Trigger 4

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:

1. Economic Policy, Wikipedia - https://en.wikipedia.org/wiki/Economic_policy
2. International Monetary Fund, Wikipedia -https://en.wikipedia.org/wiki/International_Monetary_Fund

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:

1. How Do Government Subsidies Help Industry? by Evan Tarver, June 2015 -http://www.investopedia.com/ask/answers/060215/how-do-government-subsidies-help-industry.asp

2. Subsidy, Wikipedia - https://en.wikipedia.org/wiki/Subsidy