In my essay I am going to talk about the way in which the UK government deals with market failures and the several approaches they can and have taken with the aim of preventing certain aspects of market failure from re-occurring. I will be particularly focusing on the way to government uses taxation as a way of compensating for market failures and the numerous types of market failure that they have to deal with, on a day to day basis.
Firstly, the concept of market failure must be explained; it is when a certain market is left to operate without any form of Government intervention and without this intervention, the allocation of goods and services by this free market is not efficient.
The UK government have many options available to them, in terms of ways they are able intervene in circumstances where market failures occur. However, one of the most commonly used is taxation. Consider any market failure; the over consumption of cigarettes and alcohol, the overuse of roads and aeroplanes. They are all heavily taxed, and taxation is one method I will be focusing on during this essay.
A topic that is becoming more and more pivotal to Governments plans by the decade is the environment. Technology has continued to improve over the years and has enabled us to understand the amount of pollution that’s been produced as a bi-product of our output each year. The importance of this subject was shown not only by Britain, but some of the most powerful nations in the world including USA, China, India and the whole of the EU when the Kyoto treaty was signed in 1997. This was an agreement where all nations involved agreed to legally binding reductions in their emissions of carbon dioxide by 2010. [ (http://www.revisionguru.co.uk/economics/govern9.htm n.d.) ] In order to try and prevent the levels of pollution from increasing in the UK, and also with the intention of them slowly decreasing, the Government have a tool available to them called an environmental tax. An environmental tax is a tax on a good or service that has an unfavourable effect on the environment.
My first example of an environmental tax the UK Government uses in order to compensate for market failures is the London congestion charge. London is the largest city in the UK and of course the capital, therefore this has to have some form of detrimental effect on the environment there, and it does. The roads in London are known to be some of the most chaotic in the world and in order to reduce the amount of people who commute to work by car the government introduced the London congestion charge. It can be described as a fee charged to some types of motor vehicle who enter the congestion charge zone of London at certain times. The charge is £10 per day for between 07:00-18:00 and penalties of between £60 and £180 can be distributed for those who choose not to pay. For a person earning the average salary, paying £50 a week to get to work is a lot of money, not taking into account costs for insurance, tax, and petrol.
This provides people with a huge incentive to travel to work each day on public transport as it forces them to pay for some of the negative externalities they are creating, or take an option which is better for the environment and also cheaper for them, which would be public transport. [ (http://tutor2u.net/economics/revision-notes/a2-micro-externalities-policy-options.html n.d.) ] The diagram below can be used to explain how this particular environmental tax works. Once the congestion charge is active, price increases to P1 which shifts the supply curve to the left therefore decreasing quantity demanded.
Another campaign that the government is increasingly looking to promote is recycling. As a result of this, in 1996 the UK’s first environmental tax was introduced by Conservative Secretary of State for the Environment, John Gummer; The UK landfill tax. It worked through increasing the cost of landfill, therefore making other; more environmentally friendly ways of disposing of waste seem more appealing and hopefully discourage the use of landfill. It had three main aims; Encourage waste producers to minimise the amount of waste they generate, reduce the amount deposited in landfills, and most importantly, encourage both firms and households to start recycling. [ (http://en.wikipedia.org/wiki/Landfill_tax n.d.) ] It’s become very popular throughout Britain, mainly successful through the governments allocation of Green bins and black boxes which can be used to dispose of many things found around anybody’s house.
But recycling isn’t just an issue for us at home, it is much more important that the government increase the incentive for Large firms with huge output levels to recycle. The environmental tax the government charges is £48 per tonne for active waste and £2.50 per tonne for inactive waste. These sums may seem small, but when you take into comparison the huge amounts of rubbish that large firms produce each year then this can really save them a considerable amount of money if they choose to recycle. If they decide to continue to use only our landfills then like with the congestion charge, these firms are deciding to pay for the negative externalities that they are creating, and it doesn’t come cheap to them.
Smoking is another thing that is many people consider being a market failure. Roughly thirteen million people smoke in the UK and not surprisingly, it causes many deaths, estimated to be around 120,000 every year, not to mention the millions of pounds it costs the NHS. Cigarettes are a de-merit good and without any form of intervention from the government, cigarettes would be over consumed and under-priced by the market. There are several ways in which they try to correct the market failure caused by smoking. Firstly, arguably the most effective way is through taxation. Similarly to the way the government uses environmental tax, they assign huge taxes to cigarettes which makes them very expensive. For example, currently the tax rate on cigarettes is 90% which means it costs roughly £2372 per year for a 20 a day smoker to continue their habit. Taxes this large therefore make it more difficult for people to afford to smoke as their real incomes decrease, and give consumers more of an incentive to quit. (http://tutor2u.net/economics/presentations/aseconomics/marketfailure/SmokingExternalities/default.html n.d.)
Although taxation is one of the most commonly used strategies to reduce the amount of people that smoke in the UK, it doesn’t deter everyone; this is where the tax revenues gained from cigarettes come into use. In the year 2000, the government earned £9,616,000 from taxation revenue on cigarettes. Some of this money then goes towards education schemes in schools that demonstrate the effects of smoking and how bad it can be for you. This is a key part of Government strategy in correcting this aspect of market failure as it aims to give younger people all the necessary information on smoking so they can realise all the detrimental effects it has on your body and will therefore discourage them to take up smoking in the future.
This is a key area that the UK government focuses on because if a whole generation can be educated well enough to the extent that they will choose not to smoke in later life, then the amount of people that smoke in the UK, in twenty years will be considerably lower than the amount that smoke currently. Part of the revenue gained from cigarettes also goes towards the funding of advertisement campaigns shown on the television, internet, billboards, magazines, the most recent being TV adverts featuring young children calling out for their parents to abandon their habit.
Alcohol is also another de-merit good that the government consider to be over consumed. Therefore, like cigarettes it is heavily taxed with the intention of reducing the average consumption level per person, per week. There are two types of taxes on alcohol; excise duties, and VAT. Excise duties generally depend on the category of alcohol a drink falls into, for example the government has a higher tax rate on beers and ciders that contain a higher volume of alcohol and are therefore more damaging to a person’s health, whereas drinks with a lower volume of alcohol tend to have lower excise duty charges applied to them. These excise duties are reviewed every year by the Chancellor and any amendments to the previous year’s excise duties are included in the annual budget. The excise duties create huge revenues each year for the government, for example in 2005 the revenue from beer (5992.2m) wine (4398.7m) and spirits (3587.2m) added up to a total of £13,978,000.
A scientific review of this issue concludes: “Taxation of alcohol is an effective mechanism for reducing alcohol problems…The notion that heavy or dependent drinkers are immune to the influence of price is demonstrably incorrect. Put simply, but with entire scientific accuracy, alcohol taxation is a readily available instrument which can be applied to save lives and avert alcohol-related suffering.” Therefore, these excise duties do not enable people to drink as often due to the increased cost when taking into account for tax, and therefore are a way of correcting market failure; however these taxes do not make alcohol expensive enough to stop people from drinking altogether.” (http://www.ias.org.uk/resources/factsheets/tax.pdf n.d.)
Many markets in the UK can become unstable in times of economic crisis and food producers are a group that fall into that category. They suffer primarily from 3 economic problems; firstly, a fall in long term incomes, simply because the overall supply of food has increased due to improvements in technology and better crop yields. There are also many other countries competing with us in the food industry, many are much poorer countries, therefore they are more competitive as they can sell at a lower price. Secondly, unstable pricing in the industry is a key issue.
Negative Supply shocks such as crop disease of bad weather can lead to prices so low that producers are driven out of the market. The third and possibly the most damaging economic characteristic to smaller food producers is their complete Loss of bargaining power with big supermarket chains who, as monopolies are able to name a price to smaller suppliers, leaving them with little choice but to accept that price for fear of going out of business.
The perceived market failure through the sheer power of monopolies is compensated for by the UK government through the Common Agricultural policy, also known as CAP. CAP was created by the Treaty of Rome (1957) to ensure that food supplies were constantly flowing throughout Europe and that all European farmers would receive a fair wage.