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GOVERNMENT
INTRODUCTION
- To see how government can affect economic growth let’s compare pairs of countries
that are similar in every aspect except their governments.
 Communist North Korea Vs. Free Market Oriented South Korea.
 East Germany (member of the Warsaw Pact military alliance) Vs. West
Germany (aligned with the NATO and founding member of the EEC).
→ Better economic results in those countries with liberal policies: South Korea and
West Germany.
Ways in Which the Government Affects Economic Growth
1) Through the channels of factor accumulation (physical and human capitals).
2) Affecting the speed of technological progress through direct funding of
research and through administration of the patent system.
3) Through taxation, regulation, administration of law… sets the “rules of the
game”.
DEFINING GOVERNMENT´S PROPER ROLE IN THE ECONOMY
The Case for Government Intervention in the Economy
- The government intervenes due to the existence of market failures:
1)
2)
3)
4)
Public goods
Externalities
Monopolies
Coordination failures
- Another motivation for the government to intervene is the income redistribution.
The Case Against Government Intervention in the Economy
- Few economists would argue that there should be no government intervention in the
economy. Rather, it is a question of degree.
- When government tries to take the place of private firms, the resulting enterprises
tend to operate inefficiently because they lack the incentives. The success depends on
the honesty of the officials entrusted to carry it out.
- Functions previously performed by the government are being privatized and there is
a trend of deregulation of industries.
Swings of the Pendulum
- Beginning around World War I, the idea that the government could play an active role
gained ground (extreme example of the Soviet Union).
- After the Great Depression:
 President Franklin Roosevelt´s New Deal Program.
 Theories of John Maynard Keynes about monetary and fiscal policies designed
to maintain full employment.
- Following World War II, governments in Western Europe developed elaborate
welfare states.
- The last two decades of the 20th century witnessed a shift away from government
control of the economy toward a market system.
HOW GOVERNMENT AFFECTS GROWTH
Rule of Law
- It is one of the most important public goods that governments provide. Ensures the
accumulation of the factors of production and their efficiency.
Taxation, Efficiency, and the Size of Government
- Governments raise funds by taxing citizens and businesses. These taxes affect the
efficiency of the economic activity.
Planning and Other Industrial Policies
- Economic planning occurs when the government takes responsibility for some or the
entire decision making in an economy. After the World War II:
 State enterprises: Corporations owned by the government but functioning
somewhat like private companies.
 Marketing boards: Many countries compelled farmers to sell their crops to a
state marketing enterprise.
 Trade restrictions: Governments imposed tariffs and quotas on imports in order
to protect local firms.
- In almost all cases, the policies failed.
- Firms tried to gain the favor of government bureaucrats who decide on the allocation
of investment and imports.
WHY GOVERNMENTS DO THINGS THAT ARE BAD FOR GROWTH?
Government actions often do not maximize economic growth.
First of all it’s important to consider that they have other aims that sometimes do not promote
growth, such us: spending the money collected from taxes on national defense, arts or foreign
aid; the reduction of pollution (reducing the efficiency because these anti-pollution
regulations required more input to get the same output) and reduction of income inequality
(the most important policy goal that impede economic growth.
Governments act in their own self-interest. Kleptocracy (when corruption reaches the highest
levels of government) is one of the most impediments for growth nowadays because of the
inefficiency of taxes in these governments and the policies to have more opportunities for
bribery. However some economists argued that a certain amount of corruption could be
beneficial since government want a prosperous country to have more to steal. Comparing
countries it’s a close relationship between corruption and GDP per capita. Countries with low
income per capita have higher levels of corruption.
Another reason is that the leaders want to keep themselves in power. In order to maintain this
they try to avoid changes in social structure, they don’t improve education or economic
growth that can encourage people to be opponent of the government (example: Czarist
Russia). However a lack of economic growth can also affect a government’s survival, because
of this rich countries have less regulations in the creation of firms.
WHY POOR COUNTRIES HAVE BAD GOVERNMENTS?
Economists try to show if these countries are poor because of their bad governments or vice
versa.
The argument that income affects government quality has two observations. The first one is
that the bad government isn’t always an impediment to economic growth (New York city
corruption cases in the 19th century, Japan 1950-1990…) The second observation said that the
quality of government often improve as the income grows (in rich countries government
servants are well paid trying to avoid corruption and they are less fights among the different
politic groups).
They are some economists that believe that bad government is a cause of underdevelopment.
The variation of the government policies shows the different income levels in each country.
Moreover the legacy of colonialism led to bad native elite governments that replaced the
Europeans. However, European population settles in some countries (USA, Canada, Australia…)
establishing the democracies that Europe had in that period of time. Colonial powers installed
government systems to maximize the revenue that could be collected from colonies instead of
promote economic or social development. Spain and Portugal with Latin America in 17th and
18th centuries and the rest of Europe in Africa in 19th century (creating states with ethnic mixes
that made good government difficult)
Barro economist concluded that some democracy was good for economic growth but beyond a
moderate level was bad. (China’s growth is stronger than the democratic India’s one)
CONCLUSION
We saw that government intervention is justified by market failures (externalities are
included), but sometimes exists the problem of government failure. Rule of law, regulation of
how firms behave, planning, tariffs and quotas…are tools that governments use to influence
the economy. Taxes and government expenditure affect the economic efficiency.
As we said before government goal isn’t only economic growth (income redistribution, control
of pollution, remain in power…), because of this the growth is affected depending on the
priority of the goals of the government.