Government Society and Business

Memo # 2
Submitted by: Prashant Pratap Singh (61710779)

THESIS STATEMENT:
Government plays an important role in environment market failure.

INTRODUCTION:
In reality, it is rare to experience a perfect market and when a market fails to efficiently allocate resources, we
say that the market has failed and hence it justifies government intervention. When government intervention
to correct market failure, leads to creation of more inefficiencies and misallocation of scarce resources in the
system, it is called government failure1. The major environment problems such as pollution, global warming,
acid rain, extinction of species, depleting ozone layer and etc. are examples of environment market failure.

Environment policies, a way of intervention from the government, are made keeping into consideration both
market as well as government failure. For instance, letting environment follow a free market situation and
relying on CSR activities, and assuming consumers will follow socially optimal solution, will not deliver optimal
result. Similarly, global environmental policies are likely to fail because of the information asymmetry between
the implementing agents and policy makers. Thus, the appropriate models of government intervention in
policymaking will lie between these two extremes.

The following report will try to explain various causes of environment market failure and suggest how
government intervention could be made successfully.

CAUSES OF MARKET FAILURE

Market failure for environment goods and services occur because there is no well-defined market for the same.
Even when the market do exist, it is difficult to calculate the value of the goods and services as they are
intangible. Usually environment resources such as clean air, water, ocean, atmosphere etc are considered as
free and thus are counted as zero in private valuations even when they have social value.
The major cause of environment market failure are as follows.
1. Externalities
The spillover benefit or cost to the third party who is not directly involved in the market exchange activity is
known as externalities. For Example, Pollution of river, air or an open space caused by construction activity.
Since community who is not involved with the selling and purchase of the building being constructed are
affected because of the activity in form of contamination of water, health issues associated with respiratory
problems etc. Thus, the construction firm has negative externality. In activities of positive externalities social
benefits are higher than private benefits and vice versa for negative externalities.

2. Free Rider Problem

The free rider problem occurs when people take advantage of being able to use a common resource (public
goods) without paying for it. For example clean air. One has a personal benefit of not paying for investing in
cleaner technologies and still enjoy clean air.
GREENHOUSE EFFECT / GLOBAL WARMING An Environment Market Failure
Pollutions or Greenhouse Emissions are a side effect of high economic activities in a region. However, the major
ill effects of the emissions do not falls on the people who
are conducting it (developed nations) but on the future B
generations or even on the regions who are not conducting AH > AL ; BH > BL Reduce Economic Increase Economic
those activities (developing nations). Output Output
The same can be expressed as a game as shown in Figure. Reduce Economic
AL = BL AL < BH
The Nash equilibrium of the game is that both the nations Output
(A and B) increase their economic activity. As a result,
A Increase
AH > BL AH = BH
market fails over greenhouse gasses emissions. Economic Output

GOVERNMENT INTERVENTION AND MARKET FAILURE

The government uses the following tools to correct the negative externalities.
1. Direct Government Control
Government intervenes in the market where negative externalities exists and put pressure on the producers
to take corrective actions. It creates a mandate, imposes penalties and fines, and monitor industries and
pressurize them to adopt clean and efficient ways. For instance Delhi government banned the operation
of industries in the cities forcing them to shift out of the city, Delhi government launching Odd-Even scheme
to reduce pollution from the private vehicles. Similarly, Chinese government banning private cars (1.15 M)
to arrest air pollution before Beijing Olympics2.
2. Corrective Taxes
Government could impose taxes on the businesses polluting environment while producing goods based on
the amount of pollution they create. Creating more pollution will lead to more taxes, thus would put
pressure on the companies to produce in a more environmentally responsible manner. For instance Indian
government implementing Swachh Bharat Cess, providing subsidy for investment in environment friendly
production methods solar power etc and Carbon Tax.

3. Creating a market place / Issuing Permits

Government has set up a market for issuing permits that allows companies to pollute a certain amount.
Heavy penalties are imposed on those who exceeds the limit. They are allowed to exceed their limit provided
they buy credits/permits from other market players (companies). As it directly adds a cost to the company
and affects the profit, it puts a pressure on the company to produce in a more environmentally responsible
manner and invest in better low polluting technologies. For example Carbon Trading3.

IS GOVERNMENT INTERVENTION EFFECTIVE?

The above methods ate used to different degrees by government around the world in various industries to
mitigate the negative externalities of environment market failure (pollution). Thus, it may seem that a brilliant
government is a solution to a failing market. However, governments can fail too. Following are the problems
that may arise with government intervention.

1. Measurement problem
Corrective taxes, theoretically should correct the problem. However practically how much tax to be charged
and who will be burdened with the expense are difficult to answer.
2. Enforcement Problem / Asymmetric information
As most of the calculation for taxes are based on production quantity and thus private companies has benefit
to under report their production.

3. Political pressures
Imposing penalties or putting a ban may have negative publicity and political pressure in democracies. For
instance Odd even scheme in Delhi. Any kind of ban or penalties are bound to have negative reaction from
the people suffering from it. This could be used as a tool in politics to create negative sentiments for the
implementing government.

RESOURCES:
1. http://www.economicsonline.co.uk/Market_failures/Government_failure.html
2. https://www.theguardian.com/world/2008/jul/21/china.olympicgames2008
3. http://www.fern.org/campaign/carbon-trading/what-carbon-trading