Learning objective 1. What actions governments can take to
affect the economy? What can be the consequences of government actions?
According to Andrew
Beattie in his article “How Governments Influence Markets” the government has
several possibilities to affect the markets and influence businesses in ways
that often have unexpected consequences.
Monetary
Policy: The Printing Press -
Of all the weapons in the government's arsenal, monetary policy is by far the
most powerful. Unfortunately, it is also the most imprecise. True, the
government can do some fine control with tax policy to move capital between
investments by granting favorable tax status (municipal government bonds have
benefited from this). On the whole, however, governments tend to go for large,
sweeping changes by altering the monetary landscape.
Currency
Inflation - Governments
are the only entities that can legally create their respective currencies. When
they can get away with it, governments always want to inflate the currency.
Why? Because it provides a short-term economic boost as companies charge more
for their products and it also reduces the value of the government bonds issued
in the inflated currency and owned by investors. Inflated money feels good
for a while, especially for investors who see corporate profits and share
prices shooting up, but the long-term impact is an erosion of value across the
board. Savings are worth less, punishing savers and bond buyers. For debtors,
this is good news because they now have to pay less value to retire their debts
- again, hurting the people who bought bank bonds based off those debts. This
makes borrowing more attractive, but interest rates soon shoot up to take away
that attraction
Fiscal
Policy: Interest Rates -
Interest rates are another popular weapon, even though they are often used to
counteract inflation. This is because they can spur the economy separately from
inflation. Dropping interest rates via the Federal Reserve - as opposed the
raising them - encourages companies and individuals to borrow more and buy
more. Unfortunately, this leads to asset bubbles where, unlike the gradual
erosion of inflation, huge amounts of capital are destroyed, which brings us
neatly to the next way the government can influence the market.
Bailouts - After the financial crisis from 2008-2010,
it is no secret that the U.S. government is willing to bailout industries that
have gotten themselves into problems. Bailouts can skew the market by changing
the rules to allow poorly run companies to survive. Often, these bailouts can
hurt shareholders of the rescued company and/or the company's lenders. In
normal market conditions, these firms would go out of business and see their
assets sold to more efficient firms in order to pay creditors and - if possible
- shareholders. Fortunately, the government only uses its ability to protect
the most systemically important industries like banks, insurers, airlines and
car manufacturers.
Subsidies
and Tariffs - Subsidies and
tariffs are essentially the same thing from the perspective of the taxpayer. In
the case of a subsidy, the government taxes the general public and gives the
money to a chosen industry to make it more profitable. In the case of a tariff,
the government applies taxes to foreign products to make them more expensive,
allowing the domestic suppliers to charge more for their product. Both of these
actions have a direct impact on the market. Government support of an industry
is a powerful incentive for banks and other financial institution to give those
industries favorable terms. This preferential treatment from government and
financing means that more capital and resources will be spent in that industry,
even if the only comparative advantage it has is government support. This
resource drain affects other, more globally competitive industries that now
have to work harder to gain access to capital. This effect can be more
pronounced when the government acts as the main client for certain industries,
leading to the well-known examples of over-charging contractors and chronically
delayed projects.
Regulations
and Corporate Tax - The
business world rarely complains about bailouts and preferential treatment to
certain industries, perhaps because they all harbor a secret hope of getting
some. When it comes to regulations and tax, however, they howl - and not
unjustly. What subsidies and tariffs can give to an industry in the form of a
comparative advantage, regulation and tax can take away from many more. High
taxes on corporate profits have a different effect in that they discourage
companies from coming into the country. Just as states with low taxes can lure
away companies from their neighbors, countries that tax less will tend to
attract any corporations that are mobile. Worse yet, the companies that can't
move end up paying the higher tax and are at a competitive disadvantage in
business as well as for attracting investor capital.
Sources:
1. How Governments
Influence Markets, by Andrew Beattie -http://www.investopedia.com/articles/economics/11/how-governments-influence-markets.asp
Learning objective 2. What are the external factors that affect
government's economic policy?
Economic policy refers to the actions that governments
take in the economic field. It covers the systems for setting levels of
taxation, government budgets, the money supply and interest rates as well as
the labor market, national ownership, and many other areas of government
interventions into the economy. Most factors of economic policy can be
divided into either fiscal policy, which deals with government actions
regarding taxation and spending, or monetary policy, which deals with central
banking actions regarding the money supply and interest rates. Such
policies are often influenced by international institutions like the
International Monetary Fund or World Bank as well as political beliefs and the
consequent policies of parties.
The International
Monetary Fund (IMF) is an international organization headquartered in
Washington, D.C., of "189 countries working to foster global monetary
cooperation, secure financial stability, facilitate international trade,
promote high employment and sustainable economic growth, and reduce poverty
around the world." It now plays a central role in the management of
balance of payments difficulties and international financial crises.
Through the fund, and
other activities such as statistics-keeping and analysis, surveillance of its
members' economies and the demand for particular policies, the IMF works to
improve the economies of its member countries. The organization's objectives
stated in the Articles of Agreement are: to promote international monetary
cooperation, international trade, high employment, exchange-rate stability,
sustainable economic growth, and making resources available to member countries
in financial difficulty.
Sources:
Learning objective 3. Why are governments subsidizing
commodities?
Commodity = a raw material or primary
agricultural product that can be bought and sold, such as copper or coffee.
Commodities are most often used as inputs in the production of other goods or
services.
A subsidy is
a benefit given by the government to groups or individuals, usually in the form
of a cash payment or a tax reduction. The subsidy is typically given to remove
some type of burden, and it is often considered to be in the overall interest
of the public. Government subsidies help an industry by paying for part of
the cost of the production of a good or service by offering tax credits or
reimbursements or by paying for part of the cost a consumer would pay to
purchase a good or service.
Types of subsidies:
· Production
subsidy - A production
subsidy encourages suppliers to increase the output of a particular product by
partially offsetting the production costs or losses. The objective of
production subsidies is to expand production of a particular product more so
that the market would promote but without raising the final price to consumers.
This type of subsidy is predominantly found in developed markets
· Consumer/consumption
subsidy - A consumption
subsidy is one that subsidises the behavior of consumers. These type of
subsidies are most common in developing countries where governments subsidize
such things as food, water, electricity and education on the basis that no
matter how impoverished, all should be allowed those most basic requirements
· Export
subsidy - An export
subsidy is a support from the government for products that are exported, as a
means of assisting the country’s balance of payments
· Employment
subsidy - An employment
subsidy serves as an incentive to businesses to provide more job opportunities
to reduce the level of unemployment in the country (income subsidies) or to
encourage research and development.[2] With an employment subsidy, the
government provides assistance with wages. Another form of employment subsidy
is the social security benefits.
· Tax
subsidy - Government can
create the same outcome through selective tax breaks as through cash payment.
· Transport
subsidies - Some
governments subsidize transport, especially rail and bus transport which
decrease congestion and pollution compared to cars.
· Environmental
externalities - As well as the
conventional and formal subsidies as outlined above there are myriad implicit
subsidies principally in the form of environmental externalities. These
subsidies include anything that is omitted but not accounted for and thus is an externality.
These include things such as car drivers who pollute everyone’s atmosphere
without compensating everyone, farmers who use pesticides which can pollute
everyone’s ecosystems again without compensating everyone
Sources:
