1. PUBLIC POLICY Unit - 1.4 Market Failure & Govt. Failure

2. ECONOMIC REFORMS MARKET FAILURE GOVT. FAILURE - Dr. Prem S. Vashishtha Basic Readings: Michael E. Kraft and Scott R. Furlong, ‘Public Policy’, 2007, CQ Press, Washington DC. Dutta -Chaudhuri, Mrinal, ‘Market Failure and Government Failure’, Journal of Economic Perspectives, 1990. Reasons for Govt. interventions: Correcting a social problem Alter policies Interest Groups in Action: Setting the agenda  (discouraging/ encouraging certain action) Policy formulation  (designing a specific interaction) Policy legitimization  (Debating the rationale for intervention)

3. Rationale for Govt. intervention: (Overlapping several areas indicated below.) Political a)Major shift in public opinion b)Big social movement Ethical Not necessarily due to public pressures a)poverty issue; b)social security; c)Issues of elderly, disabled, disadvantaged groups, etc. Economic/ Market failure a)Market led efficiency b)Price signals c)Exchange between buyers/sellers (different parties) Market failure occurs when private market is not efficient (sub-optional allocation of resources) 4 types of Market Failures Existence of monopolies and oligopolies Externalities Information failure Inability to provide or collective goods

4. 1. Monopoly or Oligopoly One or few companies dominate in market, control price/product/service. (e.g. electricity company – one or two companies invest in initial infrastructure, set price … ) (Debate on regulation) 2. Externalities Negative: Two parties interact. Third party is harmed and no compensation is given. Example: Electricity company – Agreement with buyers on providing electricity at a given price – Buyers say OK. What the company would do is to provide electricity by using cheapest fuel, viz; Coal. – may lead to many core health problems - neither company nor the electricity buyers but Govt. intervenes. Imposes regulation on electricity company to install pollution control device. (Consider health related cost as part of prevention cost) Then Govt. also puts an upper limit on the quantum of pollution. Positive: Two parties interact. Third party gains but does not have to pay for it. Example: Higher education, (whole society gains from scientists/ technical experts).

5. 3. Information Failure Assumption of perfect competition and full information with buyers and sellers about price, quality of commodity/service, etc. in practice it is not true Govt. regulation required e.g. Pharmaceutical industry

6. 4. Market not providing public Goods/ Collective Goods. Criteria for defining a public good:- Ability to exclude some one from getting the good. An individual charges for a good or service and thereby can prevent others from consuming it. e.g. Toll goods: jointly consumed but exclusion is feasible. Initial high charges for cables, electricity; prices set high; poor excluded. High toll tax- excluding many light vehicles. Ability to jointly consume the good joint consumption – one person ’ s consumption does not prevent others from consuming it. e.g. common pool resources: Goods jointly consumed but exclusion not feasible. ( “ Tradey of commons ” : Each individual seeks to maximize his/her use without bothering about the depletion of such goods/resources because nobody owns them. Although it is known to everybody that continuation (non-depletion) of such common resources would benefit everybody, even then most consumers start behaving in an indifferent manner. Here is the issue of sustainability. (Goods: air, water, grazing land, fisheries, ….) Govt. intervention required. Pure public goods jointly consumed but no exclusion feasible. e.g. those goods can not be provided without government intervention (national defense, public parks – private sector has no incentive to supply such goods.)

7. No Joint ConsumptionJoint Consumption Exclusion is Feasible 1 Pure private goods Examples: DVD players, automobiles, houses 2 Toll goods Examples: cable TV services, electrical utilities Exclusion is Not Feasible 3 Common pool resources Examples: air, water, grazing land, oceans, fisheries, wildlife 4 Pure public goods Examples: national defense, public parks Table 1-1 Private Goods and Public Goods Source: Pg.19, ‘Public Policy’, Michael E. Kraft and Scott R. Furlong, 2007, CQ Press, WDC.

8. Four above cases for public intervention are not exhaustive, neither are they mutually exclusive. If Govt. intervention does not work, what happens – case of Government Failure (failure to provide food to poor, clean water, most basic health service to poor …..in general failure of the delivery system). So, here is a situation of Market Failure and Government Failure. What is the solution? How would public react to changing policies? Is then deregulation required? New public debate Public-private partnership? (does it work?) Further public-private-NGO partnership? (does it work?) Transparency in the system Economic Laws Do you need a super body to oversee it if Govt. also fails?