Role of Government in the Economy

Posted by Collins Freya on December 26th, 2019

All over the world, governments are involved in economic matters. Although consumers as well as producers make many decisions on economic processes, governments use various interventions or activities to influence economic developments. In the present times, most economies are based on the free market enterprise, a model that limits state participation in economic affairs. However, the possibility of externalities and public or essential goods demand that some form of control be reined on the markets. Hence, the paper argues that government participation in economies is welcome, although it should be limited.

One of the reasons why governments should play a role in economies rests on the need for stability and growth. It is held that governments guide or direct the overall pace an economy makes. Such action is necessarily in enhancing steady growth to guard against unemployment while promoting price stability. The government attains the goals through the use of fiscal policies such as tax and expenditure adjustments. Similarly, governments are able to alter the path an economy takes using monetary policies. When employing monetary policies, the government adjusts an economy by managing the supply of money while at the same time controlling how credit is used. When a government employs the policies discussed above, it manages to control employment and prices.

During economic hardships such as history topics of the financial crises or recessions, high levels of unemployment are witnessed. The Great Depression that occurred during the 1930s was one of the worst economic downturns that affected the world economy. In order to overcome the crisis, most governments spent heavily or reduced taxes to encourage consumers to spend more. Such a move would bolster increased economic growth and money supply in the economies. Similarly, during the 1970s, rise in energy prices, led to strong fears about inflation. Based on the prevailing circumstances, governments chose to combat the menace by reducing expenditure, rejecting tax cuts and controlling money supply.

Stability is a major consideration in decisions of governments when controlling economic activities. Over time, the tools they use have changed. For instance between the 1960s and 1990s, governments preferred fiscal policy involving the manipulation of revenues to guide economies. However, following an increase in inflation rates, unemployment levels, and a rise in government deficits contributed towards the reduction of confidence in fiscal policy. With such a development, the use of monetary policies gained dominance as states sought to regulate money supply through devices such as interest rates.

From the introduction, it is remarked that the possibility of externalities and essential goods place demands on governments to take part in economic activities. Essential services such as security cannot be left to the private sector owing to the sensitivity associated with the issue. Apart from sensitivity, if security is privatized, some people may not afford the service. Consequently, governments are obligated to step in and provide essential services. Other goods or services such as roads are also taken care of by governments since it is not easy to prevent others from using them. Once a road is constructed, each person whether they contributed to its construction or not, cannot be barred from accessing it.

An externality reflects a scenario where benefits or costs spillover to third parties. Whenever a cost is imposed to a third party, such is construed to mean a negative externality. However, when a benefit accrues, it is seen as a positive externality. Pollution is a good example of a negative externality. Similarly, drug abuse has negative externalities. In such cases, governments should be involved in curtailing the negative consequences. The choice of measures to be taken depends on one’s ideology. For instance, liberals would urge governments to impose additional taxes on environmental polluters.

In conclusion, it emerges that governments have played a major role in shaping economic growth and development across the world. Governments have achieved their goals through either fiscal or monetary policies. The government’s involvement in economic matters is desirable in cases where externalities, essential goods, and stability are considered, although its involvement must be limited.