Instruments of Government Policy

Instruments of Government Policy

Instruments of government policy To correct market failures, the state uses various instruments. Each has its own advantages and disadvantages. Taxes and Subsidies Pigouvian instruments: alter prices to reflect social costs/benefits. Advantages: Flexibility — agents themselves decide how to respond Efficiency — resources flow to where the costs are lower Revenue for the budget (taxes) Disadvantages: Difficulty in determining the proper rate Political resistance Direct Regulation Command-and-control: standards, limits, prohibitions. Examples: Emission standards for cars Ban on hazardous substances Safety requirements Advantages: certainty, simplicity of understanding. Disadvantages: inflexibility, does not account for differences in compliance costs. Tradable Permits Cap-and-trade: a limit is set, permits are traded. Advantages: Certainty of quantity (unlike taxes) Flexibility: reductions occur where it is cheaper Price is determined by the market Examples: EU ETS, SO2 trading in the USA. Informational Instruments Disclosure requirements: mandatory disclosure of information. Labeling: labeling (energy efficiency, organic products). Public information: ratings, warnings. Government Failure Government failures: intervention may be worse than the problem. Regulatory capture — regulator serves the interests of the industry Rent-seeking — resources spent on lobbying Unintended consequences Political distortions For the investor Regulatory environment: understanding probable regulatory changes. Carbon markets: investment opportunities and risks. Policy analysis: how regulations affect costs and competitiveness.