WILLIAM R. KEECH, MICHAEL C. MUNGER
Abstract: Government failure is a much bigger problem than its contemporary treatment implies. Setting aside natural disasters, most of the great catastrophes of human history have been government failures of one sort or another. We argue that many so-called market failures are government failures because government defines the institutions in which markets succeed or fail. The concept of government failure has been trapped in the cocoon of the theory of perfect markets. Narrowly defined deviations from market perfection have been designated market failures, for which government corrections may or may not really be a solution. Government failure in the contemporary context means failing to resolve a classic market failure. We propose an alternative approach for evaluating whether government fails: the Pareto standard. If an available Pareto improvement is not chosen, or is not implemented, that is a government failure. We organize government failure into two types: substantive and procedural. Substantive failures include the inability or unwillingness to maintain order, to maintain sound fiscal and monetary policies, and to reduce risks of transaction costs, which we classify as corruption, agency and rent-seeking. Procedural failures are inadequacies of available social choice mechanisms, causing collective decisions to be arbitrary, capricious, or manipuated. We conclude with some reflections on human rationality and the implications of behavioral economics.