Discuss the role government plays in a global economy. Also, look at what policies are currently in place and then discussion what policies should be put in place.

 

What It Means

Over the course of history some governments have attempted to exercise complete control over economic affairs in the interest of accomplishing social or political goals, and other governments have attempted to stay completely out of economic affairs in the belief that economies work best when they are unregulated. In a capitalist economy producers and consumers make countless individual decisions that together add up to the bigger economic picture. In the United States more than in most countries, people tend to believe that the economy should be shaped by the competing interests of individual businesses and consumers, rather than by government decrees and plans. It is true that governments at the local, state, and national levels in the United States intervene in economic affairs less than their counterparts in many other countries, but they nevertheless play an important role in, and have the power to monumentally alter, the national economy.

While local and state governments can have a significant affect on their economies, at the national level the federal government has far more power to alter the economic landscape. These range from laws enforcing private property rights to laws promoting competition among businesses.

When Did It Begin

government, like its European counterparts, did little to regulate its economy during the eighteenth century and most of the nineteenth. The federal government's hands-off approach to the economy was in keeping with the views of early economists such as Adam Smith , who believed that a government best promoted economic well-being when it stayed out of economic affairs. By the late nineteenth century, however, the inhumane conditions to which the increasingly large working class was subjected in the factories and mines of Europe and America led to increased government regulation of industry. Government involvement in the economy became much more pronounced, however, in the aftermath of the Great Depression, the severe economic crisis that crippled the world economy and left approximately 25 percent of American workers jobless during the 1930s.

Roosevelt's New Deal, a set of government efforts meant to revitalize the economy, the federal government backed large-scale public-works projects that employed out-of-work Americans, and it began making transfer payments to citizens through such programs as Social Security, which benefits the elderly and the disabled.

More Detailed Information

government influences economic growth and stability through the use of fiscal policy and monetary policy . When the government raises taxes, money moves out of private hands and into government coffers. When the government cuts taxes, private citizens and businesses have more money to spend and invest, and this tends to spur economic growth. Likewise, government spending moves money out of government coffers and into private hands.

Cuts in government spending have the opposite effect. In addition to these active forms of intervention into the economy, the federal government has wide-ranging regulatory responsibilities over private businesses. Traditionally, the government has regulated industries such as utilities, where one company tends to have a monopoly in a given region. The government has often set limits on prices to prevent utility monopolies from raising prices at will.

Likewise, if two dominant companies conspire to keep prices artificially high, the government is empowered to intervene. Social goals, such as consumer health and environmental protection, also serve as the basis for a substantial amount of government regulation. Government agencies monitor companies' environmental impact, the safety of food and drug supplies, and workplace conditions.

Recent Trends

government primarily used fiscal policy to manage the economy and bring it through recessions in the following decades. Focusing so intently on lessening the impact of recessions , the government perhaps paid less attention to inflation than was warranted. Inflation was brought under control through a severe reduction of the money supply , and has never since been a serious problem. Monetary policy, accordingly, has replaced fiscal policy as the government's primary tool for shaping the economy.

The relatively tight control that the government had exerted on the utility, transportation, and other industries was relaxed. This was partly due to concerns that government regulation prevented companies from responding to market forces in a way that would force them to innovate and remain efficient, and it was partly due to the appearance of new technologies in industries like communications, which allowed new companies to compete in fields such as telecommunications which had once tended naturally toward monopoly conditions. government, under conservative Presidents such as Ronald Reagan, whose term ran from 1981 to 1989, George H. .

In the early stages of sustained growth, government has often provided the incentives for entrepreneurship to take hold. The Great Depression of the 1930s persuaded many that a laissez-faire system did not automatically provide the necessary incentives to the innovation and risk bearing essential for economic growth. This led to a good deal of writing on the role that governments might play in stimulating growth. Only in this way can a general business psychology be developed that assumes growth to be the natural course of things, so that investment programs will pay off.

Growth theorists since World War II have gone further, arguing that it is not enough simply to achieve full employment periodically. Some maintain that it is necessary to maintain full employment over an extended period of time if high growth is to result. This argument relates to the earlier point that two economies may experience the same rate of growth of capital but that overall growth and technical progress will proceed at a much more rapid rate in one than in the other because of differences in the quality of new capital goods produced. The term enterprise investment has been used to describe the kind of capital formation that involves innovations and that by building ahead of demand generates rapid rates of growth of productivity or technical progress.

But to get such growth, it has been argued, an economy must be run «flat out,» at full speed. While this has been subject to some dispute, there is a fairly general consensus that growth will be faster when unemployment fluctuates within a narrow range and at low levels. A variation on this argument is the question of how a government may intervene to determine the distribution of output between those types of expenditure that contribute to growth and those that lead to the immediate satisfaction of consumer demand. Here the choice lies between business investment, research, and education on the one hand and consumption on the other.

The larger the first three, the more rapid will be the rate of growth. Governments giving a high priority to growth have various means at their disposal for influencing it. The same method has been used to stimulate business investment outlays. «Easy money» policies on the part of the central bank, whereby the cost of borrowed funds and their availability are indirectly regulated in such a way as to encourage business borrowing, may lead to higher levels of real investment.

The true cost of stimulating growth will always be a temporary cut in current consumption. Only in the future can the economic benefits of the higher investment be realized.

The Social Cost Of Growth

As has been seen, growth is really a transformation whereby certain industries experience a rise in importance followed by an eventual decline as the market for their output becomes relatively saturated. The faster these resources move, other things being equal, the more rapidly can growth and transformation proceed. A slower rate of growth in per capita consumption will slow down the rate of transfer of resources, but it may also result in a more livable environment. The rate of growth of individual welfare, so measured as to take into account non-consumable amenities, may even be increased.

Some argue that in a growth-oriented society wants are created faster than the industrial machine can satisfy them, so that people are more dissatisfied and insecure than they would be if growth were not given such a high value. These arguments are a powerful challenge to those who see growth as the most important economic goal of a modern society.

As the British economist John Maynard Keynes pointed out in the 1930s, saving and investment are not usually done by the same persons. The desire to save does not necessarily generate investment. A natural reaction on the part of business will be to cut back on production, thereby reducing incomes earned in production. This break in the circular flow of income and expenditure suggests the possibility of a capitalist economy alternately experiencing periods of prolonged and severe unemployment and periods of serious inflation .

In the following discussion, some attention will be paid to the ways in which the various theories of growth account for this important historical fact.

Role of the entrepreneur

Differences in growth rates between countries and between different periods in any one country could be traced largely to the quality of entrepreneurship. The latter in turn reflected certain historical and cultural values carried by the business class. Schumpeter also attributed much of the growth of technical progress and of the supply of labour to the entrepreneur. The savings available in a mature economy would tend to exceed the amount that the economy would want to invest and by progressively larger amounts as time went on.

This condition naturally would lead to increasing rates of unemployment as the discrepancy between demand and potential output widened. Hansen's views were very much coloured by the economic conditions of the 1930s.

The role of investment

If nine-tenths of any change in income is spent on consumer goods and one-tenth is saved, consumption will increase by $9. But again, one person's expenditures are another person's income, so that incomes now rise by $9 of which $8.1 is respent on consumer goods. The process continues until expenditures, incomes, and production have increased by $100, of which $90 is consumption and $10 the original change in investment. The British economist R. In their equations, the rate of growth of supply is equal to the rate of growth of capital stock.

Through investment this capital stock is augmented. The rate of growth of demand depends upon the rate of growth of investment or, more correctly, upon the rate of growth of nonconsumption expenditures. Thus investment affects both demand and supply.

Demand and supply

Models of growth may be classified according to whether they emphasize adjustments in demand or adjustments in supply . Hicks assumed that the spending propensities of consumers and investors were such as to cause demand to grow at a rate in excess of the rate of growth of maximum output. The long-run rate of growth of the economy would be determined by the rate of ascent of the ceiling, which in turn would depend upon supply factors such as the rate of growth of the labour force and the rate of growth of technical progress or productivity. If for some reason these were to grow more rapidly, then output would also grow more rapidly as demand adjusted upward to the more rapid growth of supply.

An example of a demand-determined model of growth is one developed by the American economist J. In the Duesenberry model, spending propensities of consumers and investors are such as to generate steady growth in demand. This increase will cause the rate of growth of demand to increase. The question is whether it will also cause the rate of growth of production to increase or whether it will merely result in price increases. If productivity or technical progress responds to a higher rate of growth of demand, as Duesenberry assumes, then production can grow more rapidly.

Other models of growth also illustrate this distinction between demand-determined and supply-determined growth. Simply stated, in his model an inadequate rate of investment will be offset by shifts in the distribution of income between profits and wages, which will cause consumption to change in a compensating manner so that overall demand is unchanged. While there are important differences between the Hicks and Kaldor models, both can be described as models of supply-determined growth. Another model of supply-determined growth is that implicit in the traditional neoclassical analysis.

A final example of a model of growth that illustrates the problem of adjustment between supply and demand is to be found in the work of the Dutch economist Jan Tinbergen and his followers. In contrast to neoclassical growth models where the market brings about an adjustment of demand to supply, the «target-instrument» models of Tinbergen assume that the government undertakes to regulate demand and supply in an effort to achieve certain targets such as full employment or a predetermined rate of growth. If it appears that unemployment will be too high and the rate of growth too low, the authorities take countermeasures. The government may, for example, cut taxes on corporate profits in order to stimulate investment.

If investment is excessive and there is danger of inflation, the government may take other measures to reduce aggregate demand such as cutting its expenditures. In the example just given, both the rate of growth of demand and the rate of growth of supply are effectively determined by the fiscal authorities.

Economic stagnation

The rise in unemployment rates and the slowdown in growth rates of GNP and per capita incomes throughout the capitalist world beginning in the early 1970s is clearly a case where demand and supply did not grow at similar rates. A common theme in much of their work was the adverse effects of high unemployment and low utilization of the capital stock on investment and, therefore, on productivity growth. The high unemployment rates for labour and capital are initially traced to policies restricting aggregate demand that were pursued by monetary and fiscal authorities from the first half of the 1970s. What emerges from these theories is a chain of causation that describes the way in which, in the period since World War II, inflation and growth have become causally connected through the responses of governments to actual and anticipated inflationary pressures.

Such responses lead, as they did in the early 1970s, not only to high rates of unemployment of capital and labour but also to low rates of investment and productivity growth.

Foreign trade

Yet growth in most economies is very much dependent upon imports and the ability to export in order to pay for imports. The fact that some economies recovered relatively quickly from World War II and grew much more rapidly in the postwar period than others has stimulated a great deal of comparative analysis in growth theory. The exceptionally high growth rates in Japan and Germany compared to the general sluggishness of the British economy are related to foreign trade. A policy of encouraging growth has the effect of keeping the demand for imports high and making labour markets tight, thereby tending to push up money wage rates.

At the same time, such a policy also tends to encourage innovations and investment projects that are very productive, particularly if the demand pressures are sustained. The question is which policy will in the long run result in less rapidly rising costs and prices. Running an economy «flat out,» however, is likely to cause a short-run balance of payments crisis and lead to devaluation of currency.

Mathematical growth theories

In addition to the theories discussed above, a large body of literature has developed involving abstract mathematical models. First, a set of equations is drawn up describing what the model builder feels are the important relations between economic variables such as output, capital, investment, and consumption. A related class of studies attempts to take account of the welfare of workers and consumers in the maximization of growth. These «optimal growth» models seek to maximize consumer satisfaction over time.

In a model such as this the solution will not be the highest possible growth rate but one that will maximize the welfare of consumers. The importance of such models for planners would seem to depend on the realism of their assumptions as to consumer desires and technology. Model building and theorizing about growth has proceeded on various levels of abstraction. Some models, while realistic, are not applicable to all economies.

Thus, a model that neglects international trade is of little use to a European economist trying to understand the more basic causes of differences in growth rates between countries.