Unit 10 Women’s right to vote and the reduction in child mortality in the United States

10.2 Government as an economic actor

Like firms and families, the government is an economic actor. Its taxes, spend­ing, laws, wars, and other activities are as much a part of economic life as the investment, savings, buying, and selling activities of families and firms. Also like firms and families, governments enable people to do things together that they could not do individually.

public good

A good that, if available to anyone, can be made available to everyone at no additional cost. This characteristic is called non-rivalry. Some economists define public goods more strictly as goods that are both non-rival and non-excludable (non-excludable means that it is impossible to prevent anyone from consuming them).

tax

A tax is a compulsory payment to the government levied, for example, on workers’ incomes (income taxes) or firms’ profits (profit taxes) or included in the price paid for goods and services (value added or sales taxes).

The most basic of these things that governments enable us to do is to interact under a set of laws—everything from speed limits to intellectual property rights—that regulate what we do. The government thus provides a legal framework within which the economy operates. The laws and regulations, and their enforcement that make up this legal framework are, at least ideally, a public good. This means that the benefits of having this legal framework are non-rival (your enjoyment of safe streets does not detract from mine) and non-excludable (if the streets are safe, nobody can be deprived of benefiting from that).

The government is an actor that dwarfs families and most firms. The US government, including federal, state, and local governments, employs almost ten times as many people as the country’s largest firm, Walmart. However, governments were not always economic actors on this scale. In Figure 10.2 we show the total tax rev­enues collected by the government of the UK as a fraction of gross domestic product—a measure of the size of the government relative to the size of the economy—over more than 500 years. The fraction rose from about 3% in the period prior to 1650 to more than 30% since the Second World War.

Fullscreen

https://core-book-server.vercel.app/macroeconomics/10-government-as-economic-actor-02-government-as-economic-actor.html#figure-10-2

Figure 10.2 The growth of government in the UK (1500–2021).

Note: Pax Britannica refers to the century between the end of the Napoleonic Wars and the beginning of the First World War, in which (compared to earlier or subsequent periods) Europe and most of the world was relatively peaceful, with the UK the militarily dominant nation. The Glorious Revolution deposed King James II in 1688 and increased the independent power of parliament.
UK Public Revenue; Patrick K. O’Brien and Philip A. Hunt. 1993. ‘The rise of a fiscal state in England, 1485–1815’. Historical Research 66 (160): pp.129–76.

Not only is the government a much bigger economic actor than any family or firm, it is also unique among actors in any society. Within a given territory, it can dictate what people must do or not do and can use force and restraints on an individual’s freedom to achieve that end.

government

Within a given territory, the government is the only body that can legitimately use force (or threats of force) to control the behaviour of citizens. Also known as: the state.

The distinguishing characteristic of the government, compared with private economic actors like firms, families, individuals, trade unions, and professional organizations, is that it is the only body in a geographical territory (the nation) that can legitimately use force and the threat of force to compel its citizens to do or not do legally specified things. Legitimate here means that most people regard these government activities as being right and acceptable. Governments routinely do things—locking people up, for example—which most people accept, but if done by a private individual would be considered wrong, and punishable.

Because citizens generally consider the use of the government’s coercive powers to maintain order, regulate the economy, and deliver services as legitimate—meaning that they accept the government’s authority—most citizens comply with government-made laws. One application of the government’s coercive power is the collection of taxes, which can be used to fund government operations.

Beyond its legitimate use of coercive powers, a second feature of the government, which also distinguishes it from firms and other private economic entities, is that it has obligations to its citizens based on civil and human rights. To advance and protect these rights, governments can use tax funds to provide services such as national defence, police protection, and schooling. In some cases, these services are provided without restrictions to those who use them, and without charging a price.

Jean Tirole, an economist who specializes in the role of government policy and regulation, describes the ways that governments can improve the working of an economy in his Nobel Prize lecture.

Nonetheless, there is wide variation—over time and between countries—in the extent to which a government’s authority is accepted as legitimate by the citizens, as well as the extent to which the government fulfils its obligations to its citizens. As this section will discuss, the government can be part of the solution to economic and social problems, addressing market failures and other issues, but it can also be part of the problem, causing issues in its own right.

Part of the solution

Governments have vastly improved living standards and the quality of life for their citizens. Examples include:¹

• Poverty alleviation: Fifty years ago, even in rich countries, many retired or elderly people were trapped in poverty. For example, in 1966, 28.5% of US citizens aged 65 and over were classed as ‘poor’. Government payments to the less well-off have greatly reduced serious economic deprivation among the elderly. In 2021, 10.3% of people aged 65 and older in the US had incomes that fell below the official poverty line.
• Provision of public goods: Some goods and services that are central to social and economic well-being—such as national defence, clean air, policing, flood protection, transport networks, and digital infrastructure—are public goods; they cannot be efficiently provided by the private sector.
• Economic security: In the higher-income countries, increased government spending, as well as the policy lessons from the Great Depression and the ‘golden age of capitalism’ (the three decades following World War II) have reduced economic insecurity by making the business cycle less volatile and providing income transfers for those who lose their jobs in a recession.
• Increased life expectancy and the dramatic reduction in child mortality in many countries: When these occurred in the late nineteenth and early twentieth century, they were not primarily the result of advances in medicine, most of which came later. They followed government policies that improved sanitation and water supply.

Pareto efficient, Pareto efficiency

An allocation is Pareto efficient if there is no feasible alternative allocation in which at least one person would be better off, and nobody worse off.

fairness

A way to evaluate an allocation based on one’s conception of justice.

market failure

If the allocation resulting from market interactions is not Pareto efficient, we describe the situation as a market failure. The term may be used loosely to refer to any interaction resulting in a Pareto-inefficient allocation, whether or not a specific market is concerned.

external effect, externality

An external effect occurs when a person’s action confers a benefit or imposes a cost on others and this cost or benefit is not taken into account by the individual taking the action. External effects are also called externalities.

In The Economy 2.0: Microeconomics we use two criteria to evaluate economic outcomes: Pareto efficiency and fairness. Where we judge the results of private economic interactions to be Pareto-inefficient or unfair, there is a potential role for government policy to address the problem. For example, Pareto inefficiency—also described as market failure—occurs if decisions made by private actors in the economy impose an external effect—an uncompensated cost or benefit—on others. The potential mutual gains for the decision-maker and those affected are not realized. As described in Section 10.4 of the microeconomics volume, taxation or government regulation may provide a remedy.

Where the extent of inequality in the distribution of income or wealth in the economy as a whole is judged to be unfair, the government may try to reduce inequality through redistributive taxation or programmes aimed at raising the living standards of the less well-off. Or it may regulate specific types of interaction: Section 5.8 of The Economy 2.0: Microeconomics describes a situation in which a democratic government grants employment rights that result in a fairer share for workers of the gains from an employment contract.

merit good

A good or service that should be available to everyone on moral grounds, irrespective of their ability to pay.

Governments pursue their objectives by some combination of four means:

• Incentives: taxes, subsidies, and other expenditures to alter the costs and benefits of activities that have external effects, and to redistribute income
  • taxes on road use, vehicles, or fuel to reduce congestion and pollution
  • taxes on harmful consumption goods such as alcohol and sugary drinks
  • public transport subsidies, especially for rural areas
  • subsidies for R&D, and renewable energy.
• Regulation: direct regulation of economic activities to promote efficiency and reduce unfairness
  • competition policies to reduce the price-setting powers of firms
  • mandatory universal participation in social and medical insurance, and pension schemes
  • minimum wages and employees’ rights at work
  • financial regulation, central bank policies, control of aggregate demand.
• Persuasion or information: altering available information and people’s expectations about what others will do (for example, their belief that their property is secure or that other firms will invest) so as to allow people to coordinate their actions in a desirable way
  • establishing the expectation that aggregate demand will be relatively stable, so that firms will invest and families will be less exposed to risk
  • information allowing people to make better decisions, such as on the risks associated with financial products, climate change, children’s toys, and foods.
• Public provision: provision of public goods, and in-kind provision of goods and services or monetary transfers to reduce inequality of living standards
  • national defence and policing
  • vaccination and other public health programmes
  • transport networks
  • merit goods such as basic education and healthcare, and legal representation in court proceedings
  • income transfers to protect the living standards of low-income families.

Part of the problem

To enact such potentially beneficial policies, governments must have extraordinary powers, both to acquire information and to compel compliance with policies. This creates a dilemma. For the government to be a successful problem-solver, it must also be powerful enough to potentially be a problem itself.

Examples from history, and today’s news, show governments exploiting their monopoly on the use of force to silence opposition, consolidate power, and acquire huge personal wealth for their officials and leaders.

They include dictators, unconstrained by political institutions:

• France: The ‘Sun King’, Louis XIV, ruled France from 1643 to 1715. Between 1661 and 1710 he constructed a luxurious palace and grounds for himself at the Palace of Versailles, which is now one of the top tourist attractions of the world.
• Romania: Nicolae Ceausescu, head of state for over two decades (1965–1989), used a secret police force to conduct mass surveillance and repression. He accumulated extraordinary wealth, including more than a dozen palaces that had bathrooms with gold-tiled baths and solid-gold toilet paper holders.

And elected autocrats:

• Ivory Coast: As president from 1960 to 1993, Felix Houphouet Boigny accumulated a fortune estimated to be between $7 billion and $11 billion, much of it held in Swiss bank accounts. He once asked, ‘Is there any serious man on earth not stocking parts of his fortune in Switzerland?’
• Russia: Several high-profile political opponents of President Vladimir Putin, including Alexei Navalny, Yevgeny Prigozhin, and Boris Nemtsov have died suddenly in unexplained circumstances.

There are also examples among democratically elected leaders:

• Hungary: The authoritarian regime of Viktor Orban suppresses opposition through media control and electoral manipulation, and stands accused by the EU of systemic corruption.
• South Africa: Former President Jacob Zuma used state funds (intended to be used for his security) to build an opulent family residence.
• India: The government of Prime Minister Narendra Modi has eroded democratic rights and undermined opposition through legal harassment of opponents and intimidation of the media.
• United States: President Donald Trump has attempted to suppress media criticism by issuing executive orders to remove Congressional funding for public broadcasting and media, and limiting press access to the White House.
• France: Former President Nicolas Sarkozy was found guilty of corruption in 2020, and again in 2024, relating to misuse of campaign funds and bribery.

But although democracy may not eliminate such behaviour, we will learn that it does provide a means of constraining the government to be less of a problem, and more of a problem-solver.