a different arrangement.

Government may intervene by provision, taxation or subsidy, and regulation; and a government failure can arise from any of these. Such failure could be either on the demand side or on the supply side. Demand-side failures include preference-revelation problems and the illogic of voting and collective behaviour. Supply-side failures largely result from principal–agent problem. Frequently cited mechanisms and instances of government failure include regulatory capture and regulatory arbitrage, the unintended consequences of an intervention, and cases where an inefficient outcome is more feasible politically than the Pareto improvement to it.