What part does the state play?

Posted by Abd. Ghafar ARM

Governments try to influence the economy of a country for several reasons:

1. To make sure that essential goods and services are produced and made available to those sections of the community who need them.

2. To prohibit or control the production of goods and services considered undesirable or harmful to society, such as drugs.

3. To regulate the activities of producers and suppliers in order to protect the interests of consumers.

4. To help disadvantaged sections of the community by redistributing income through taxation and welfare benefits.

5. To help producers and suppliers by providing grants and subsidies and improving trading conditions.

Market, planned and mixed economies

The extent to which a government tries to influence or control the economy of its country depends on the political views of the government. At one extreme, in a planned or centralized economy the government will try to exert complete control over the economy and activities of business. At the other extreme, in a fully market economy the government will prefer to leave regulation of the economy to the forces of supply and demand. Between these extremes are mixed economies in which government influence and the forces of supply and demand all have a part to play.

The planned or centralized economy

In a planned or centralized economy the government or the state decided what is produced, how it is produced and who receives it. The government allocates the resources of the country, including labour, to the production of specific goods and services. There is little or no competition because businesses and industry is owned and run by the government. Planned economies also avoid waste and duplication, such as advertising virtually identical products. However, the large number of administrators needed to do the planning and make decisions can be just as wasteful as some of the activities of the market economies.

The market economy

In a market economy customers choose the goods and services they want, and producers decide what they are going to supply based on what products will give them the most profit. Resources are thus allocated according to the forces of supply and demand without any government control or interference.

For this to happen people must be willing and able to buy the goods and services they want at the prices charged by producers – in other words there must be effective demand for the goods or services. In addition, the prices charged by producers must be sufficient for them to make a profit – there is no point in producing goods for $12 each and only being able to sell them for $10.

The mixed economy

In practice most economies are somewhere between a market economy and planned economy. A mixed economy is a balance between leaving the economy to the forces of supply and demand, and government control. The emphasis on government control or the forces of supply and demand varies from country to country.

Why does a government want to influence the economy?

There are three main areas of an economy that a government tries to influence:

1. Unemployment: if unemployment is high the government has to pay more out in unemployment benefits. This means there is less to pay for other services provided by the government. In addition, unemployed people have less to spend on non-essential goods and services, so unemployment can lead to a reduction in demand for these.

2. Inflation: a continuing rise in the general level of prices. The more expensive goods and services are, the less people can afford to buy. High inflation resulting in high prices can lead to increased unemployment, as less labour is required to produce fewer goods and services.

3. Economy growth: the more goods and services a country produces using available factors of production, the better off the people in that country are. Increasing production can lead to economic growth. To achieve this, government tries to stimulate demand (both at home and abroad) for their country’s goods and services, and encourage business to meet that demand.

What is the business cycle?

National economies often seem to go through cycles of buoyancy and decline (boom and bust), known as the business cycle. There are four clearly identifiable phases in the business cycle:

1. Recession – falling demand leads to cuts in output, rising unemployment and businesses making losses and even closing down.

2. Recovery – demand begins to increase, possibly due to government fiscal and monetary policies. Output increases and employment levels rise. Sometimes recovery can be a slow process as business confidence slowly returns.

3. Boom – as business and consumer confidence strengthens, demand continues to increase and businesses create more jobs, increasing wages to attract employees, and invest in capital equipment. High employment and demand leads to inflation.

4. Downturn – increased costs due to high wages and inflation lead to lower profitability and discourage continued growth. Demand falls, possibly due to government action to curb consumer spending. Output again decreases in response to falling demand possibly leading eventually to higher unemployment and another recession.

How does a government influence business and the economy?
A government’s economic policies fall into four broad categories:

1. Fiscal policies, which are to do with how the government raises and spends its money.

2. Monetary policies, which are to do with the amount of money there is in the economy.

3. Legislation, including consumer protection, environmental protection, marketing and trading legislation, and employee protection.

4. Policies on nationalization, competition and international trade.

Fiscal and monetary policies are discussed in Unit 32, while consumer, environmental, marketing and trading, and employee legislation is discussed in Unit 34. Here we look at nationalization, competition and trade.

Nationalization

In some countries, governments take over the provision and running of certain industries and services themselves. These may be paid for either wholly or in part by the government out of taxes. The actual industries and services vary from country to country, but usually include one or more of the following:

1. Defence services.
2. Transport, such as the national railway system.
3. Power and energy, including coal, electricity and gas.
4. Postal services.
5. National broadcasting.

There may be other services that are provided and run by the government in your country. An industry or service that is taken over by the government is called a nationalized industry. In other words it has been taken into ownership by the state, or nation. The main reasons for nationalizing some industries are:

1. Industries such as defence must be provided for the nation as a whole or not at all and cannot just be provided for those who pay for them.

2. Only a government with access to huge financial resources can provide the necessary investment in, for example, rolling stock (trains and carriages), rail systems, stations and so on for industries such as railways, both to provide these in the first place and to ensure the system is adequate and safe.

3. Industries such as power and energy are considered essential to the operation and well-being of the nation, and therefore too important to be left to private enterprise.

4. Nationalizing large industries with many employees can be a way of maintaining levels of employment.

5. Control of industry is often part of a government’s political policies.

In recent years, however, there has been a trend in many countries for nationalized industries to be returned to private ownership, rather than to continue being owned and run by the government. This is called privatization. Privatization usually occurs because nationalized industries may become too large and inefficient. Very large organizations are slow to react to the changing needs of society, because they have huge, cumbersome and expensive administrations. There is little incentive for nationalized industries to operate efficiently or cost-effectively, since the government will always make up any losses. In addition the services provided by nationalized industries may be costly. In terms of type and quality, services are often what the industry wants to provide, rather than what the customer requires.

Competition

Most governments are keen to encourage competition between businesses. This is because they believe that competition means that businesses have to attract customers by offering better quality products, keeners prices, a wider variety of products designed to meet what consumers want, and better customer service (such as advice and after-sales service). In some countries anti-competitive practices such as price-fixing or restricting the choice of customers are prohibited by law. Mergers that might result in a monopoly that could be against the interest of consumers (where the resulting business is so large that it can control the market by setting prices and standards of service and quality) are investigated and may be prevented.

International trade

All countries depend on other countries for supplying some of the goods and services their societies need. Exports (goods and services sold to other countries) bring money into the exporting country while money paid for imports (goods and services bought from other countries) goes out of a country. The amount by which a country’s exports exceed imports, or vice versa (known as the balance of trade), therefore affects its income and wealth: the more exports exceed imports, the stronger the country’s economy. By opening up foreign markets, with the possibility of increased sales, international trade also provides opportunities for businesses to grow, while the increased competition from foreign businesses leads to improved goods and services at competitive prices, with more choice for consumers.

Government can encourage exports and limit imports in several ways. Import taxes and tariffs (additional taxes or restrictions imposed) increase the price or restrict the quantity of imports, making domestic product more attractive to consumers. Many international agreements promote international trade and competition by limiting tariff on import. Such agreements may be local, within a group of countries such as the Southern Africa Customs Union (SACU), and the Gulf Cooperation Council (GCC), or global, such as the agreement of the World Trade Organization. Exports may be encouraged by promoting the country’s goods and services abroad (through events such as trade fairs), subsidizing production of goods for export, and controlling the exchange rate.

The exchange rate is the rate at which one currency can be exchanges for another. This determines the comparatives cost of goods in different countries. For example, if 1 dollar ($) exchanges for 3.5 Saudi riyals (SR) ($1:SR 3.5), $ 1 purchases imports from Saudi Arabia worth SR 3.5. If the exchange rate changes to $ 1: SR 3, $ 1 now only buys SR 3 of imports from Saudi Arabia. Imports from Saudi Arabia are now therefore more expensive compared to the same goods and services produced in countries trading in dollars. Customers in those countries will tend to buy home-produced goods and services because they are cheaper. To keep exports competitive, therefore, most countries try to maintain a fairly low exchange rate of their currency against others.

Summary

• All governments become involved in economy and business of their country in order to influence unemployment, inflation and economic growth.

• The amount of involvement of a government in the economy depends on the political views of the government.

• The main methods of influencing an economy available to a government are fiscal policies, monetary policies, legislation and policies on competition and trade.

Glossary
Planned economy: an economy that is controlled by the state.

Market economy: an economy that operates according to the forces of demand and supply, without interference by the state.

Mixed economy: an economy that is partly left to the forces of demand and supply, and partly controlled by the state.

Unemployment: the level of people without jobs who are both seeking and willing and able to accept suitable employment.

Inflation: a general rise in the level of prices.

Economic growth: an increase in the value of goods and services produced by a country and sold at home and abroad.

Fiscal policies: government economic policies based on how the government raises and spends its money

Monetary policies: government policies based on controlling the amount of money in an economy

Nationalization: taking ownership and control of an industry or business by the government.
Privatization: returning a government-owned industry or business into private ownership.
Exports: goods and services sold to other countries.
Imports: goods and services bought from other countries.

Exchange rate: the rate at which the currency of one country can be exchanged for the currency of another.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambrigde University 2002