Government as the Problem
Just as there are examples of market failure, there are many examples of government failure.12 Regulation can end up making situations worse and reducing public welfare. When, for example, the government overestimates the extent of a market failure, its regulatory policy could end up forcing the economy to incur unnecessary costs and reducing public welfare. Another cause of government failure could be shortsighted, inflexible, and contradictory policies of government agencies. A flawed political system might allow certain interest groups to influence government intervention to accrue economic rents at the expense of social welfare. The industry that the government is trying to regulate might capture the regulatory process to its own benefit. The theory of regulatory capture has demonstrated that regulation designed to protect consumers often ends up benefiting the industry to the detriment of consumers.13 Public choice theory demonstrates that some costs (i.e., failures) are characteristic of a democratic system of government. The problems of government failure are exacerbated when the government lacks the resources and competence to design and administer appropriate regulations and to manage public services, which is particularly true in complex environments requiring much specialized knowledge. If there is corruption in government, the situation is even worse.
India provides an example of the failure of public services. The Indian economy is growing rapidly, the stock market is doing well, Indian companies are expanding abroad, and a large middle class is emerging. Economically, it is the best of times. Contrast this with the other side of India, characterized by persistent gender and caste inequality, and growing income inequality. Fifteen percent of boys and 19 percent of girls do not attend even primary school. Seventy-nine percent of rural households and 46 percent or urban households do not have adequate sanitation. India is not alone in this failure of the state; it is easy to cite similar statistics for many other developing countries. About 884 million people in developing countries do not have adequate access to clean drinking water, while 2.6 billion lack basic sanitation. Nearly 1 billion people are illiterate and 101 million children of primary school age are not in school. The boom in the private sector has been accompanied by a significant failure by the state to provide basic public services.