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Government Failure: Definition & Examples

Instructor: Erin Carroll

Erin has taught English and History. She has a bachelor's degree in History, and a master's degree in International Relations

In this lesson you will learn what government failure is. The lesson will discuss when the term was coined, and also offer a few examples of government failure.

What is Government Failure?

'Government failure.' You might think that sounds like a political science term, but it actually has a lot more to do with economics. In America, it's not uncommon to hear someone say that government is the problem. Whether or not you believe that has a lot to do with how you think about the economy and government failure.

Government failure refers to when the government intervenes in the economy to fix a problem, but only ends up creating more problems. That means it harms social welfare and/or makes the market less efficient. In order for government failure to occur, there first has to be a market failure. That means that the market is failing to produce positive outcomes for society. The government will then decide whether and how to intervene. If the government intervenes and only makes the problems worse, then it has failed.

The term originated in the 1960's when economists began to criticize any government intervention or regulation of the economy. At that time, economists who believed in laissez-faire capitalism argued that the free market was inherently efficient. They began to argue that government always created inefficiency, and was always a problem.

The Invisible Hand v. The Government

These economists believed that government intervention often leads to government failure because it interferes with the invisible hand that guides the free market. First described by Adam Smith, the invisible hand is the result of individuals following their own self-interest in the economy often leading to positive outcomes for society. The invisible hand was the reason why competitive free markets distribute resources fairly. Individuals will try to improve their lives and become wealthier through buying and selling goods and services in the most efficient way possible. This will keep the market efficient, and improve social welfare.

Although Adam Smith acknowledged that external forces and problems could disrupt the invisible hand, many economists maintain that the invisible hand will always create better outcomes than government no matter what. This is because government uses laws and regulations to force people to act against their self-interest. Some of these laws are great like outlawing murder, for example. However, other laws that force corporations to pay taxes are seen by some economists as limiting their profitability, and creating inefficiency.

A Changing Meaning

Recently, the term 'government failure' has gotten a broader definition. Many economists now believe that the invisible hand doesn't always create positive outcomes. These economists argue that when the government fails to act and fix a problem in the market, it's also government failure. Unfortunately, by broadening the meaning of government failure, you'll often see it get thrown around to label any bad event from natural disasters to a housing crisis. Let's look at two examples of government failure that have more general acceptance amongst economists.

Agricultural Subsidies

Farming can be a very unstable industry. If there's a bad harvest, or too much supply in the market, farmers can lose a lot of money. That can make the whole agricultural industry volatile. After the Great Depression, the United States government began providing subsidies to farmers to cover their losses, and stabilize the industry. However, farming has changed since then. Farmers are making more money. More importantly, huge agricultural companies and corporate farms, rather than small farms, dominate the industry. That means that taxpayers are paying to support huge corporate farms that are making a lot of profit. This has created more inefficiency in the market, and therefore, many economists see agricultural subsidies as a government failure.

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