“State intervention is justified by market failure”. Discuss in relation to the Welfare State in the UK.

STATE INTERVENTION IS JUSTIFIED BY MARKET FAILURE

Classic economists have always held that the ideal and optimal economic performance is determined by the degree of involvement of market forces Recent economic models however have shown that when the interests involved are public goods , there is a need for a certain level of government intervention . This study therefore seeks to examine the situation in a welfare state and allowable state intervention to produce a successful and progressive economy

Mainstream neo-classical economic theories , however , discourage too much state intervention . It is the belief

of these economists that too much state intervention unduly restricts the possibility of conducting free trade . It is the theory that the perfect economic model can only be achieved in a laissez faire model (Brebner , 1948 . Later economic theories however take a different stand from the neo-classicists in that they postulate that there is a need for government intervention up to a certain extent

This study will therefore seek to examine and analyze the proper circumstances that must exist before the government may intervene , such as market failure in a welfare state . In arriving at a proper understanding of this issue , it is important first to examine the economic models that exist in a welfare state

Market Failure

Market failure is an outcome derived from self-interested behaviour of individuals in the context of free trade , in which economic efficiency does not result . The basic reason for market failure is the inefficient allocation of the economy of the goods and services that are available The inefficient utilization of these goods leads to soaring prices as the supply will decline and a higher rate of opportunity costs

Forms of Government Intervention

The governments through the fiscal units have many tools at their disposal to curb any ill effects that a perceived market failure may bring . The two most effective form of government intervention in a basic economy are the impositions of ceiling prices , particularly in relation to public goods which the government has an interest to regulate , floor prices , which are used to ensure that the trading of public goods is lucrative enough an that there is an incentive for people to supply it , and last but not the least , taxes

These diagrams illustrate the effect of government intervention on the supply of public goods when it imposes a price floor and a price ceiling . As the first figure illustrates , when there is a low supply caused by the economic disincentive of a low price or profit margin , the government intervenes by placing a price floor which is above the average price in to create a surplus . This is particularly effective in ensuring the public goods are properly provided

The second figure illustrates the effect when the government is trying to protect the welfare of people . It places a price ceiling to ensure that the price at which the public good is provided is not too high for the public or the consumers

It is important to remember that in both these forms of intervention either a surplus or a shortage may occur if this is maintained in the long run . The government , in to be effective , must be vigilant in the length of time and level of intervention that it implements

The other method by which a government controls the market is by levying taxes on goods . The tax acts as a regulator in the sense that by imposing a tax on a public good , suppliers are going to raise the price of the good proportionally in to pass the burden on to the consumer . This causes the demand to adjust and suppliers will find a surplus and prices will also adjust accordingly

Criticisms on Government Intervention

There are those who argue that left to market forces , there is a possibility that the economy might work effectively for everyone . This is the main argument of those who support the laissez faire theory of a free market where it is believed that in a perfect system , the optimal output of every economy can only be attained if there is no state intervention

In many cases , especially in developing countries where the rich are the only ones who have the capability to invest in businesses , the problem of monopoly crops up . This eventually results in the development of the imperfect or monopolistic competition . This is the theory that most supporters of government intervention submit

The Concept of the Welfare State

It is a common misconception to assume that in a welfare state , the government provides all of the welfare . Welfare States , especially in Europe , do not have the government as the sole provider of all of the welfare for the population but rather the welfare is provided by a combination of independent , voluntary and government services . This may be provided by the government , a government agency or company , a private corporation , a charity , a non-government organization or forms of non-profit organizations as well

Problems within the Welfare State

It is useful to classify major problems of contemporary welfare-state arrangements into (i ) basically exogenous disturbances and (ii basically endogenous developments caused by the welfare state itself

Exogenous Factors

It is a commonplace that recent and predicted future changes in demography in developed countries , in particular the graying ' of the population , simultaneously boost social spending and have a negative influence on the tax base - since there are seldom automatic adjustments of social security fees and benefit rules in response to changes in demography . Indeed , in the EU-19 , the number of individuals above the statutory retirement age is already close to 25 percent of the number of individuals of working age - and is projected to rise to about twice that figure , or even more within three or four decades

The slow-down of the rate of productivity growth in the market sector in developed countries after the mid-1970s has created more or less the same financing problems , since neither the contribution rates nor the benefit rules in the social insurance systems are automatically adjusted to changes in productivity growth . So far , politicians have usually tried to deal with this problem in the same way as they have tried to adapt to demographic changes , that is , by ad hoc reductions in benefits and increases in social-insurance fees

Increased immigration to developed countries may place an additional strain on the financial position of various welfare-state arrangements in spite of the fact that such immigration is likely to improve ' the age structure of the population . The reason would be difficulties for such individuals to get employment . Poorly functioning labor markets partly as a result of regulated wages , would be an explanation . To the extent that governments are unable to alleviate these deficiencies politicians will most likely remain under political pressure to stiffen the restrictions on immigration

Baumol 's cost disease (Baumol , 1967 ) regarding labor-intensive human services - such as child care , education and old-age care - is another largely exogenous threat to the financial viability of today 's welfare-state arrangements . More specifically , since the relative costs of such services tend to increase over time (owing to slow productivity growth for such services , it will be necessary to raise tax rates gradually (without apparent limits ) in countries where these services are tax financed , even if the provision of such services would be allowed to increase only rather slowly . The problem is somewhat different in the case of health care . After all , productivity in the health-care sector tends to rise rather rapidly along with advances in medicine and surgical techniques . However , since these improvements partly take the form of increased possibilities to treat health problems that could not be treated before , it is unavoidable that the demand for health care will also be boosted (at given incomes and prices . As a result , health care will , in fact , be exposed to similar financing problems as other human services , although partly for different reasons

Endogenous Factors

In contrast to the welfare-state problems discussed above , disincentive effects via tax distortions and moral hazard are the result of endogenous adjustments of individuals to the welfare-state itself . In the case of income insurance , moral hazard arises simply because the individual will be able to choose more leisure at a very low cost to himself in terms of lost income . It is also well known that health-care insurance induces some patients to ask for excessive medical tests and expensive treatment , demands that many physicians may be willing to satisfy

As an illustration of the potential importance of moral hazard for per capita hours of work , we may note that nearly a fifth of the population of working age (15-64 ) in Western Europe today (2006 ) live on various cash transfers from the government - the most important examples include unemployment benefits , labor-market programs , social assistance sick-pay insurance , and early-retirement pensions (OECD Employment Outlook , 2003 , pp . 188-190 . Such moral hazard effects of generous welfare-state arrangements in Western Europe are , therefore , an important explanation for the limited per capita hours of work in that part of the world . As a comparison , per capita hours of work (per year in the United States are between 30 and 50 percent higher then in Western Europe

The character and size of the incentive effects of welfare-state arrangements depends , of course , on the specific rules of both the benefit arrangements and the financing of these . For instance , to the extent that tax-financed benefits are paid to retired individuals rather than to individuals in working age , the negative substitution effects on labor supply of the tax wedges are counteracted by positive income effects of the tax payment (since , in this case , the taxpayers of working age do not get anything back in exchange for the tax payments It is also a commonplace that negative incentives to acquire education as a result of marginal (in particular , progressive ) tax rates are often counteracted , or perhaps even overcompensated , by subsidies to investment in human capital . In some countries tax revenues are used to finance services that are close substitutes for home production , and hence complement to work in the open labor market . Subsidies to child care and old-age care outside the family are important examples . In this special case , the negative substitution effects of tax wedges on the labor supply would be counteracted by positive cross substitution effects on labor supply of the subsidized (or directly provided services

From an empirical point of view , the consequences of welfare-state spending on the efficiency and growth of the national economy are , of course , a perennial question . In the case of countries with modest levels of such spending , there is rather general agreement among economists that the positive effects of higher welfare-state spending on economic efficiency and economic growth are likely to dominate over the negative effects . This is particularly likely if increased public spending , starting from low levels , is concentrated on features such as sanitation , basic health care , elementary education , and infrastructure and if more comprehensive and generous income protection would further mitigate tendencies toward social unrest . However , there is also general agreement that , sooner or later , ever-increasing social spending will render the net effects on economic efficiency and growth negative although it is difficult to identify the turning point

CONCLUSION

Economic restructuring , with less state intervention at its core , is resulting in massive job losses in many countries , including the developed ones . The age-old problem of inefficiency still besets the service sector and in fact , is even made worse by skyrocketing costs of delivery of services . In most poor countries that have privatized public utilities , state universities , public hospitals , etc , basic social services have become even more inaccessible , driving the already marginalized social sectors deeper into the pit of poverty . As the World Bank itself has discovered , has not produced greater efficiency nor increased revenue (Singh 2000

In other words , market failure justifies state intervention . After all statistics will show that leaving the economy to market forces did not necessarily result in improved efficiency . Therefore , when it comes to commodities or public goods that are necessary for the welfare of the citizens , government intervention is justified in stepping in when market failure occurs or even before such occurs . No businessman or entrepreneur can claim that they are more interested in uplifting the situation of others than making more profit

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