Government’s Role in Economy

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Government’s Role in Economy. Basic Concepts. Government. organizations of individuals particular set of institutions and people authorized by formal documents legally empowered make binding decisions on behalf of a particular community externally: war, trade, border control, ... - PowerPoint PPT Presentation

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  • Governments Role in EconomyBasic Concepts

  • Governmentorganizations of individualsparticular set of institutions and peopleauthorized by formal documentslegally empoweredmake binding decisions on behalf of a particular communityexternally: war, trade, border control, ...internally: tax, education, health, welfare, ...

  • Good GovernanceRule of lawgovernment can take no action that has not been authorized by lawcitizens can be punished only for actions that violate an existing lawProperty rightsRegulatory regimeMacroeconomic policiesAbsence of corruption

  • Governments PowerPowerability to get people or groups to do what they otherwise would not doGovernments powerto develop institutionsto carry out policiessometimes unpopularhas to be sufficiently strong

  • Governments Powersufficient powerconstrained powerMadison: oblige the government to control itselfrestraints to check arbitrary and corrupt behavior by the governmentKey: building effective political institutions

  • Political InstitutionsOrganizations, individuals, and agenciesElectoral rulessingle-member district and first-past-the-postproportional representation systemConstitutional rulesdivision and limit of powerbetween branches of governmentbetween central and local governments

  • Political InstitutionsConstrain arbitrary exercise of power by politicians and bureaucratsdelineate property rights between state and private sectorenforce property rightsinfluence competition in political processhold public officials accountable for their actions

  • Economic Policy Outcomes

  • Economic Policy OutcomesPolitical institutions play important roleResolve redistribution conflict from economy policiesThree examples of policy choicesbudget deficitfinancial markettrade policy

  • Budget DeficitDifference between revenue and expenditureGovernment influence on budgetmuster political support for taxationresist demands for expansion of spendingPolitical institutions of budget proceduresbalanced budget rulespower of finance ministry

  • Balanced Budget AmendmentNever passed U.S. Congress

  • Balanced budget rules in U.S.All U.S. states but Vermont have constitutional (41) or legal (8) requirement for balanced budgetGramlich (1995:180) holds that all real-world balanced budget amendments have significant enforcement problemseven with the tricks, constrained state fiscal policy is more responsible than unconstrained state fiscal policy

  • Balanced budget rulesare more likely to be effective ifvoluntarily adoptedimpose hard constraintsdifficult to reverseeffectively enforced bya credible third party orhigher level government

  • Influence of Electoral RulesMinority (coalition) governments tend to have higher budget deficit than majority governmentStates with systems of proportional representation tend to have higher budget deficit than states with majoritarian systems.Budget deficit tends to rise in election year

  • Financial market regulationInfluence of political institutionsindependent financial regulatory agenciescentral bank independencechecks and balances in political processAmong developing countries, central bank independence doesnt seem to affect inflation outcomes

  • International trade liberalizationGovernments trade policy influenced by domestic political conflict between gainers and losers from trade liberalizationIndustries that tend to have tariff protectionindustries in declineindustries that are highly unionizedmake substantial campaign contributionsmore geographically dispersed

  • CorruptionExercise of public power for private gainhas large costs for economic developmentundermines well-functioning marketsa tax that distorts competition & lower returnsa barrier to new entries in market competitionsubvert states legitimacyweakens state capacity to provide institutions to support markets

  • Causes of corruptionDistorted policy environment (opportunity)Weak judiciary (credible threat to punish)Poor civil service managementLow public sector pay (not evident)Other factorsOpenness to international tradeComplexity of regulatory environmentHigh and variable inflation

  • Political institutionsPolitical institutions can help reduce the opportunities and incentives for corruptionRestrain politicians from arbitrary actionsHold politicians accountable for their actionDecentralizationElectoral rulesPress freedomCivil society

  • Taxation institutions & policiesTax provides the state with resources to build market-supporting institutionsWeak tax collection institutions lead to disproportionate reliance on tax revenue from more visible and easier sourcesinternational tradelarge firms

  • Tax collection institutionsPoor countries tend to have weaker tax administration & higher reliance on tariffs

  • ConclusionsPolitical institutions matterGood governance is essential to economic developmentEffective Stateplays a catalytic, facilitating roleencourage and complement the activities of private businesses and individuals


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