Economics

The Role of the Government in a Market Economy

Free market economies are phenomenal when at their best. They are flexible, self-correcting and decisive. At this stage, public interest goes along with private interest, improving public welfare, a term which Adam Smith, the father of modern economics, refers to as the “invisible hand” (Samuelson & Nordhaus, 2009). Yet, markets are not always at their best. Real life economics have confirmed that this is a hypothetical stage which never existed and never will exist. Therefore, there must be an active role for the government to correct ‘market failures’ and stimulate the economy. The article aims to investigate the role of the government in a market economy.

Source: Investopedia

One of the main roles of the government is to promote efficiency. Markets per se fail to allocate resources efficiently and create imperfect competition. This is reflected in the formation of monopolies. A monopoly is a market structure where there is only one seller for a good without a close substitute (Zhao, 2012). Monopolists generally reduce output and raise prices in order to maximize their profits. In this case, public interest does not go along with private interest; hence, the “invisible hand” is defective. It is the responsibility of the government to restrict monopolistic behavior and “ensure that there are [efficient] markets” (Beshai, 2003, para. 8). Externalities or costs and benefits imposed on the individuals outside the market are another form of ‘market failure’. Governments need to prevent negative externalities including pollution and promote positive externalities or commonly referred to as public goods. Under free market economy public goods, for instance public benches, would disappear because they are not profitable (Samuelson & Nordhaus, 2009). The government must ensure that the “invisible hand” is functioning properly.

Resources could be efficiently distributed; yet, not fairly allocated. This would lead to income inequality, creating extreme poverty and extreme wealth. In order to test the hypothesis that economic inequality is on the rise, a study was conducted comparing the total worth of the world’s billionaires with the total world Gross Domestic Product (GDP). Crony capitalism is an economic system in which businesses thrive not as a result of risk, but rather as a return on money amassed through a nexus between a business class and the political class. The crony-capitalist index depicts the total wealth of the billionaires as a percentage of their countries GDP and divides sectors into crony sectors and non-crony sectors.  It does not include data of millionaires and misses the data of billionaires who did not publicly declare their wealth; however, this does not detract from the value of the index because it serves to give an estimated picture and not the exact figures. Despite these shortcomings, the general concept is clear. Billionaire’s wealth comprises a huge percentage of their countries GDP and crony sectors are responsible for the majority of their wealth in developing nations. One explanation for this is that developed countries have relatively better laws and regulations that do not just promote efficiency, but also distribute income fairly through different methods. Examples of these methods are transfer programs like social security, financial aid and subsidies, and progressive taxation which is a mechanism that charges individuals taxes relative to their income.Another way of measuring inequality is the Gini coefficient. It is a measure of the distribution of income across a population. The Gini coefficient ranges between 0 and 1; where 0 represents perfect equality and 1 represents perfect inequality. The Gini coefficient in the U.S. stood at 0.434 in 2017, according to the Organization for Economic Cooperation and Development (OECD). Norway, on the other hand, has a Gini coefficient of only 0.25. It is clear that it is the duty of the government to minimize the gap between the rich and the poor and allocate resources fairly among all members of society.

Another significant role of the government is to ensure growth and stability. Governments have to intervene in their economies in an attempt to maintain economic stability as government debt can quickly “become a burden on the economy and weaken its foundations”(Campbell, 2009). This was the case in Greece before Germany forced it to implement strict austerity measures. As part of the European Union and the Euro, Greece enjoyed the same low borrowing rate as Germany (Radi 2012). The former was able to adjust its fiscal policies and increase spending to previously impossible levels. The government of Greece accumulated huge amounts of debts which could not be repaid without further borrowing. When the credit crisis of 2008 swept the globe and Greece was unable to borrow more money, it had to declare bankruptcy. Hence, it is extremely important that the government maintains a stable fiscal policy. Similarly, monetary policy provides a mechanism for influencing the growth rate of an economy. Changing interest rates and the money supply affects the inflation rate (Samuelson & Nordhaus, 2009). And it is the responsibility of the government to adjust the monetary policy to ensure price stability and trust in the currency. It is indisputable that the use of any has significant repercussions for the economy.

Resources

Campbell, K. (2009). The Economic Role of Government: Focus on Stability, Not Spending. The Heritage Foundation.

Planet Plutocrat. (2014, March 15). The Economist.

Samuelson, P., & Nordhaus, W. (n.d.). Economics (Nineteenth ed.). Mc Graw-Hill

Rady, D. A. M. (2012). Greece debt crisis: Causes, implications and policy options. Academy of Accounting and Financial Studies Journal, 16 SI, 87.

Zhao, B. (2012). Monopoly, economic efficiency and unemployment. Economic Modelling, 29(3), 586-600. doi:10.1016/j.econmod.2012.01.001