December 11, 2011

Economic Role of Government and Its Expenditure and Tax Policies

Market failures can lead to deficiencies in economic outcomes. To correct such deficiencies the government may step in to ensure efficiency, equity and stability.

Since the great depression of 1930s, governments in many countries have undertaken the responsibilities of curbing inflation and unemployment and of promoting growth of the economy.

Samuelson has written that nineteenth-century America came as close as any economy has to being a pure laissez-faire society. But critics saw many in this laissez-faire approach. Beginning in the 1890s, the US government policy changed from the idea "government governs best which governs least." The government involvement in economy gradually increased. Constitutional powers of government were interpreted broadly with the objective of securing the public interest and policing of the economic system increased.

Federal Interstate Commerce Commission (ICC) was set up in 1887 to regulate rail traffic across state boundaries. In 1890, The Sherman Antitrust Act came into existence to prevent monopolistic combinations in "restraint of trade." In 1913, Federal Reserve System was established and regulation of banking increased. Federal Deposit Insurance Corporation was started and bank deposits were covered by it. Many industries were characterized as regulated monopolies or regulated industries. They included airlines, electric, gas and water utilities, oil, natural gas, pipelines, telephones and financial markets. Food and drug regulation, mine safety and worker safety regulation and air & water pollution regulation were introduced. During Regan years, this tempo of increasing regulation was halted.

Samuelson commented that that public slowly has accepted government constraints on laissez faire capitalism.

The Functions of Government in Capitalist Society or Economy

The role of state was examined by philosophers starting from Plato. In Indian scripture, role of king was extensively described. Political scholars expressed their views. In economics,a new field called 'public choice' examines role of government.

Samuelson discussed public choice by outlining normative role of the government and a descriptive analysis of how governments are making public choices.

Under normative role, four major economic functions are prescribed for the government.

1. Establishing the legal framework for the market economy.
2. Determining macroeconomic stabilization policy.
3. Affecting the allocation of resources to improve economic efficiency.
4. Establishing programs that affect the distribution of income.

Paul A. Samuelson and William D. Nordhaus, Economics, Chapter 32, McGraw Hill Book Co., 13th Edition, 1989.

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