Public Choice Theory of Government Intervention

Abstract

Previous chapters have examined the efficiency rationale for government intervention, namely where markets fail to achieve allocative efficiency, and the means by which such intervention is financed. The basic Keynesian model of the management of aggregate demand is an example of how, in theory, intervention can be used during times of mass unemployment in order to maximise the output of the economy, so moving the economy back onto its production possibility frontier. Crowding out reduces the efficacy of intervention but, if less than 100 per cent, increased output may lead to a welfare improvement (see Chapter 5). However the analysis of Pareto optimality demonstrated that detailed knowledge of both production conditions and consumption preferences is required if allocative efficiency is to be attained through non-market systems (see Chapter 2). Moreover ‘second best’ theory suggests that piecemeal intervention may be counter-productive, increasing rather than reducing allocative efficiency.