The Comparative Advantage of Government: A Review

Abstract

Why should governments be involved in the provision of any good whatsoever? In theory, market failures are necessary but not sufficient conditions for justifying government intervention in the production of goods and services. Even without market failures, there might be a case for government intervention on the grounds of poverty reduction or merit goods (for example, mandatory elementary education and mandatory use of seatbelts in cars and of helmets on motorbikes). In every case, contends Belli, a case for government intervention must first identify the particular market failure that prevents the private sector from producing the socially optimal quantity of the good or service. Second, it must select the intervention that will most improve welfare. Third, it must show that society will be better off as a result of government involvement - show that the benefits will outweigh the costs. It is impossible to judge a priori whether or what type of government intervention is appropriate to a particular circumstance or even to a class of situations. Such judgments are both country - and situation -specific and must be made on a case-by-case basis. To be sure, it is easier to make such judgments about market failures based on externalities, public goods, and so on, than about the market failures based on imperfect information. Market failures rooted in incomplete markets and imperfect information are pervasive: Markets are almost always incomplete, and information is always imperfect. This does not mean that there is always a case for government intervention and that further analysis is unnecessary. On the contrary, there is a keener need for analysis. The welfare consequences of the new market failures are more difficult to measure so government intervention's contribution to welfare is likely to be more difficult to assess and the case for intervention (especially the provision of goods and services) is more difficult to make. One must also keep in mind that government interventions are often poorly designed and overcostly. Poorly designed interventions may create market failures of their own. Governments concerned about low private investment in high-risk projects, for example, may guarantee them against risk but in the process create problems of moral hazard and induce investors to take no actions to mitigate such risks. And some interventions may turn out to be too costly relative to the posited benefits. In seeking to provide extension services, for example, governments may incur costs that are higher than the benefits farmers receive. This paper - product of the Operational Services Team, Operational Core Services Network - part of a larger effort in the Bank to improve economic analysis.