Government Intervention and

Government Failure
 Why Government Intervention is needed?
• Markets in developing countries function imperfectly
• Government intervention needed to push the economy towards
Pareto-optimal (efficient) situation
• The Indian government is a large buyer of rice and wheat. Its
stated objectives for doing so include
– (i) providing price support to farmers,
– (ii) distributing subsidized foodgrain to the poor through the targeted
public distribution system (PDS),
– and (iii) maintenance of buffer stocks to ensure price stability and food
security
• Both production and procurement of rice increased in India
– Output trebled since 1960
– Food Corporation of India procurement increased from 10% in 1978-79
to 33% in 2010-11
– TPDS offers high subsidised food to BPL and less subsidised food to APL
 Deficiencies of TPDS
• High exclusion and inclusion errors
– Centre distributes food to states on the basis of
poverty line although food insecure households
higher than poverty ratio
– TPDS covers only 57% BPL families
– ghost cards are common
• non-viability of FPSs
• failure in fulfilling the price stabilization objective
 Deficiencies of TPDS

• leakages and diversion

– During 2003–04, out of an estimated subsidy of Rs
7258 crore under TPDS, Rs 4123 crore did not
reach BPL families. Moreover, Rs 2579 crore did
not reach any consumer but was shared by
agencies involved in the supply chain
 Government Failure: Omission and
Commission
• Failures of Commission: High-cost of public sector
enterprises engaged in economic activities
• Failures of Omission: Deterioration of public
services such as maintenance of infrastructure
such as road
 Government intervention has different objective?

• Intervention assumes that government is omniscient,

selfless, social guardians and corrections are costless
• Coordination and administration of public sector may be
costly
• Decision regarding policy not made by experts
– Political pressure
• Politicians seek support from various groups for reelection
• Bureaucrats have interest in promotion and power
– Corruption and favoritism
• Decision-maker attempt to minimize social cost of a
given activity subject to winning reelection or possibly to
maintaining or at least avoiding diminution of chances of
promotion
 Cost of Government Intervention
• Rent seeking
• Shortage of trained personnel
• Hire politically connected people
• Poor administration
• Lack of incentives
• Economic cost of public policies become high
 Advantages of Interventions
• Advantages
– Maintenance of law and order including
enforcement of contracts
– Provision of information (health practices,
agricultural research)
– Provision of basic public service of large-scale
(water supply)
 Government Failure: Limiting Scope

• Do not have advantage on manufacturing,

banking, agricultural marketing etc.
• Divert government resources and efforts away
from areas where it has comparative advantage
• Emphasis on activities where government does
not have advantage severely limits
government's capacity in activities where it has
advantages
Existence of market failure may not imply a
case for government intervention

We need to think of an alternative institution