Understanding Economics: (12)-Policies to Correct Market Failure |19 March 2008

Firstly, with the use of regulations, the government may control economic activity.  Hence, in its own right or through other regulatory bodies, government may legally influence the goods or services that are produced and consumed in a market.  For example, government may set a minimum age at which a person is allowed to buy certain products, such as alcohol and cigarettes. 

Other forms of regulation may include the requirement for an individual to purchase an insurance policy before being legally permitted to drive a car, the age at which students are required to attend school, and the payment of social security contributions, to name a few. 

These policies tend to influence the quantity and quality of goods or services consumed.  However, through regulations, the government may also directly determine the price level in the economy.  These may be through having legislation which sets a minimum wage or other prices.  For example, in many economies, the government controls the maximum selling price of basic staple foodstuffs or utility tariffs which may not necessarily be at a level where the profits of the suppliers are maximised.

Secondly, the government may use financial intervention tools.  This tend to be in the form of taxes, which are levies imposed on the income and wealth of individuals and firms, or subsidies, which are the provisions of finance and other resources to support an individual or a firm. 

Price subsidies vary and may be in the form of a partial subsidy.  Two examples within the local context would be the cost of public transport provided by Seychelles Public Transport Corporation (SPTC) which is partly subsidised by the government or concessionary price of fuel for registered fishermen.  Subsidies may also be full, and this is when the government offers certain free services such as health and education. 

The government’s intervention in the market through taxation, which although provides an important source of raising revenue may arguably be viewed as an instrument to discourage the consumption of certain commodities.  The typical example is the generally high tax levied on alcohol beverages and tobacco. 

Thirdly, whilst a government may intervene through the provision of financial assistance, in some cases, it enters the market by taking over the production of the good or service.  This may be partially as well as entirely.  Therefore, through state production, the government would aim to address the existing malfunctions that exist in the market.  Hence, as discussed in the preceding article, the government tends to intervene in order to make sure that public goods such as road networks and infrastructures, as well as merit goods such as health services and education, are available across all segments of the economy. 

This, however, is not to say that these goods or services should be supplied solely by the state.  It is very common to find some goods or services being offered by both the government and private sectors.  Education and health care are particularly good examples of these and in most countries, private clinics and hospitals function alongside that of the state.  The same applies to private and public schools.  Nonetheless, in order to achieve its role of welfare maximisation, in the national interest, in some cases, the government happens to be the sole provider of a particular good or service. 

The fourth mode of intervention used by the government to correct market failure is through the transfer of income.  This may be used for the purpose of redistributing income between different groups in society, for example, as it is the case in Seychelles, from the working population to those who are retired (Social Security benefits).  The justification for such a transfer is to achieve fairness from a social economic perspective.

These transfers of income tend to be in the form of a cash benefits paid by the government from revenue collected from tax-payers.  In many economies, income transfers may also be for the purpose of assisting individuals who have experienced an unexpected loss of income.  As an example, this may be when a person is not working due to illness.  In Seychelles, the common cash transfers include social security benefits and pension, as well as payments to individuals under means testing, with the latter being an income supplement.

Views differ as to whether the solution to market failure should be government interventions.  Whilst this may result in the availability of certain goods or services at non profit-making prices and an improvement in the welfare of some individuals, the important consideration is likely to be whether government intervention increases the level of economic efficiency in the market.  If this is achieved, then the intervention must be judged to be economically desirable.

Contributed by the Central Bank of Seychelles. E-mail: enquiries@cbs.sc