Government economic policy

The role of government in a mixed economy

The government as an employer

• The public sector, administered by the government, is a major producer, employer (civil servants are often employed to work in government departments and agencies) and consumer  in many modern economies.
• Public sector organizations manage the following:
• National, regional and local government authorities and their administrative departments  and offices.
• Government agencies responsible for the delivery of public services
• Food standards agency
• Health authority
• Law enforcement agency
• Public corporations
• Taxes on income, wealth or spending are the main sources of revenue for public sector firms, they also pay the salaries of all public servants.

The government as a consumer and producer

• Public expenditure on goods and services accounts for a large portion of the total spending of an economy.
• Current expenditure is the repetitive spending on certain goods and services by the government consumed in the current financial year.
• Wages and salaries of public sector workers
• State pensions
• Welfare payments
• Consumables
• Running costs of government offices
• Capital expenditure are one-time investments on certain projects and assets:
• Computer equipment
• Roads
• Dams
• Schools
• Hospitals
• These investments can have a large impact on the development of an economy, specially on its productive capacity

Objectives of government spending

• To provide goods and services that are in the public interest
• Public goods (Street lighting and national parks)
  
• Merit goods (Education, healthcare and affordable housing)
  
• To invest in national infrastructure (Roads, railway networks and universities)
  
•  To support agriculture and key industries (Subsidies)
• To manage the macro-economy (Invest or cut expenditure)
• To reduce inequalities in incomes and help vulnerable people (Transfer payments for retired people, child support and unemployment compensations)

     --> Private firms benefit from public spending.

Macroeconomic objectives

Definition of macro-economy

• Macroeconomics is the study of how a national economy works.
• A macro-economy consists of all the different markets for goods and services, labor, money, foreign exchange and all other traded items. Changes in the behaviors of different producers and consumers in individual markets can therefore affect the distribution of incomes, total output and overall level of prices, employment and trade in a macro-economy.

Measuring the capacity of a macro-economy

• The Gross domestic product (GDP) is the total value of all gods and services in a macro-economy in a certain period of time, usually a year. 
• The national income is total amount of money received by all the suppliers of resources selling them to private firms and public sector organizations that will produce goods and services.
• Total expenditure or aggregate demand is the sum of:
• Consumer expenditure on goods and services
• Investment expenditure by firms on productive assets on new capital such as machinery and working vehicles.
• Public expenditure on capital and current items.
• Exports or expenditure by overseas residents on goods and services produced by the macro-economy.

Government macro-economic objectives

• A low and stable rate of inflation in the general level of prices
• A high and stable employment
• Economic growth in total output (GDP) and increased standards of living
• A stable balance of international trade and payments
•  Additional:
• Reduce poverty and reduce inequalities in income and wealth
• To reduce pollution and waste, protect the natural environment and therefore encourage more sustainable economic growth.

Policy instruments

• A macro-economy has two sides: the demand side and the supply side which should always be balanced in order to accomplish all objectives. 
• The government can use policy instruments in order to influence factors on both sides.

Demand-side policies

• Total public expenditure
• The overall level of taxation
• The interest rate
• The amount of money consumers are able to spend depends on their disposable income, the income left after income taxes have been deducted. 
• Taxes on profits will affect the amount of money firms have left to invest on new productive capacity and labor.
• Increasing public expenditure can boost total demand and therefore demand a higher output and employment in an economy.
• Interest rates affect the motivation consumers have to save/ borrow money. This may also encourage spending overseas.
• Fiscal policies
• Variation in the overall level of public expenditure of public expenditure and/or taxation in an economy to manage aggregate demand and influence the level of economic activity, which affects economic growth.
• Expansionary fiscal policy
• Increase aggregate demand in the economy to boost employment and output (during recession)
• Increase expenditure
• Lower taxes
• Incentive to increase output and investments in new productive capacity
• Lower taxes on personal incomes will motivate people to work and become part of the work force and employees will increase productivity.
• --> Budget deficit
• The government will have to borrow money to finance this fiscal policy, public expenditure exceeds tax revenue.
• Contractionary fiscal policy
• Reduce pressure on prices in the economy by cutting aggregate demand. (Recuperate economy and save money)
• Reduction in public expenditure (Cutting public sector wages)
• Raising taxes (Personal income and expenditure taxes)
• Reduce total disposable income
• Reduce consumer expenditure
• --> Budget deficit may be cut or go into a surplus
• Reduces employment and growth in output
• Distribution of income
• Balance the amount of extra taxes the rich and the poor pay.
• Invest the additional money from the rich on:
• Public services
• Welfare for poor people
• Spend the money and increase overall spending
• Rich people would save it
• Problems
• Fiscal policy is complicated to use
• Increases in public expenditure crowds out private spending
• The more money the private sector lends, the less it has for its own investments
• Higher interest rates motivating people to buy government bonds will reduce borrowing for firm and lead to a drop in productive potential
• The money borrowed by the government involves interest rates which will be lower government funds
• Increasing taxes on incomes and profits can reduce incentives to work and enterprise
• An expansionary fiscal policy creates expectations of inflation
• Workers will request higher wages after the increase in profits due to the economy overheat
• Monetary policy
• Changes in the money supply and/ or interest rate in an economy to influence the level of aggregate demand and economic activity.
• These changes can influence the exchange rate of the currency, international trade and transactions.
• Expansionary monetary policy
•  Cut in interest rates
• Expansion in money supply
• Aggregate demand is boosted
• More money in circulation
• Quantitative easing
• Buy bonds and assets back from banks
• Used when:
• Unemployment rising
• Economic growth falling
• Contractionary monetary policy
•  Raising interest rates
• Cutting money supply
• Borrowing will be more expensive
• Less amount to spend on products/ services by consumers and firms
• Sell bonds to banks with attractive interest rates
• Used when:
• Economy is overheating (Supply cannot quite reach demand)
• Inflationary pressures rising 
• Problems:
• Rising unemployment
• Less investment from firms will cut back economic growth in the future
• Exchange rate policy
• Changes in interest rates can influence the exchange rate of a national currency
• These changes can impact demand, balance of international payments and inflation rate.

Supply-side policies

• Specific public expenditures
• Subsidies
• Changes to individual taxes
• Reducing taxes on wages and profits to increase the reward from work and enterprise
• New regulations and reforms
• Legislation to outlaw unfair competition and anti-competitive practices by monopolistic/ powerful firms
• Boost productive potential
• Increase aggregate supply
• Encourage enterprise and employment
• Supply-side policy instruments include the following:
•  Selective tax incentives
• Selective subsidies
• Improving education and training
• Labor market reforms 
•  Limit the supply of labor to an occupation
• Lower welfare benefits/ Regulate minimum wages and benefits
• Competition policy
• Break up monopolies
• Removing trade barriers
•  Tax imports or restrict entry of imports to expand the market share of local firms
• Privatization
• Public sector activities transferred to the private sector
• More efficient
• Motive to make a profit
• Lower price and higher quality.
• Benefits for consumers.
• Regulations and deregulations
• Setting up of new laws that restrict certain activities:
• Protect key industries.
• Protect consumers from unfair or unhealthy products and advertisements.
• (...) Support any of the other policies by adding some legislative support.
• Removal of these restrictions in order to:
• Reduce costs.
• Free up resources.