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What's to be done with Government?

Thu, Nov 22 2007, 15:14 GMT
by La Caixa Economic Research Dept.

La Caixa

As in any other scientific discipline, economics continues to discover the limitations of earlier ideas. It is also learning what conclusions of the past continue to be valid. In any case, it must be recognized that many of the matters of economic policy being debated today were already controversial more than 200 years ago when the science of economics was born. These comings and goings reveal the difficulties that exist in extracting firm conclusions about matters subject to many influences and perceived from many different points of view. One of the most recurring themes thinkers in economic science have dealt with is the role of Government in the economy, a matter central to the organization of society.

 The result is not greatly stimulating.Mercantilists believed that the government generally benefited the economy, at least when it supported domestic production intended for export. Adam Smith’s doctrine then pointed to the damage the Government’s action was capable of inflicting on the free operation of the market. Keynesians considered that the government could contribute to improving economic results and that intervention was a good thing. «Public choice» economists are convinced that the State can often ruin things. Those in favour of «rational expectations» believe that often economic policy is something of an illusion and that it cannot do much to change reality.

 It is therefore not surprising that the role of Government in the economy continues to be controversial. There is now scarcely any country where the State administers the economy one hundred percent. China, the star of the emerging economies, bases its brilliant performance on the progressive withdrawal of the State from the management of the economy. In the advanced economies, however, debate continues about the extent of the weight of the public sector, the extension of policies characteristic of the Welfare State (education, health, housing, etc.) and the action of the public sector in the area of economic policy. These are controversial issues that have to do with much-discussed questions such as proposals to reduce taxes, the effects of fiscal policy, protectionist moves in Europe and the United States, what should or should not subsidize the public budget, the degree of freedom parliaments should have when it comes to drawing up budgets, the make-up of spending and the weight of the various taxes, etc.

 The size of Government in terms of revenues and spending also continues to be a subject of debate but in general there is agreement in that public deficits are not desirable. Formerly, except in periods of war, states used to balance their accounts. Since the Seventies, however, deficits have become practically a constant, occasionally reaching excessive degrees. Attempts to halt a drop in demand by pushing down on the accelerator of public spending have proven erroneous. It may be that over the short term the fiscal boost would drive economic activity but this stimulus would end up with dire results for inflation, an incorrect allocation of production resources and could even lead to recession. This observation has made it possible to give support to the idea that excessive deficits end up hurting the economy. Today, parliaments understand the problem in spite of the political attractiveness of increasing public spending. In the European Union, at the beginning of the Nineties, the Treaty of Maastricht raised budget stability as a question of common interest. The guidelines of fiscal policy have been extended and it is considered that they are helping to improve the performance of the economy. It is not so much a matter of the size of the Government as of the orthodoxy applied in its accounts.