Strategy Survival Guide

• Information failures. The effective operation of markets relies on the fact that all the participants in
the market have complete and perfect information relevant to that market. When this information is
not available to all participants, this is described as asymmetry of information, and market failure can
arise. Information asymmetries lead to sub-optimal outcomes. For example, a buyer may not have
full information on the characteristics of a product or service he/she wishes to buy – this is known as
adverse selection.
• Public goods. Markets work effectively to provide private goods and services, which are typically
rival and excludable in nature – i.e. each specific item or service can only once be sold/bought, and
once purchased, can be exclusively "enjoyed" by the purchaser. In contrast, public goods and
services are non-rival and non-excludable – if one person purchases the good or service, that does
not stop others from purchasing it; and there is generally no way to stop people from enjoying the
good or service. True public goods and services are comparatively rare, but the provision of national
defence and of law and order are typically used as illustrations.
(II) Equity, which is to do with the delivery of social or distributional objectives. Even where markets are
working efficiently, they may result in a distribution of income (or other benefits/costs) that is unacceptable to
society. This will often arise through a lack of incentives to improve equity, or because the necessary
information is available only to government.
3. Identify what actions are available to government in order to deliver the desired outcomes:
As well as providing a useful checklist for justifying government activity, the issues outlined above can also
be helpful in pointing towards the type of activity that government might want to undertake – Stage Three of
the process. Government intervention should typically be directed at tackling the particular market failure that
is occurring, or at delivering the specific social objective in question. A wide range of interventions is
available to government, and it will often be appropriate to consider several options. Examples include tax
incentives, grants, loans, and information campaigns.
4. Consider whether the costs of government intervention are justified:
There are two separate aspects to this stage of the process:
• The first stage is to identify the additional benefits that would arise as a result of government
intervention. The concept of additionality is important – what should be measured is not the gross
benefit, but the benefit net of what would have happened without intervention.
• The second stage is to identify the negative impacts of the government intervention. These negative
impacts may include the direct costs of the intervention, but they may also include further negative
impacts arising as a result of "government failure" – i.e. it is possible that government will get its
intervention wrong, or that the intervention will have unintended consequences.
Only if the net benefit of intervention outweighs the costs of intervention is government action justified. In
practice, this stage of the process may form part of the economic appraisal of the options for intervention,
either through cost-benefit/cost-effectiveness analysis or through multi-criteria analysis.
Strengths
Using this four stage process – and in particular the list of market failures – is a good way of checking
whether or not government should be involved in an issue.
Weaknesses
If applied incorrectly, the approach does contain pitfalls. For example, it is important to be sure that the net
benefits of government intervention justify the costs. And even if an individual intervention is justified, it is
also necessary to consider the overall burden imposed by government intervention – there may be a case for
focusing intervention only on priority policy areas, so as to avoid "micro-management".
References
Micro-economics or public economics text-books include chapters on the basic market failures and how they
should be dealt with.
HM Treasury Green Book and HMT micro-economics courses
Strategy Survival Guide – Strategy Skills
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