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This chapter focuses on government failure. Most economists now agree that the idea of government failure needs to be placed alongside the idea of market failure in discussions of government intervention. However, unlike market failure, there is no agreed upon definition of government failure. The economics literature is also obscure on which aspects of government failure are intrinsic to the fact that government has a monopoly of coercive power and which aspects are consequences of democratic political competition. The chapter provides an overview of these ideas and develops some simple economic examples to illustrate the main ideas.

This chapter looks at the comparative systems approach to understanding the way in which different institutional regimes affect the governance of technological development. It focuses on four institutional constraints: market failure, government failure, corporate failure, and network failure. Each has the potential to impede or disconnect the linkage between the production of technology and the use or adoption of technology.

The question of what kind of institutional set-up would be appropriate for promoting economic development is approached in terms of combination between market and state. The traditional debates on the choice of development strategy between free trade and infant industry protection is examined with reference to the historical experiences of developed economies as well as recent confrontations between import substitution industrialization and the IMF-World Bank structural adjustment policies. The nature and significance of market failures versus government failures are illustrated in terms of comparisons between the Latin American Debt Crisis in the 1880s and the Asian Financial Crisis in the 1990s. The choice of the market versus the state, as well as growth versus equity, is discussed in reference to the changing paradigms in the IMF-World Bank.

This chapter sets out the economic theory of the role of the state that underpins the rest of the book. It starts with a simple model – the Fisher model – of rational consumer choice over the life cycle. Subsequent sections relax the underlying assumptions, discussing in turn imperfect information in the goods market, the economics of insurance, the effect of imperfect information on insurance markets, and social insurance as a response to information failure. The concluding section summarizes the implications for policy, including discussion of market failure and government failure.

The question of what kind of institutional set‐up would be appropriate for promoting economic development is approached in terms of combination between market and state. The traditional debates on the choice of development strategy between free trade and infant industry protection is examined with reference to the historical experiences of developed economies as well as recent confrontations between import substitution industrialization and the IMF–World Bank structural adjustment policies. The nature and significance of market failures versus government failures are illustrated in terms of comparisons between the Latin American Debt Crisis in the 1880s and the Asian Financial Crisis in the 1990s.

Successful innovation policies are those that actively create and shape markets, not only fix them. In the past this has been achieved through “mission-oriented” policies aimed not at fixing market failures or minimizing government failures, but rather on maximizing the transformative impact of policy. Countries around the world are currently striving to achieve innovation-led growth that is both inclusive and sustainable. For this to happen, public policy needs to support innovation and direct future activities. Innovation policy must focus on building more “symbiotic” (less parasitic) innovation “ecosystems.” This chapter discusses new types of policy questions needed to address the collective, uncertain, and persistent nature of innovation and posits four key areas: directing public policy, evaluating public policy, organizational change to accommodate risk taking and exploration, and the socialization of risks and rewards.

The final problem threatening societies like the US concerns the pervasive bias in favour of privately produced goods and services at the expense of those provided by government. Inadequate public provision, Galbraith argues, hampers the most effective use of society’s expanded productive capacity while unnecessarily impoverishing most citizens’ lives. This outcome is due to an amalgam of the factors and forces identified earlier in the book – namely, the debt-fuelled process of want creation, the malign impact of vested interests, the ideology of market fundamentalism and the associated attack on the proper economic role of the state. Galbraith’s analysis raises issues that have recently resurfaced in heated debates over privatization. It also strongly resonates with recent developments in environmental economics and policy. In short, Galbraith’s theory of social balance remains one of the enduring contributions of The Affluent Society, fifty years after its publication and counting.

China’s experience in technology-intensive industries suggests a new model of development: the global hybrid model. The global hybrid model relies on hybrid firms combining foreign finance and shared ethnic ties with the host economy to drive technological development. This model offers ways to overcome market failure and government without relying on a highly effective state, the type of state notably absent from most of the developing world. The global hybrid model offers an important corrective to the current approaches to the political economy of development: the augmented Washington Consensus approach, the statist revisionist (developmental state) approach, and the transnational network approach. However, the global hybrid view is limited to those sectors with high clockspeeds, fragmented or disaggregated value chains (high modularization), and high technology intensity.

This chapter describes the evolution of development economics thinking after the Second World War as one of a constantly shifting balance between addressing market failures and government failures. The pendulum has swung from statist “big push,” through market-oriented “Washington Consensus,” to a more balanced approach between state and market that also includes the role of civil society as a third player. The chapter interprets these swings as not just technical responses to real-world problems with either approach, but as the result of political forces and institutional incentives. Looking ahead, the chapter sees development thinking in the future being dominated by two issues that go beyond the “market-versus-state” dichotomy: sub-national pockets of poverty, and global public goods. The chapter concludes by noting that development economics thinking proceeds in evolutionary rather than revolutionary steps, with each shift building on the experience of the previous phase.

There are reasons to be sceptical about whether it is possible to move from an individualist position to considering the interests of groups. The ‘impossibility theorem’ seems to imply that people might always have inconsistent preferences, and that nothing can be done by groups that is not in some way imposed. Collective action is assumed by some theorists to be unstable. There are, however, many forms of collective action, there are good, strong reasons why even self-interested individuals should cooperate, and some collaborative mechanisms have proved remarkably resilient. The main problems which public services pose for individualists are not best considered by generic criticism of collective action, but by how the position of individuals can be respected and defended within collective structures.

This chapter is an essay on the ends and means of economic development. The objective of development is defined as the achievement of ‘rapid, inclusive, stable, and sustainable growth of national income, within a democratic political framework’. As regards the means to attain this objective, the fundamental choice concerns the balance between the state and the market in the organization of economic activity. The state may wish to intervene in markets to alter the distribution of income. It may also do so to correct ‘market failures’ caused, for example, by the presence of ‘external effects’. But the benefits of intervention have to be weighed against the costs of ‘government failure’, which may arise for several reasons, including in particular, the presence of ‘principal-agent problems’. The chapter also emphasizes the crucial distinction between the government paying for goods and services and the government producing and delivering goods and services.

The notion of “structures” has evolved over the decades to cover both macro and micro issues, and to hold different meanings. In the 1940s, the focus was on market failures and the active ways in which governments could promote economy-wide change in production, such as agricultural transformation, industrialization, urbanization, and “modernization.” A second wave of thinking in the 1980s highlighted government failures, emphasizing the functioning of markets, institutions, and regulatory and incentives systems. Proponents of the “structural” adjustment programs advocated for restoring external and domestic balances, prescribing liberalization and privatization. A third and more recent wave of literature seeks to reconcile these extremes. New Structural Economics draws lessons from history to identify factors that help or hinder the reallocation of resources from low- to high-productivity sectors. It promotes the strategic selection of competitive industries according to the comparative advantage, and recommends a new distribution of roles between governments and markets.

The chapter examines three issues addressed in the literature. The first is the objection that governments cannot be trusted with making these intervention decisions. The chapter accepts the force of the objection, but argues that such government failure must be part of the proportionality calculus. The second issue is whether consent matters for intervention. The chapter claims that the consent of the victims' fellow citizens is irrelevant, as is the consent of the incumbent regime and its supporters. And finally, the chapter proposes an alliance of rights-respecting governments as the more plausible institutional alternative to approve and supervise justified interventions.