Chapter 15 Economic and Environmental Policy: Contributing to Prosperity

Government as Regulator of the Economy

An e conomy is a system of production and consumption of goods and services that are allocated
through exchange

In The Wealth of Nations, Adam Smith advanced the doctrine of l aissezfaire economics, which
holds that private firms should be free to make their own production and distribution decisions

Laissezfair capitalism had limits certain areas of the economy, such as roadways, are natural
monopolies and are better handled by government than by private firms

It was not until the Great Depression that the government assumed a large economic role

Today, the US has what is described as a m ixed economy although the economy operates
mainly through private transactions, government plays a substantial role

One way the US government participates in the economy is through the r egulation of privately
owned businesses

US firms are not free to act as they please but instead operate within the limit of government
regulation, which is designed to promote economic e fficient and equity

Efficiency through Government Intervention

Economic efficiency results when the output of goods and services is the
highest possible given the amount of input that is used to produce it
Promoting Competition
To compete, lessefficientproducers willhave to cut theirproduction
costs or face the loss of customers to lowerpriced competitors
Markets are not always competitive
If a producer can acquire a monopoly on a particular product
or can successfully conspire with other producers to fix the price of the product at an
artificially high level, the producer does not have to be concerned with efficiency th
PricefixingwasprevalentintheUSinthelate19 centurywhen

large trusts came to dominate many areas of the economy, including the oil, steel, railroad,
and sugar industries
The goal of such regulator activity is to improve efficiency by
restoring market competition or by placing a limit on what monopolies can charge for
goods and services
Government acceptance of corporate giants also reflects the
realization that market competition is not longer simply an issue of domestic firms
!

Making Business Pay for Indirect Costs

Economic inefficiencies also result when business or consumers fail
to pay for full costs of resources used in production
Economists label these unpaid costs e xternalities The Clean Air
Act of 1963

Water Quality Act of 1965

Deregulation and Underregulation
.

Although government regulation is intended to increase economic efficiency, it can

have the opposite effect if it unnecessarily increases the cost of doing business

If the government places excessive regulatory burdens on firms, they waste resources
in the process of complying

The result of overregulation is higherpriced goods that are more expensive for
consumers and less competitive in the domestic and global markets

A more concerted response is d eregulation the rescinding of regulation already in

force for the purpose of improving efficiency
Air Deregulation Act
Deregulation can be carried too far Freed of regulatory restrictions, firms can engage in
reckless or
unethical practice out of a belief that they can get away with it

 Equity through Government Intervention

Economic equity occurs when an economic transaction is fair to each party
A transaction can be considered fair if each party enters into it freely and ethically
The Progressive Era was marked by some equity efforts
Food and Drug Administration
The New Deal ear produced another wave of equity measures, including financial regulation
Securities and Exchange Act of 1934
The New Deal also provided greater equity for organized labor
Fair Labor Standards Act of 1938
Ten federal agencies were established to protect consumers, workers, and the public from
harmful business activity
The Politics of Regulatory Policy
Economic regulation has come in waves, as changes in national conditions
have created social awareness

The first wave came during the Progressive Era, when reformers sought to stop the
unfair business practices of the new monopolies, such as railroads

The second wave came during the Great Depression when reformers sought to
regulate troubled economic sectors, such as banking

Although business firms fought the Progressive Era and New Deal reforms, their
opposition diminished gradually as they adapted to the idea that the new regulatory agencies
were charged with overseeing particular industries, such as banking and pharmaceuticals

The third wave of regulatory reform, in the 1960s and 1970s, differed form the
Progressive and New Deal phases in both its form and its politics
This third wave has been called the era of new social regulation because of the
broad goals it addresses in three policy areas: environmental protection, consumer protection,
and worker safety

The Environmental Protection Agency (EPA)

.

Because newer agencies such as the EPA have a broad mandate, no one firm or
industry can easily influence agency decisions
Group competition also exists within new regulatory spheres
Most of the older agencies, including the FCC and the SEC, are run by a
commission whose members are nominated by the president and serve fixed
terms but cannot be removed by the president during their term of office

Most of the newer agencies, including EPA, are headed by a single director who can
be removed from office at the presidents discretion

As a result, the newer agencies tend to be more responsive to the president than to the
firms they regulate

Government as Protector of the Environment

Conservationism: The Older Wave
Although antipollution policy is relatively new, the government has
been involved in land conservation for more than a century
The nations parks and forests are subject to a multiple use policy
Conservation is more than an issue of protecting natures unspoiled
beauty, it also involved the protection of species that cannot survive outside their natural habitat

Environmentalism: The Newer Wave

Environmental Protection
Environmental Protection Agency
Within a few months, the EPA was issuing new regulations at
such as rapid pace that business firms had difficulty implementing them
Corporations eventually found an ally in President Gerald Ford

 The economy was a slump, and the costs of complying with the
new regulations were slowing the recovery
Polls indicate declining public support for regulatory action
Since then, environmental protectionpolicy has not greatly
expanded, nor has it greatly contracted
Environmental regulation has led to dramatic improvements in
air and water quality
Global Warming and Energy Policy
No environmental issue receives more attention than global
warming
Most scientists theorize that the temperature rise is attributable
to emissions from carbonbased fuels
Greenhouse effect
US is behind many western countries in environmental
protection policies
Kyoto Protocol
No single national can solve the problem on its own
.

Government as Promoter of Economic Interest

Promoting Business

Business firms are not opposed to government regulation as such

They object to regulatory policies that harm their interests

Loans and tax breaks are other ways that government promotes business interests

Today, individual taxpayers carry a substantially heavier burden. However, some

economists do not regard the change as particularly significant, claiming

that higher corporate taxes would be passed along to consumers in the form of
higher prices for goods and services
The most significant contribution that government makes to business is in the traditional
services it provides, such as education, transportation, and defense
Promoting Labor
.

Laissezfaire thinking dominated governments approach to labor well into the th 20

century

Union activity was held by the courts to be illegal because it interfered with the rights
of business

Government hostility toward labor included the use of police and soldiers to break up
strikes

The Great Depression brought about a change in labors position

The National Labor Relations Act of 1935 gave workers the right to bargain collectively and
prohibited business from disrupting union
activities or discriminating against union employees

Minimum wage and maximum work hour guarantees

Unemployment benefits

Safer and more healthful working conditions

Nondiscriminatory hiring practices

Promoting Agriculture

Government programs today provide billions of dollars of assistance annually to

farmers, small to large
Farm subsidies
Fiscal Policy as an Economic Tool

Before the 1930s, prevailing economic theory held that the economy was selfregulation,
that it would correct itself after a downturn; but the economy did not return after the
Great Depression

The governments efforts to maintain a thriving economy occur in party through its taxing and
spending decisions, which together are referred as its f iscal policy

Demandside Policy

Keynes claimed that a downturn could be shortened only if the

government compensates for the slowdown in private spending by increasing its spending
level

Keynesian theory holds that the level of the governments response

should be commensurate with the severity of the downturn

During an e conomic recession, which is a lesssever downturn,

government spending should also be increased but by a lesser amount

Keyness theory is based on d emandside economics

It emphasizes the consumer demand component of the supplydemand

Supplyside Policy
!

Demandside situation has been the preferred policy of Democratic

lawmakers

A fiscal policy alternative to demandside stimulation is s upplyside

economics, which emphasizes the business (supply) component of the supplydemand
equation

Supplyside theorem was a cornerstone of President Ronald Reagans

response to the economic downturn that began before he took office in 1981

Encourage business investment with resulting increases in employment

and income

Supplyside theory was also the basis of President George W. Bushs

economic initiatives, which included reductions in the personal income tax and in the
capitalgains tax

Democrats typically advocate a progressive, or g raduated, personal

income tax, in which the tax rate increases significantly as income rises, thus shifting more

of the tax burden to wealthier individuals

!

Aprogressivetaxdiffersfromar egressivetax, wherelowerincome

individuals pay a higher rate

As with demandside stimulation, supplyside policy has it costs

Bush argued that his tax cut would boost economic activity to such
an extent that government revenue would actually increases
The loss in revenue from the tax cut exceeded the gain in revenue
from heightened economic activity

Like demandside policy, supplyside policy is intensely partisan

Republican lawmakers tend to balk at demandside measures
Democratic lawmakers tend to balk at supplyside measures

Fiscal Policy: Practical and Political Limits

Demandside stimulation as an economic tool emerged in the era whenthe
federal governmenthad a relatively small and mostly balanced budget it was feasible for
government to boost spending during aneconomic downturnwithout going so deeplyin debt
as to jeopardize longerterm economic growth

Supplyside stimulation had a similar early history

Today, however, the use of either toolas the Bush and Obama
presidencies illustrateproduces large budget deficits that could dampen longterm
growth
Monetary Policy as an Economic Tool

Monetary policy is based on adjustments in the amount of money in circulation

The Fed
Control over the money supply

Washington DC

All members are appointed by the president with the approval of the Senate

Regulates the activities of all national banks and those state banks that chose to
become members of the Federal Reserve System

The Federal Reserve has been the depository bank for federal funds and is the
instrument through which the federal government borrows money, pays federal employees,
makes payment on the national debt, and transfers funds between banks

The Fed decides how much money they want in the market

Lowering or rising interest rates

The Fed and Control of Inflation

Inflation is an increase in the average level of prices of goods and services

Quantitative easing involves the buying of financial assets strictly for the
purpose of injecting more money into the economy and paying them through the simple act
of printing more money

The Politics of the Fed

Compared to fiscal policy, monetary policy can be implemented more

quickly

Changes in fiscal policy usually takes moths to implement

Whose interest should the Fed wields

Issue of its accountability