Public Policy: Using Market-Based Approaches - Department for ...

SECTION 7
Market-Based Mechanisms
We have seen in the previous sections that market failures and social objectives
lead to government involvement in sectors of the economy. We have also seen
that government intervention can bring its own problems.
One reaction to this problem is to ask whether, even when a market failure
exists, an unregulated private sector may be more desirable than government
intervention. Government failure might outweigh the market failure it is trying to
correct. However, a third option may be to change the mechanism the publicsector
uses.
Government failure results from the loss of certain advantages of free-market
provision: such as incentives for efficiency and the role of the price mechanism
in allocating resources. One approach, therefore, is to try to introduce these
disciplines into the mechanism the public-sector uses. We refer to such
mechanisms as ‘market-based mechanisms’, which we define as mechanisms
that attempt to use market forces to reduce the problem of government failure.
The use of market-based mechanisms is unlikely to completely eliminate the
impact of government failure. Nor is it guaranteed that their use will reduce this
problem; that depends on how well they are designed and implemented.
However, the careful use of market-based mechanisms can help to overcome
some government failures. For example, in many cases it is possible for
governments to achieve their objectives by setting obligations that private firms
have to meet or, where it is decided to keep service provision entirely in the
public sector, by introducing customer choice to give a more efficient allocation
of resources.
For our purposes we divide market mechanisms into five broad categories.
However, any particular application may involve a combination of more than
one of these categories. In this section we describe each of these mechanisms in
turn, before noting the problems that need to be taken into account when
considering the use of these mechanisms. The mechanisms we consider are:
● competitive tendering of service provision;
● introducing user choice;
● marketable permits (‘cap and trade’;)
● taxes and subsidies;
● regulating access.
In addition, we consider the use of auctions as a means to value scarce resources.
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