Governments Role in a Market Economy - Essay Example

Government’s Role in a Market Economy Introduction Theoretically, the government’s role in a market economy is limited to restoring and promoting conditions, which are necessary for the working of a free market, and producing and/or distribution of goods that the players in the free market cannot produce or distribute. Specifically, it is argued that in ideal market conditions, the society would only care about efficiency, therefore restricting government’s role in the economic sphere to a bare minimum. Considering that the markets are anything but ideal, governments usually intervene in market economies; specifically, it becomes the governments’ duty to define private property rights, and also ensure that they are implemented; to regulate business; provide certain public goods; levy taxes; and redistribute income (Baumol and Blinder, 2011). In other words, governments assume a managerial role if only to correct market failures such as externalities and monopolies among others; and business cycles such as recessions or economic booms. Governments’ roles in a market economy are also necessitated by the fact that although the society cares about efficiency, it also cares about other issues such as economic fairness, and the merits/demerits of goods. Government’s role in the market In a market economy, the government takes up the role of allocation, whereby, it corrects market failures, and also considers the merit and demerit of goods sold in the market. Additionally, the government assumes the role of redistribution whereby, it comes up with a fair tax structure that considers the income levels of different groups of people with a view to enhance economic fairness. Additionally, the government has a responsibility of redistributing market resources either in monetary form or in-kind. Finally, the government has a stabilisation role, whereby it engages the economy either through fiscal or monetary policies. 1. Allocation role Through allocation, the government in a market economy corrects market failure by addressing market externalities, monopolies, public goods, and the merit/demerit goods. Externalities Externalities are the costs or benefits that an economic decision maker does not account for (Tanzi, 1997). Since they are not considered in the decision-making process, the externalities cause divergence between the supply and the marginal cost of production (MSC) in a market, or demand and the marginal cost of consumption (MSB) in a market (Tanzi, 1997). In theory, maximum efficiency in a market economy is attained when MSC and MSB are equal. By intervening, the government addresses the externalities, hence correcting the resulting market failure. Provision of public goods The government has a role to provide its citizenry with some public goods such as national defence, and national leadership among others (Arnold, 2010). No consumer in a given country is excluded from consuming the public good. Additionally, the government does not incur additional costs by providing the national goods to, say, new born children. Based on that, economists argue that the efficient price of the public goods is zero. Notably, government funds public goods from the general budget, which is a product of the taxes that people pay. Even though high income earners pay more taxes than their low-income earning counterparts, the provision of public goods is uniform across the income groups. For example, both high-income earners and low-income earners are under the same national defence irrespective of their contributions to the tax kitty. Monopolies The presence of a monopoly in a market economy means that a specific firm does not have competitors. More often than not, monopolies limit the output of goods or services, thus creating a shortage of supply in the market, and this eventually leads to high prices. Before addressing the plight of consumers as a result of the monopolistic tendencies, governments usually investigate the reasons why monopolies exist. Usually, monopolies are created either artificially or naturally through high entry barriers to a market (Arnold, 2010). Artificial barriers of entry include legislation by the government, which restrict market access or low-accessibility to input hence giving an existing firm an advantage over others who may want to enter the same market. Natural entry barriers usually comprise high costs, spread over an entire market, and breaking up the market would often translate to high costs, which would drive the consumer prices even further up. To address artificial monopolies, governments usually adopt legislative actions which seek to break up such monopolies. In the United States for example, the antitrust law is perceived as a non-monopoly law, which prohibits collusion among firms operating in the same industry, with a view to protect consumers. On the other hand, governments have two possibilities when addressing natural monopolies; first, the government can force a firm ‘to act as it were a perfectly competitive firm” or secondly, the government can respond through state provisions, hence forcing the monopoly to consider producing at optimal levels and subsequently lowering prices (Arnold, 2010, p. 206). Merit/demerit goods Merit goods are defines as the consumption items that a “society wants to encourage”, while demerit goods are those consumption goods that add no value to the consumer, and hence they are discouraged by the same society (Lane and Ersson, 2002). The latter category of goods includes such things as health care, education and housing, while the former items include products like alcohol and tobacco. Through its allocation role, the government imposes either subsidies or taxes to merit and demerit goods respectively in order to either encourage or discourage their consumption. Most market economies have subsidies or direct provisions for merit goods, but also impose ‘sin taxes’ on the demerit goods. 2. Redistribution role The distribution role of government in a market economy is pegged on the fact that although the society cares about efficiency, it also cares about fairness and equity. If left to run without government intervention, a market economy would not create a fair or equitable market especially because both suppliers and consumers have varying capacities, which would either be advantageous or disadvantageous to them. As Baumol and Blinder (2011, p. 35) notes, people in a market economy “earn incomes according to what they have to sell. Unfortunately, many people have nothing to sell but unskilled labour, which commands a partly price. Others lack even that. Such people fair poorly in unfettered markets” hence raising the need for government intervention. The government’s redistribution role is therefore meant to enhance fair and relatively equitable market system through either the distribution of opportunities or income (Lane & Ersson, 2002). The government uses the tax structure as one of its redistribution mechanisms for purposes of ensuring that there is equity and ‘fairness’ in the tax regime. Additionally, some governments use cash or in-kind transfers to redistribute resources or opportunities to the population (Lane & Errson, 2002). An example is the Medicaid program in the US, which enables poor people aged below 65 years to access ‘equal’ healthcare opportunities 3. Stabilisation role Fiscal policies and monetary policies are the two measures that governments can use to stabilise market economies. Through fiscal policies, governments determine the tax structure of and how the acquired funds will be utilised through government spending (Walsh, 2003). This means that fiscal policies are for example deal tools for use in enhancing equity and fairness in a specific market. Specifically, and in a bid to stabilise the economic situation in a country, the government can raise its taxes for the high-income earners, in order to attain more funds to fund social welfare programmes targeting the low-income earners. Through the monetary policy on the other hand, the government regulates such economic details such as interest rates, reserve requirements and money supply among others (Walsh, 2003). When handling monetary policies issues, governments usually consider “the relationship between interest rates, inflation and money” (Walsh, 2003, p. 9). Notably, a free-market economy cannot regulate such policies without the respective government agencies taking part. Why there can never be a truly “free-market” economy Most economic analysts agree that no market, however independent, can work without government intervention. The mere intervention by government therefore makes the ‘free-market’ concept not necessarily true. Ideally, a free market economy is devoid of any external influences. Specifically, the forces of demand and supply rule the market hence shaping other things such as competition, profitability, and efficiency among others. As Dwivedi (2010, p. 24) notes however, the free-market economy is unable to achieve “optimum distribution of goods and services, optimum allocation of resources, maximum efficiency and maximum social welfare”. Additionally, the free-market is accused of being responsible for the growth of monopolies, increased poverty and unemployment levels, and unequal distribution of wealth (Dwivedi, 2010). All these failures and inefficiencies therefore invite government’s intervention. In addition to the socio-political and cultural wellbeing of their subjects, governments are also charged with enhancing the economic environment in a country. Conclusion As Lane and Errson (2002, p. 2) aptly observe, governments are the “ultimate guarantors of the state”. Being a guarantor does not however give the government any participatory roles at least theoretically; rather, it means that the government is the umpire for market economies. As such, the government has a moral and political authority to check and even correct any deficiencies created by private enterprises, contractual relationships, and security/stock exchanges; it also has the right to address the concerns raised by labour or consumer organisations. References Arnold, R. A. (2010). Microeconomics. Boston, MA: Cengage Learning. Baumol, W. J. & Blinder, A.S. (2011). Macroeconomics: Principles and Policy. Boston, MA: Cengage Learning. Dwivedi, D. N. (2010). Microeconomics-I. New Delhi: Pearson Education. Lane, J. & Errson, S. O. (2002). Government and the Economy: A Global Perspective. New York: Continuum International Publishing Group. Tanzi, V. (1997). “The changing role of state in the economy: A historical perspective.” IMF Working Paper, WF/97/114. 1-28. Walsh, C.E. (2003). Monetary Theory and Policy, Part 5; Parts 199-216. London: MIT Press. Read More