In one of the previous blogs, we explained how there's different degrees of government involvement in different economies.
The information within this blog will specifically relate to the role of government within the context of a free market system approach.
Supporters of the free market system see the private sector as way more efficient than the public sector/government because of its 'competitive nature'. So keep this in mind when reading the blog.
The role of the government within the economy is considered within four points:
- The first point is that the government should not get involved in the production of good and services lol.
- The market system / economy does however need the government in terms of providing a form of stability and certainty through laws, rules, regulation, monitoring and enforcement. These points need to be in place for firms and consumers to make contracts. Also think about for instance property and copyright laws.
- Markets do not always produce efficient outcomes, and sometimes the government requires to intervene to 'correct' the market failure (think Bailouts)
- It's generally acknowledged that markets produce relatively efficient outcomes but not equitable ones. So when society wants a higher level of equity as for instance in the form of a more equitable distribution of income -- then this requires government intervention. This is seen as a controversial topic within economics as our system is designed in a way where there is mostly always a trade-off between efficiency and equity
There are generally five ways in which the government can intervene within the economy:
- A first way is through public provision of goods and services such as infrastructure and 'national defence'. This is done through either public ownership or by public financing within the production processes of the private sector (eg subsidies). In recent years it also has become more popular for the government to hire the private sector for the provision of public goods.
- Another way in which the government can intervene is within its position as a market participant. The government is the largest employer of labour within the economy and as such it can through for instance its wage policies and other practices achieve certain objectives.
- The government can also influence the economy through its expenditure/spending. Besides influencing the economy through its spending patterns of goods and services, it can also engage in something called 'transfer payments' -- these are basically payments where the government doesn't receive anything in return. Examples are subsidies, child support grants, disability grants
- Another method is through taxation. Although taxations' primary purpose is that of government income, it can also be used to manipulate the economy (eg sin taxes on tobacco, alcohol or lower tax rates for smaller businesses). In those cases taxes function as incentives.
- As mentioned before, the government is important to the economy for a rule of law point of view. Through laws and regulations the government can also impact the economy. Here consider minimum wages, anti-tobacco laws, minimum prices, etc.)