Identifythree key

refer to the files

Chapter 4

Economic Policies

By. Anthony Jones

An economic policy is a course of action that is intended to influence or control the behavior of the economy. Economic policies are typically implemented and administered by the government. Examples of economic policies include decisions made about government spending and taxation, about the redistribution of income from rich to poor, and about the supply of money.

Economic Policy

The United States is a Democracy

Microeconomics

Macroeconomics

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Through our governance process citizens decide what they want, including functional roles and economic policies. In the last chapter, we looked at the evolution of this process through an examination of government roles. In this chapter, we take a different vantage point by looking at current government policies through the lens of microeconomic and macroeconomic theories.

The main difference between microeconomics and macroeconomics is scale. Microeconomics studies the behavior of individual households and firms in making decisions on the allocation of limited resources. Another way to phrase this is to say that microeconomics is the study of markets.

In contrast macroeconomics involves the sum total of economic activity, dealing with the issues such as growth, inflation, and unemployment. Macroeconomics is the study of economies on the national, regional or global scale.

1.
Government Influence by Regulation

Government
Regulation

Governments, through their elected representatives, get to tell people what to do.

Governments are charged with regulating all sectors (including the government sector itself)

Government Influence by Financial Methods

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Eminent
Doman

A common tool used by governments to the power of the government to take private property and convert it into public use.

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Eminent domain refers to the power of the government to take private property and convert it into public use. The Fifth Amendment provides that the government may only exercise this power if they provide just compensation to the property owners.

Tax policy includes decisions about the types of taxes collected, tax exemptions, tax progressivity, tax enforcement, and overall rates of public taxes.

Fiscal Policy

Taxes can be either broad based or specific.

Regressive taxes charge everyone the same amount for a product or service, but a larger percentage are those with lower incomes. Taxes on food are a prime example of a regressive tax.

A progressive tax makes those with more disposable income pay a greater portion of it in taxes.

‹#›

Broad-based taxes are assessed on everyone (e.g., income tax or sales tax), while other taxes focus on specific things (investing, buying certain products, owning certain things).

Monetary Policy: Money Supply and Interest Rates

Monetary policy concerns control of the money supply or how much money is in circulation.

In the United States, monetary policy is controlled by the Federal Reserve System.

Two main areas where the Fed influences the money supply are in setting interest rates and regulating bank activity.

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The Federal Reserve System is the central bank of the United States.

The FRS provides the country with a safe, flexible, and stable monetary and financial system.

Known simply as the Fed, it is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.

The Fed’s main duties include conducting national monetary policy, supervising and regulating banks, maintaining financial stability, and providing banking services.

Economic Policies at Different Levels of Government

The federal government has the largest tax and spending impact.

The federal government has sole control of interactions with other countries and with interstate commerce.

The Supremacy Clause written in the constitution states that federal policy takes precedence over state and local policies

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Most of the issues that have been addressed in this chapter have related to the federal government. The federal government has the largest tax and spending impact. The federal government has the constitutional role of printing money and controlling its supply. The federal government has sole control of interactions with other countries and with interstate commerce. In addition, the Constitution, with its “Supremacy Clause,” states that federal policy takes precedence over state and local policies.

Thank You!!

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4 Economic Policies

Jonathan Anderso

n

Case Scenario: Policies and peppermint 104

Introduction 105

Microeconomic Policies 106

Macroeconomic Policies 116

Economic Policies at Different Levels of Government 129

Analytical Case: Policies 129

Practical Skill: Data 13

0

Summary and Conclusion 130

CHAPTER CONTENTS

CASE 4 SCENARIO

Policies and peppermint

Zach and Zoey are at U Scream Ice Cream, just down the street from Happy Paws,
Zoey’s store that will open soon. Zach comments that Zoey was right about foot
traffic from the veterinarian’s office on the corner—people have been stopping in
front of Zoey’s shop daily to watch the progress! They both order a single scoop of
peppermint ice cream.

Zoey has learned there are many government economic policies that can affect
her business, directly or indirectly. In a market-based system, she can start such a
business as long as she meets various regulations about incorporation and licens-
ing and the care of animal

s.

Zoey knows that most of the products she intends
to sell must disclose the ingredients they use or the materials from which they
are manufactured. She eventually wants to find a line of organic products for her
customers, as many people who have stopped have expressed an interest in
them.

Zoey also just learned the Somewhere City Council is toying with downtown
revitalization and a possible ordinance mandating retailers to beautify the area

between their storefront and the street. The ordinance may not pass since
many retailers oppose the increased costs, which could be a significant burden for
her as she opens. However, the city’s economic development initiative might pay
for 50 percent of the expense, and the spruce-up sure would make her place
look better.

Zoey was able to get a couple loans because interest rates have been kept
low by national government policy to stave off the worst effects of a recession.
Zach even took out a small loan to help, and Zach and his father pitched in with all
of the paperwork, too. However, this same government policy means the economy
will be slower to rebound. Although Zoey’s personal and business taxes will be
modest because they are progressive, and she will have virtually no profit after
she pays herself, they still affect her bottom line and her ability to survive as a
business. Zach and Zoey walk out of the ice cream shop and stroll past Splurge
jewelry store.

Government policy has also allowed online businesses to thrive without taxes for
a number of years, which puts pressure on brick-and-mortar businesses such as
Zoey’s. Fortunately, her state has recently imposed an online sales tax when
companies have a large online presence (over a million dollars of sales) or a physical
presence in the state. That means big companies like Overstock and Petco must
collect sales taxes and remit them to state government, as must her local
competitors. Of course, Zoey would have to collect sales taxes if she opts to have
an online presence, too, something that she is considering. So much to juggle!
Zach and Zoey pause for a moment in front of the Splurge window display and
Zoey admires an unusual pink diamond ring. “Someday,” she says to Zach, “when
my business is successful, I’m going to be able to afford something as beautiful
as that.”

So even in this small business example, we see numerous examples of many of
the policies that are discussed in this chapter regarding market freedom, regulations,
information disclosure, tax liabilities, economic subsidies, interest rates, recessionary
smoothing, and trade policies.

Introduction

The United States is a democratic society. Through our governance process

citizens decide what they want, including functional roles and economic policies.

In the last chapter, we looked at the evolution of this process through an examina –

tion of government roles. In this chapter, we take a different vantage point by

looking at current government policies through the lens of microeconomic an

d

macroeconomic theories.

Microeconomics looks at how human incentives (e.g., profits from hard work),

and disincentives (e.g., laws criminalizing certain behaviors) work in an economic

Economic Policies 105

setting. We look at five economic policy areas from a microeconomic perspective
and assess where the US tends to focus on balance.

Macroeconomics is the science that looks at how whole national economies work.
Areas of interest in macroeconomics include fiscal policies (i.e., tax levels, how
taxes are spent, and levels of public debt), money supply, interest rates, anti-
recessionary actions, trade, and capital flows. Every person must have a keen instinct
with which s/he reacts to what is going on in the economy. Further, each business
person must understand how pertinent government policies will affect them and
their operations—from regulatory to monetary to fiscal policies—no matter whether
it is a small business or corporation, serves an exclusively domestic clientele, or
has an international customer base. Fortunes are frequently made (and sometimes
lost) by understanding and working within the parameters of government policies,
and little but wasted time is to be had by complaining about policies that have
already been publicly approved. For example, while breaking up monopolistic
companies is much feared, historically it has proven extraordinarily profitable
for those owning the companies, as well as providing a well of opportunities in
opened-up industries. On the other hand, businesses that do not pay attention to
monetary policy may find that they are critically overextended just when the Federal
Reserve tightens credit.

Microeconomic Policies

Microeconomics1 assumes that individuals will make rational choices in their best
interests when provided with the opportunity. These choices spur competition, which
in turn spurs hard work and innovation. Because of the massive number of decision
points occurring in the market, allowing prices to float (Adam Smith’s invisible
hand) is strongly preferred over government-controlled pricing. As a capitalist
economic system, these principles are often infused in US economic policies.
However, microeconomics does not cover all areas of economic activity, and the
assumptions of perfect and high-performing markets must often be enhanced with
government intervention. For example, armies lie outside of microeconomics
because they are not paid for by individuals. Society has the right to regulate busi –
nesses to ensure that they do not excessively corrupt the environment. Consumers
need accurate or relatively full information to make good decisions. Monopolies,
price fixing, bid rigging, and so on sabotage the invisible hand. And without a
reliable legal system to protect contracts of not only the wealthy but the poor,
transactions will slow and the market will shrink. US economic policies in micro –
economic policy areas, then, must decide what the right balance is, and exactly how
to ensure that the market functions well, without being overly regulated. We look
at five areas.

Size-of-Sectors Policy: Division of Responsibilities

It is possible to have entirely state-run or command economies without a private
sector. Even production of consumer products can be run by the government, and

106 Introduction to Business–Government Relations

the labor market and all production quotas can be planned. Such comprehensive

planned or “command” economies were tried in Russia, eastern Europe, China,

North Korea, and Cuba, among others in the twentieth century, but only a few

remain. Experts generally agree that only China made lasting economic and social

strides under their command economy (see Lawrance 1998 and Chapter 12 for a

discussion of this “mixed” case), and even that country has elected to migrate to

a capitalist system.

Socialist systems (within the capitalist sphere) have a substantial private sector,

but still rely heavily on the government. While consumer and industrial goods

are under the control of the private sector, the public sphere is more likely to

operate the health system as a fully run government enterprise (called the “single

payer” policy option in the US), comprehensive retirement plans, extensive public

transportation systems, and power industries. For countries with oil and gas,

retaining these rights often produces an enormous profit center that may be used to

defray higher taxes, as discussed below. Historically, socialist systems have a

mixed record of success, ranging from some of the most successful economies

in the world—such as in Scandinavia—that have virtually eliminated pover

ty

(Campbell and Pedersen 2007), to less successful ones—such as in South America,

Africa, and Asia—in which the opportunities of state control are squandered by poor

management by government or outright corruption.

In capitalist economies, the bulk of the economy is run by individuals, private

companies, and non-profit organizations. Governments still provide national

defense, public safety, and economic and market stability, but tend to have more

modest levels of social welfare programs such as education and default health care,

and strongly resist intervening in consumer and industrial markets. Capitalist

economies have been the mainstay of the modern world since the emergence

of Europe from feudalism in the 1300s. Capitalist economies have a wide range

of effectiveness as well, depending on the quality of implementation and the

fortunes, or misfortunes, of history. Today, capitalism is enjoying the largest

resurgence it has seen since the “roaring twenties.” While the US capitalist system

is not as unfettered as it was in the 1920s, government policies since put in place

make the severity of an event like the Great Depression less likely.

Sector policy in the US provides that all consumer and industrial goods are

privately provided, the oil and gas industry is entirely private (Makhijani 2013),

the healthcare industry is shared but highly lucrative for the private sector, education

is largely public or publicly subsidized, transportation is largely shared (e.g., public

roads and private vehicles), and retirement via Social Security is shared, since

it is only a safety net rather than a full pension system. While approximately

38 percent of the economy in the US is controlled by the public sector, much of

that directly funds private sector activities. For example, government purchases

by the military branches run into hundreds of billions of dollars. Non-profit

organizations may be contracted to provide public social services. And government

runs many risk pools such as flood insurance, bank insurance, and Social Security

that, if run properly, pay for themselves over time. Let’s look at two types of

government control.

Economic Policies 107

Most functions of government act as an expense for government, either through
taxes or user fees, but on occasion they can provide revenue similar to profit for
cross subsidization. When government has full authority, it can be established with
three different financial goals. First, government can run functions with its own
personnel and accountability largely through political, executive, and legal
parameters. This ownership is wholly or largely subsidized by taxes, but the expense
in many areas is lessened by user fees. Most core government agencies, includin

g

defense, public safety, corrections, K-12 education, basic infrastructure, public
heritage resources such as parks and public lands, space exploration, justice, etc.,
operate primarily on tax receipts. Such agencies are set up in law, strictly regulated,
and controlled by the annual legislative appropriation process. To provide more
flexibility or cost savings, frequently governments subcontract some of their
responsibilities. For example, various US governments “own” 100 percent of the
prison population by responsibility, but subcontract out approximately 8 percent of
the prison population to for-profit corporations (Mason 2012). The private prison
population in the UK is an even larger percentage than in the US (Tanner 2013).

Second, government can run self-funded operations with the explicit intent
that they are not profit making and have a degree of independence from central
government functions. The conversion of the Post Office to the Postal Service, for
instance, was to force government postal services to be efficient on one hand, but
to ensure the public interest in universal rural delivery and modest cost on the other.
In the US, federal examples include Fannie Mae, Freddie Mac, the Export–Import
Bank, the Federal Deposit Insurance Corporation, the Federal Crop Insurance
Corporation, the Corporation for Public Broadcasting, and the Tennessee Valley
Authority. State governments often set up universities as public corporations but
nonetheless subsidize them heavily.

Finally, in less common instances, government can own profitable production
or resources as a proprietor, stockholder, or investor where profitability is expected.
Local governments often have utilities that subsidize the general fund, state
governments have lotteries that pay for education or other social goods, and national
governments may own and operate oil and other mineral operations. For example,
most of the oil companies in the world are operated or largely controlled by their
respective governments, with primary exceptions being the US, UK, the Nether –
lands, and Canada. See Exhibit 4.1 regarding sovereign wealth funds for more
information about this profit-making model and the long-term investment that it
can lead to.

108 Introduction to Business–Government Relations

EXHIBIT 4.1

Sovereign wealth funds

Sovereign wealth funds are created by governments for long-term investment
(Jen 2007). The purpose of the investments varies from specifics such as
pensions, education, and social welfare to general fund stabilization. In the latter

Economic Policies 109

case, the idea is that should resources run out, there will continue to be a stream
of income for the long-term. Investments can also function as “rainy day” funds
when there is a short-term but severe economic downturn. Funds can be
created by general tax revenue, but are more often generated by one-time
resource development opportunities related to the sale of oil and gas, minerals,
and land. The countries with the largest amount of sovereign wealth funds
include (in order) China, UAE, Norway, Saudi Arabia, Singapore, Kuwait, Hong
Kong, Russia, Qatar, and the United States.

The US example is interesting in that the federal government has no
sovereign wealth funds; they are all instruments of state governments. The State
of Texas has two funds, which were created shortly after statehood (1854 and
1876) for regular and university education. Alaska’s permanent fund is the
largest of the states, and results in extremely low state tax rates and an annual
refund to citizens between $500 and $2500 most years. Other states that have
sovereign wealth funds are listed below:

Alaska 47 billion
Texas (2) 37
New Mexico 16
Wyoming 5.6
Alabama 2

.5

North Dakota .7

An interesting comparative case is the UK and Norway. When North Sea oil
reserves opened up, they were divided among four countries, the bulk going
to the UK and Norway because of their long coastlines. Prime Minister Margaret
Thatcher was just coming to power, and she pledged to downsize government,
including privatizing coal and other commodities, and did not elect to create
a state-owned oil company, or create a sovereign fund. The revenues amounted
to nearly 10 percent of the national budget, and helped fund a small economic
boom. Today, the reserves are less productive and the lease revenues quite
small. Norway took a different path, creating a private corporation (Statoil) but
retaining 60 percent ownership. Like the UK, its leases provided annual income,
but it invested a portion of the income in a sovereign fund. That fund is now
worth 712 billion dollars, over three times the size of the government budget,
and is required to be invested in the Oslo Stock Exchange, supporting
Norwegian industry. Furthermore, Norway has kept taxes high (so it has not
squandered its wealth), but its per capita income is one of the highest of any
substantially sized country. The economic status of the inhabitants and country
is perhaps the soundest in the world.

110 Introduction to Business–Government Relations

Regulatory Policy

Although governments in capitalist economies do not run large portions of
the economy, governments are charged with regulating all sectors (including the
government sector itself) by establishing prohibitions, requirements, and legal
standards such as laws against fraud, zoning ordinances, requirements for employee
safety, and environmental regulation. Yet outright regulation is not the only tool
governments use to incentivize behavior (Lunn 2014). Governments can also use
financial leverage to encourage certain behaviors, no matter whether it is tax
deductions for charitable contributions or mortgage deductions, or subsidizing
companies to hire difficult-to-employ individuals, to reduce the unemployed
population. Finally, governments can choose not to regulate or incentivize, but can
still encourage self-regulation by industry, consumer and citizen conscientiousness,
and encourage ethical and model practices. Let’s look at each of these options.

Government Influence by Regulation

Governments, through their elected representatives, get to tell people what to do.
Many laws and regulations are common sense or common decency, such as those
concerning assault, battery, bribery, burglary, child abuse, domestic violence, drug
trafficking, embezzlement, extortion, forgery, fraud, identity theft, kidnapping,
money laundering, murder, perjury, rape, robbery, tax evasion, theft, treason, and
vandalism. And, of course, this is just a sampling of laws that are widely supported,
although people may disagree about definitions and respective punishments.

In terms of the business–government paradigms that we have already examined
(Chapter 2), regulation of business is in lieu of control by government ownership.
The “ideal” use of a regulatory framework in capitalist theory is when there is the
least possible regulation in order to have an orderly and fair business environment.
Generally, the cost of implementation of regulations is borne by business in terms
of opportunity costs and compliance with restrictions on business practices. The
smaller, but still significant, cost of enforcement is generally borne by government.

There are five generic areas of regulatory oversight of business. These are only
mentioned here since they will be discussed in depth later in this, or other, chapters
(primarily Chapters 3, government roles, and Chapter 5, social regulations). The
first is related to the safeguard of patents, debts, and contracts. For example, the
Constitution provides for orderly management of bankruptcy by the courts. Second,
the protection of the market is critical in terms of ensuring a fair playing field and
a stable source of money and credit. Government intervention in this area has
increased since the Great Recession of 2008. The proper treatment of employees
includes rights regarding working conditions, collective bargaining, wages, unem –
ployment, employer invasiveness, and discrimination, among others. This area has
seen the withdrawal of government support. Another area is the welfare of custo –
mers. Some important areas include fitness of products or goods, scams, product
safety, and consumer credit. In general, although the theory of caveat emptor (that
is, let the buyer beware) prevails in the US, it is overridden by a number of risk-
reduction considerations commonly accepted today. Finally, there is the protection

of the environment. With the creation of the federal Environmental Protection
Agency in 1970, efforts to protect air, water, land quality, and endangered species,
and efforts to prevent excessive production and manage disposal of hazardous waste
increased.

Dozens of federal laws cover each of these domains. Each state also has its
equivalent regulation, with supplementary or higher standards. In addition to the
five generic areas of regulatory oversight, there is the specific regulatory oversight
for every industry. In some US industries regulation is extensive, such as in banking,
oil and mineral refinement, nuclear energy, transportation related to safety, and
health care. In others, such as the regulation of sales and ownership, it is relatively
lax or nonintrusive. An important recent example of regulation is the Dodd–Frank
Wall Street Reform and Consumer Protection Act of 2010, which re-regulated
the financial market to some degree in the wake of the Great Recession and the
financial excesses that caused it.

Government Influence by Financial Methods

A second means of the government influencing business is by using a variety of
financial methods. Such methods may either increase government expenditures or
decrease its revenues. With the rise of market mentality throughout the world,
governments have been encouraged to use financial incentives over regulation when
possible. They are also increasingly expected to use their financial leverage for the
direct benefit of business when it does not harm the public good. This has been
especially true in the Anglophone countries, where financial methods have long
been closer to the raison d’être of society. There are six different methods of using
financial methods to influence business: tax breaks, subsidies, infrastructure
development, services to support business, service and product procurement, and
below-market value use of government resources. A mixture of a regulatory and
financial method is when government requires behaviors, but sets low fines more
as an encouragement to do good, rather than as a substantial deterrent against
violations (see Chapters 8, 9, and 10). The strength of this perspective is that it can
provide a less intrusive and disliked method for government’s arsenal in trying to
achieve a balanced social agenda. The challenge is that government has limited
resources, and issues of equity quickly get raised when there is a perception of abuse
or misuse of government support.

Use of the “Bully Pulpit” of Government

The term “bully pulpit” was coined by President Teddy Roosevelt in referring to
his ability to use his office to advocate for the public good—in his case, promoting
the expansion of the federal park system (Goodwin 2013). Even though governments
may not require or financially subsidize behaviors, like parents, governments may
still encourage socially conscious and ethical behaviors. They may encourage
civic behavior in public service announcements, websites, and public statements.
They can support the use of watchdog groups that self-regulate businesses, such as
the Better Business Bureau or numerous environmental and health-rating systems.

Economic Policies 111

It can foster neighborhood associations and do-good professional associations such

as the National Academy of Public Administration (as opposed to member advocacy

organizations). Perhaps one of the most important areas is in encouraging

philanthropy, which it does by both financial incentives (substantial tax deductions

)

as well as by public acknowledgment and praise.

Over the years, the federal and state governments have passed many reforms to

reduce the number of regulations and streamline regulatory processes. For example,

the Paperwork Reduction Acts of 1980, 1995, and 2010 seek to limit the paperwork

burden that can be required of citizens and businesses, as well as to streamline

collection. While nearly every President has voiced interest in reducing red tape,

the Clinton Administration made it a major policy initiative with then Vice President

Al Gore as the leader.

Information Symmetry Policy: Regulation of the Market to Make It
More “Perfect”

A system based on markets, competition, and rational behavior has a number of

assumptions. One of the important assumptions is access to valid information

to make good comparisons, and thus encourage efficiency and innovation on the

producer’s side, and economy and value on the consumer’s side. Information

asymmetry is when one side of the buyer–seller equation has inadequate information

and can take advantage of the other side. While this is more frequently the case for

buyers who are consumers, it is sometimes also true for sellers who are the

producers.

It is possible to adopt a “buyer beware” philosophy that lets the market deal with

the issue. This philosophy can work well in simple markets, such as used household

goods, where expectations are low and liabilities are small. However, this solution

has two major problems. First, many of today’s products and transactions are

highly complex and far beyond the normal consumer to master. Buying a complex

product like a car is challenging. Even when used cars are sold in an “as is” category,

which is equivalent to “buyer beware,” the seller normally must significantly

discount the price. Or imagine buying a house without recourse, in which there was

an undisclosed cracked foundation, only obvious during the rainy season. Second,

when the entire market is unregulated, then everyone must assume the worst,

transactions are far slower and more cautious, and prices are substantially higher.

Appropriate regulation actually lowers prices in consumer-oriented societies.

There are many ways in which products and services are regulated to protect

consumers from fraud, willful concealment, or deceptive practices. Consumers can

read product labeling. Contracts for services must disclose various conditions.

Contracts for properties must disclose different types of exceptional liabilities.

Companies must provide fair statements of their worth and financial practices for

potential and current stockholders. Guarantees must be honored. Harmful materials

or dangerous features are prohibited. Ratings of health or quality may be required.

Consumers can use civil litigation, with or without lawyers, as one source of

recourse. Alternatively, consumers may turn to divisions of consumer protection

112 Introduction to Business–Government Relations

that are found as separate agencies or in state-attorney offices as well as many larger

counties and cities. Rampant or egregious disregard of regulations frequently

involves the US Department of Justice, such as when General Motors had to pay a

$35 million fine in 2014 for not issuing required recall notices promptly enough

(Wald and Ivory 2014).

Not only do regulations serve to protect consumers in promoting a more perfect

market, they can also protect sellers from fraudulent or deceptive practices by

buyers. By far the most important tools for business are the rules upholding

contracts. Because of the legal enforcement provisions in contracts, for example,

lack of payment for cars and other products can result in repossession, and lack of

payment for a house or apartment in foreclosure or eviction. Use of a false credit

card is illegal. Disruptive consumers can be expelled or prohibited. Again, regula –

tions increase the ease and speed of negotiations; countries that do not have strong

contract laws or have poor enforcement tend to be cash economies with much lower

per capita volume of transactions.

Monopoly Restrictions: Regulation of the Market to Make It
More “Perfect”

A second major assumption of capitalist economies is that there are both choices

for consumers and competition among companies (Samuelson and Nordhaus 2009).

A lack of choice has two negative consequences for consumers. First, when there

is a lack of choice due to monopoly, consumers are constrained into what are often

less-than-ideal products or services. For example, for decades before the breakup

of the largest US telephone company (AT&T, at that time known as “Ma Bell”) in

1982–1984, it only offered a single plan of service based on a standard system of

local and long-distance charges. Although it was a very well-managed company,

provided a stream of technical improvements, and was required to keep most rates

reasonable due to heavy regulation, it was only innovative in a technical sense and

did not provide significant variety for consumers. Incredible as it seems today, the

widespread use of color and the compact phone did not occur until the “princess

phone” series debuted in 1959, touchtone dialing was only widely introduced in

1963, and modular jacks were not available until the 1970s. After divesture,

companies provided more payment plans and features such as caller ID, and

promoted cell phones and eventually Internet access, making telephones practical,

handheld computers.

The other major problem with monopolies is the opportunity to charge high prices

for poor service or quality. (Government monopolies can produce high taxes or fees

for poor service as well.) Regulating monopolies only works relatively well when

there is a public right to do so (e.g., public communication needs), the service is

relatively straightforward, and the cost of enforcement is not too onerous.

The need to break up monopolies and limit cartels involved in price fixing has

been recognized and addressed by government for over 100 years through anti-trust

laws. The Interstate Commerce Act of 1887, which focused on the railroad industry,

was the first law to provide consumers some protection from the effects of railroads

Economic Policies 113

acting as monopolies in some areas and cartels in others. That Act has been
broadened today to include other forms of transportation. The Sherman Anti-Trust
law was passed in 1890 to address the issue of monopolies and cartels in all
industries; this legislation was expanded and strengthened by the Clayton and
Federal Trade Commission Acts in 1914.

Collectively, these Acts prohibited the creation of monopolies (via mergers and
acquisitions), the functioning of monopolies (e.g., when a company can unilaterally
use predatory pricing to quash competition), restricted collaboration among
businesses (e.g., price fixing), and prohibited corporate cooperation to restrict free
trade (cartels). Famous historical examples of anti-monopoly company break-ups
(beyond AT&T mentioned above) include Standard Oil, American Tobacco
Company, and the Aluminum Company of America (later called Alcoa). A famous
example of price fixing is provided in Exhibit 4.2. A more recent case found
Microsoft guilty of anti-competitive bundling; the company was not broken up since
there were other consumer options, but the remedy cost Microsoft nearly $70 billion
in a suit and a series of consent decrees lasting 21 years (Chan 2011).

While the goals of anti-competition laws are admirable, the practice is highly
political and subject to many influences, differing corporate philosophies, and
subjective judgments. For example, US Steel was exceedingly big in 1920 and used
its monopoly to charge higher prices, but still won its anti-trust suit; in the mid-
1920s Ford had over 50 percent of world automotive production and yet it actually
drove prices down dramatically, and thus was never the target of an anti-trust
lawsuit.

The last decade has seen an age of mergers and acquisitions in airlines,
banks, and the entertainment/communication industries, and, on balance, an age of
corporate concentration. A related, but nonetheless separate, issue is economic
leverage over the economy, rather than just on street-level prices. For example,
banking continues to be a relatively competitive industry; however, the largest banks
are generally considered “too big to fail” because their collapse could have a
negative domino effect on the economy. This has become a rallying cry for many
corporate critics who see the necessity of government bailouts as providing a kind
of expensive insurance exclusively for the largest banks (because small banks are
allowed to fail, which they do in considerable numbers) and as encouraging the
largest banks to engage in riskier behavior. Fewer mergers have been successfully
opposed by the Department of Justice in recent years. For example, while the
Department of Justice opposed the merger of US Airways and American Airlines,
the companies prevailed and created the world’s largest airline in 2014 (but only
after making some concessions about not merging regional air routes lacking
competition).

Comparatively, the United States, European Union, and other Anglophone
countries (e.g., Canada) have the most robust anti-competition laws (Hylton and
Deng 2006) despite the lackluster success rate of anti-competition lawsuits recently.
Such laws are weaker or lacking in South America, India, and Japan, in which
monopolies have existed for a long time, or in China and Russia, in which the
conversion to capitalism has been accompanied by the rapid ascendance of corporate
empires pieced together and re-created from former state industries.

114 Introduction to Business–Government Relations

Economic Policies 115

Property Rights Policy: Property and Contracts

Private property is held in low regard in communal societies and communist states,
moderate regard in socialist states, and high regard in capitalist states. The Native
Americans have always held land communally as bands or tribes rather than as
individuals, even after they were transferred to reservations in the 1800s. Traditional
communist states essentially outlawed private property ownership; current com –
munist states such as China have kept communist parties but largely abandoned the
economic principle of communal ownership of property. Many former communist
countries now practice high levels of “crony capitalism,” in which public officials
and the courts strongly favor the rights of the well connected, often blatantly using
condemnation proceedings to forcibly evict people. Countries with a more socialist
leaning, as in Europe, strongly support private ownership, but bend it to public needs
more sharply, such as in public planning to ensure the protection of agricultural
lands and public spaces.

On the other hand, capitalist states such as the UK, US, Canada, and Australia
give the highest regard to private ownership. The idea is that individuals will best
develop the land if it is privately held. In the US, the right to take private land
is possible under a process known as eminent domain, but the US Constitution
requires appropriate compensation under the Fifth Amendment “takings” clause.
Generally, eminent domain is limited to public needs for transportation such as
roads, expansion of public facilities such as schools, military needs (rarely used
today because of the massive build-up of military facilities in the twentieth century),
and to restore public blight to better conditions. While it is allowable to use eminent

EXHIBIT 4.2

Price fixing in the

US

Archer Daniels Midland corporation is an American food company that has a
dominant global position in the food processing industry (and bioenergy), with
an annual revenue of approximately $90 billion a year.

In the 1990s, company executives routinely managed market prices around
the world in cooperation with colleagues in other industries, or what is more
commonly known as price fixing and cartel collusion. Despite the fact that the
practice had been relatively blatant and longstanding, it was largely unnoticed
because of the modest effect on world food prices, until a senior executive
named Mark Whitacre tried to extricate himself from embezzling charges by
informing about price fixing in ADM related to the animal food additive, lysine.

Because of the anti-competition laws that were broken, three top executives
went to prison, the company was fined $100 million, and the corporate
reputation was tarnished. Whitacre also ended up in prison for 8.5 years on
tax and wire fraud, as well as money laundering (Lieber 2000). This story was
captured in the 2009 movie The Informant, starring Matt Damon as Whitacre.

domain for economic development purposes, such as parcel consolidation by cities
for economic development (Kelo v. City of New London, 2005), it is highly
unpopular and frequently receives a lot of adverse media attention; therefore, the
practice of using condemnation for economic development is relatively limited.

While all modern societies use contracts of some type, they vary by extent and
detail. At their most informal, agreements can be confirmed by interfamily marriage,
smoking a peace pipe, or simply shaking hands, a custom still occasionally upheld
as binding in the US when witnesses are present and in special circumstances. The
use of written contracts is the common practice around the world, and the use of
extensive details has been taken to its logical extreme in the US, in which consumers
must hire specialists such as lawyers or real estate agents, and companies routinely
have large legal departments or divisions to manage contracts. This is in part because
the US legal system honors contracts robustly, only allowing their abrogation under
extraordinary conditions. This is understandable, since the US was founded by a
series of social–legal contracts including the Mayflower Compact, various state
charters granted by the kings of England, the Declaration of Independence, the
Articles of Confederation, and, ultimately, the US Constitution itself. While one
can bemoan the state of contracts—the fine print, the esoteric language, and their
enormity nowadays—nonetheless the ability to rationalize and regularize agreements
and ownership provides a bedrock economic base of predictability that fosters
transactions and investment so pivotal to the workings of a capitalist system.

Macroeconomic Policies

Beyond keeping the market in balance, countries must consider the roles that they
will play in establishing the economic structures within which the market will
operate, and manage their own role in the economy. Some macroeconomic policies
are essentially the other side of the coin from microeconomics; the size of the public
sector (large or small) is certainly related to fiscal policies regarding government
revenues and expenditures. Some macroeconomic policies are looked at on a
national level; trade policy, for instance, is a discussion of competition on a global,
rather than merely domestic, scale. Other policies are clearly outside the direct focus
of microeconomics, such as recessionary policy and monetary policy. Here we
consider seven macroeconomic areas.

Fiscal Policy

Revenue Policy

Until the Civil War, tariff revenues (i.e., taxes on goods coming into the country)
generally constituted 90 percent or more of federal revenues, declined to 50 percent
or so until the federal income tax was enacted in 1913, and today are only a bit
more than 1 percent of federal revenue.2 Today, tariffs, fees, fines, and miscellaneous
income account for less than 5 percent of the total revenue collection. Over
95 percent of revenue is via taxes on citizens—income, payroll (e.g., Social Security
and Medicare), corporate, and excise taxes (generally sin taxes). Thus, revenue

116 Introduction to Business–Government Relations

Economic Policies 117

policy today is really tax policy. Tax policy includes decisions about the types of
taxes collected, tax exemptions, tax progressivity, tax enforcement, and overall rates
of public taxes.

Taxes can be either broad based or specific. Broad-based taxes are assessed on
everyone (e.g., income tax or sales tax), while other taxes focus on specific things
(investing, buying certain products, owning certain things). The US uses a wide
mix of tax strategies, with the federal government relying most heavily on income
taxes (business taxes provide about 10 percent of tax receipts), state governments
relying on smaller income and/or sales taxes, and local governments relying most
heavily on property taxes. The federal and state marginal tax rates for business have
been dropping over the years, and the increasing use of tax havens by corporations
has further decreased minimized business taxes to effective rates below 20 percent.

Tax deductions, credits, and exemptions are called tax expenditures. They
decrease the taxes required of individuals or corporations if they spend their money
in a certain way—say investing in business expansion or spending on alternative
energy or contributing to charities. Through tax expenditures, government strives
to stimulate certain parts of the economy or certain kinds of spending.

Taxes can be regressive, flat, or progressive. Regressive taxes charge everyone
the same amount for a product or service, but a larger percentage are those with
lower incomes. Taxes on food are a prime example of a regressive tax. Flat taxes

Mayflower passengers signing the Mayflower Compact

EXHIBIT 4.3

Source: Wikimedia Commons.

charge the same amount of tax to everyone. A 10 percent across-the-board income
tax is flat because the “pain” of taxes is relatively equal. A progressive tax makes
those with more disposable income pay a greater portion of it in taxes. The US
Federal income tax is progressive because the official marginal rate ranges from
10 to 39.6 percent.

Tax enforcement can be made easy or difficult by policy, and enforcement can
be lax or aggressive. Because of underpayment and non-payment problems, policy-
makers can always increase revenues by increasing staffing levels in revenue
agencies. However, that means tax agencies have more ability to conduct tax audits,
which is frequently strongly opposed by the business community. Similarly, tax
enforcement can be more aggressive in going after tax fraud, corporate cheats, and
deadbeat individuals, depending on the policies set up by legislators and elected
executives. In 1984, a new federal statute created a Sentencing Commission, which,
among other areas, raised the sentences in tax evasion considerably. Yet after a 2005
Supreme Court decision, federal judges have much more flexibility, which they have
increasingly been using to downgrade sentences. For example, despite sentencing
guidelines, billionaire Ty Warner got off with probation for evading taxes on over
$100 million in income. On the other hand, in order to stem the rise in identity theft
refund fraud, long prison terms have been going to violators (Novack 2014).

The debate about the appropriate level of taxes has always been strident, because
nobody likes to pay them and everyone would like them to be lower. One problem
is that most people underestimate the benefits that they receive from government,
and overestimate what they actually pay (e.g., most people pay an effective rate far
lower than the “official” marginal rate). Another problem is perception—any tax
at all seems high. For example, tax rates for the wealthy are a fraction of what
they were from the 1930s to the early 1980s (e.g., the marginal rate in 1944 was
94 percent!), but there continues to be strong pressure to reduce them further. Despite
the near-unanimous disapproval of taxes, Oliver Wendell Holmes was quoted as
saying, “I like to pay taxes. With them I buy civilization.” He was referring not
only to the basic security, enormous infrastructure, and manifold services that
government provides, but the enlightenment and quality of life that it creates
through education, legal due process, and democratic processes that are costly but
transformative.

In terms of overall government spending in the United States, the total effective
tax burden currently ranges from 35 to 40 percent of the gross domestic product
(GDP). Federal spending was about 22.8 percent of GDP in 2012, while state and
local spending amounted to around 14.3 percent when including federal transfers.
The absolute size of all government budgets has been increasing at all levels since
World War II. Overall expenditures have increased from $62 billion in 1950 to $5.13
trillion in 2010.3 However, far more useful as an indication of the size of government
is its scale in relation to the economy. Government has grown from approximately
a 23 percent share of the economy in 1950 to 37 percent in 2012. The proportional
growth rates for both federal and state/local expenditures have been roughly
equivalent, although state and local governments are more dependent on federal
grants than in the past. See Exhibits 4.4 and 4.5 for a comparison of the growth of
government in absolute and relative terms.

118 Introduction to Business–Government Relations

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On a global comparison, the United States’ level of taxation is approximately in
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aggressively neoliberal countries tend to be better than the US when all levels of
taxation are taken into account.

Expenditure Policy

Although there are many ways to look at how governments spend the money they
collect (or borrow), we will look at only two here. First, we will look at expenditure
via the size of its employee workforce. Then we will briefly discuss the challenges
of different types of spending emphases.

In the earliest days of the country, the federal, state, and local governments were
all relatively small. For example, less than one tenth of one percent (.007 percent)
of the population was employed by the federal government (civilian) in 1800, and
the bulk of those were employed by the Post Office; state and local govern-
ments were also very small.4 Federal civilian employment grew to .7 percent of the
population in 1940, to 1.4 percent by 1970 when it reached its peak, and in 2010
had shrunk to .7 percent of the population. The peacetime average employment for
all governments (local, state, and federal) grew from 4.2 percent of the population
immediately after World War II to 6.4 percent in 1970, 7.4 percent in 2000, and
declined to 6.4 percent by 2012. After the initial boost to government employment
at the beginning of the 2008 fiscal crisis, which was intended to prevent employ –
ment in both sectors from collapsing simultaneously, government was cut in
proportional and absolute numbers. By 2013, total government employment was
the smallest percent of population since the 1960s. While the current level of
14 percent of the entire workforce working for government may seem high in
comparison to before the World War I (when roads were largely unpaved, street
lighting was minimal, public education was rudimentary, and public health coverage
was primitive), the US remains at the bottom of the list of developed countries,
with only Japan having a smaller percentage (Hammouya 1999).

Absolute government employment has grown since World War II (see Exhibit
4.6), but it has grown very differently among the various levels of government.
Federal employment has been relatively flat in absolute numbers, while state
government has grown moderately. Outpacing federal and state levels, local
government growth has been very substantial with its focus on service provision.

A second way to look at expenditure is by policy areas. Which areas will get
how much of a specific pie? In Chapter 1 we discussed spending levels in specific
policy areas related to federal, state, and local governments, so here we will only
examine a “big picture” perspective—security versus welfare. On one hand, how
much should be spent on police, prisons, parole systems, prosecutorial agencies and
departments, the court system, the military, national security agencies, spy agencies
and other domestic and foreign security issues? On the other hand, how much should
be spent on education, transportation, disaster assistance, emergency services,
public health and support of the healthcare system, social welfare, corporate support
(via economic development, bailouts, or subsidies), environmental protection, and
other issues related to the well-being of the country’s citizens?

Economic Policies 121

122 Introduction to Business–Government Relations

As a wealthy country, the US is able to focus on both in economic terms, but on
the whole, more attention is paid to security than welfare. For example, the US has
the highest incarceration rate in the world—751 per 100,000 people compared to
a rate of 627/100,000 in Russia, the next highest, or five to ten times greater than
the rate of most other developed countries. It also has the largest number of
criminals behind bars of any country in the world, at 2.26 million prisoners (Park,
Nguyen, and Carter 2013). The US military is able to carry on several small wars
simultaneously (e.g., the Iraq War was 8.8 years and the war in Afghanistan has
lasted over 13 years). Not surprisingly, recent military expenditures have been high
(see Exhibit 4.7) and match the total expenses of the next eight countries combined
(SIPRI 2014). Despite its wealth, the United States does perform acceptably
in welfare, but ranks at the lower end of advanced democracies in areas such as
education (17th according to Pearson Education), public health outcomes (37th
according to the World Health Organization), and environmental protection
(33rd according to the Environmental Performance Index).

Debt Policy

During the 2007–2010 recession, the federal government relied on extra government
spending (or equity and bond purchases) to attempt to stimulate the economy.
Economists debate the actual impact, but there is no question that aggregate demand

Number of government employees at all levels

EXHIBIT 4.6

21,000

18,000

15,000

12,000

9,000

6,000

3,000

0

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Total (Calculated)

State (US Census Bureau)

Federal (US Census Bureau)

Local (US Census Bureau)

Source: www.data360.org.

http://www.data360.org

Economic Policies 123

increases when government borrows money and then spends it in the current
economy. The theory is that this provides a catalyst that will stimulate underlying
actual demand, such that government spending will be replaced by private spending
as the economy recovers.

There is a great deal of debate, but little consensus about the impact of the
government deficit on the economy. First of all, let’s be clear on some terminology.
Debt is something that is a collective ongoing measure of how much is owed,
whether that is personal or governmental. The national debt is the total of what the
United States government owes to lenders. The deficit is an annual budgeting
concept. At the end of any year a budget is in surplus or deficit. It has either spent
more or less than it has received from revenue. If the federal government ends
the year in deficit, that must be covered through borrowing, which increases the
cumulative national debt.

The US government borrows money through the mechanism of selling Treasury
Notes (T-bills) or savings bonds. The Treasury Department offers bonds at a certain
rate of interest and purchasers fund the governmental debt. The government also
funds the deficit by borrowing from other governmental accounts, like Social
Security or Medicare. At the end of the 2014 fiscal year, the national debt was
approximately $18 trillion, of which almost a third was held by other government
funds, and half of that was from Social Security. Ten percent of the debt is held by
the Federal Reserve System.

Relative expenditure levels of the nine largest military budgets

EXHIBIT 4.7

700

600

500

400

300

200

100

0

D

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fe

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se

S
p

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n

d
in

g

China

Russia

Saudi Arabia

France

United Kingdom

Germany
Japan
India

$607 Billion
$640 Billion

Billions of Dollars

US

Source: Stockholm International Peace Research Institute, SIPRI Military Expenditure
Database, 2014. Compiled by PGPF. © Peter G. Peterson Foundation.

Note: Figures are in 2013 US dollars, converted from local currencies using market exchange
rates.

Debt is generally not allowed by state constitutions as a part of the annual budget

process. However, state and local governments nonetheless borrow money for

long-term obligations primarily through bond measures, which are considered

separate from the general fund. At one time, these bond measures were used largely

for expensive infrastructure improvements in which the expense was essentially

being amortized (e.g., spreading out the cost of a sewer system or bridge over a

number of years). Today, local government bond issues are more frequently used

for services and, occasionally, for general fund support. State and local combined

debt stood at about 4 trillion dollars in 2011, with California having the most debt

and Vermont having the least, in absolute terms. But in relative terms, Connecticut

is highest and Nebraska is lowest; California’s relative debt is in the middle, with

a per capita rate of $3060 (Scott 2011). State debt is projected to rise more slowly

than federal debt as of 2013, as state and local governments have cut workforces

substantially and the housing market has begun its rebound. See Exhibit 1.8. The

graph illustrates the times in which there have been deficits and surpluses (only

from 1998 to 2011). It shows the dramatic impact of the great fiscal crisis in 2008

on debt accumulation, in which revenue dropped and expenditures spiked.

As with the workforce and budget, however, it is important to evaluate the size

of the debt in relation to the economy as a whole. The US national debt is a function

of many factors, but the two most dramatic factors are war and recession. The

great wars—the American Revolution, the Civil War, and World Wars I and II—

caused huge national expenditures that took decades to pay off. In the case of World

War I, for example, there was not enough time to pay down the debt completely

before the country was mired in depression, so it was rolled into the costs of new

national calamities.

There are two ways to bring down the size of debt. One way is to pay it off as

one would do in a household or business. Thus, after World War I, subsequent

Presidents and Congresses ensured that every year from 1920 through 1930, the

national debt was being paid down with small but steady surpluses, to approximately

35 percent of the absolute amount borrowed. Yet almost as important as decreasing

the size of the debt was renewed expansion of the economy. Between payments for

debt reduction and increased growth in the economy, the overall debt was reduced

from a 1919 high of 32 percent to less than 15 percent in 1929. This can be seen

in Exhibit 1.9, which plots debt levels since 1790.

Beginning in the 1980s, different economic philosophies have affected the debt

cycle. Tax rates were perceived to be too high in the 1970s, which led to tax

reductions at all levels of government. Services were not reduced at the same time,

however, so revenue and expenditure patterns rarely matched, pushing up annual

deficits and overall debt in the same way that a war normally would. A reverse

of this pattern occurred in the latter part of the Clinton Administration when a

conservative Congress and a “new Democrat” President vied with one another

in an effort to reform government. One positive example was the Welfare Reform

Act of 1996, which kept in place programs that ensured the very poorest children

and their mothers would continue to get assistance, but that reduced excessive use

and abuse of the program in order to cut costs. The pattern was again reversed under

124 Introduction to Business–Government Relations

a Republican presidency in the early 2000s, with new tax cuts and increased defense

spending, raising the debt modestly (about $1.5 trillion), even though the economy

was expanding rapidly. The collapse of the economy in 2008 triggered substantial

new deficit spending, as was seen during the Great Depression in the 1930s to

prevent excessive retraction of the economy.

Monetary Policy: Money Supply and Interest Rates

Monetary policy concerns control of the money supply or how much money is in

circulation. The money supply consists of how much money people and companies

have, plus what they have borrowed. The assumption is that the more money that

is available, the more will be spent, and that will grow the economy. The money

supply is controlled primarily by increasing or decreasing the cost of money, which

means the interest rates of borrowing. By the law of supply and demand, the lower

the interest rate, the cheaper it is to borrow money and the more spending will

happen. The higher the interest rates, the less money is borrowed and spent,

reducing demand and depressing economic activity.

In the United States, monetary policy is controlled by the Federal Reserve

System. The Federal Reserve (or Fed) is a quasi-governmental independent entity

governed by seven members who are nominated by the President of the United States

and confirmed by the Senate for 14-year terms. The long terms are meant to insu –

late the governors from political pressure. (For more information see http://www.

federalreserve.gov and also Chapter 2.)

Two main areas where the Fed influences the money supply are in setting interest

rates and regulating bank activity. The Fed loans money to the Federal Reserve

banks and sets interest rates for those loans. The rest of the banks in the country

tend to follow the ups and downs of the interest rates set by the Fed. So when the

Fed raises its interest rates, the whole system raises its rates and the cost of

borrowing money goes up, reducing the number of loans and thus the money supply

available to be spent. The Fed will do this when it perceives the economy to be

strong and it wishes to slow economic growth. Conversely, when the economy is

not doing well and the Fed wants to increase the money supply available to be spent,

it lowers its interest rates.

Another other way the Federal Reserve influences the money supply is by

the rules it imposes on banks, particularly the amount of cash reserves (Reserve

Rate) a bank must have on hand. The higher the percentage of a bank’s assets

that must be kept on hand, the less it is able to lend. Reducing the Reserve Rate

increases the money available to be lent and spent. While the Fed may want to

stimulate lending, it must also be careful to make sure banks retain enough cash to

stay solvent. The Federal Reserve may also attempt to influence the economy

through buying or selling Treasury bill investments; however, the impact is debated

since money is essentially just moving from one account to another. There are other

regulations on banks imposed by the US Treasury Department and the Security and

Exchange Commission, but monetary supply is essentially a Federal Reserve

domain.

Economic Policies 125

http://www.federalreserve.gov

http://www.federalreserve.gov

Recessionary Policy

Recessionary policy has already been extensively discussed in Chapter 1 in terms
of comparing the competing visions of what is known as demand-side economics
(e.g., Keynesian) versus supply side (e.g., the Chicago School of economics
philosophy). In the ideal, Keynesian economics promotes a strong and large
capitalist private sector with a moderately sized government to provide a variety
of ongoing national, local, and individual functions such as defense, education, and
transportation. Because of the normal ups and downs of the business cycle, it also
advocates strong government spending when the business cycle is down, especially
in infrastructure and employment. It also advocates programs that tend to collect
money over the long-term, such as unemployment insurance, and that will be
drawn upon more heavily in bad times. Such programs, which were absent during
the Great Depression, provide economic stabilization. There is little doubt that the
large Keynesian infusion of government funds into banks, select corporations,
infrastructure, and state and local governments greatly softened the downfall caused
by the Great Financial Crisis of 2008. Many believe that the infusion of funds, along
with programs such as the Federal Deposit Insurance Corporation (FDIC) and Social
Security, averted another great depression.

Supply-side economics points out the power of a growing economy. For example,
the federal government dutifully made payments on the large World War I debt
and brought it down one third in absolute terms by 1929. However, because of
economic expansion, the debt had fallen by one half as a function of the GDP.
Government revenues were also up considerably in 1929, largely owing to the
expansion of the economy. The central insights of supply-side economics are that,
in the long-term, a stable absolute debt becomes less significant as the economy
grows, and a vital private-sector economy becomes more important in order to
maintain that growth.

A big challenge for Keynesian economics is one of being virtuous in good times.
It is easy to spend money when it is flowing into the Treasury, rather than save it
for a rainy day. While economic discipline at the federal level was good through
the 1970s, it collapsed in the 1980s. Conservatives wanted to cut government
heavily except for a build-up in defense, and Liberals refused to eliminate programs.
In the end, Conservatives were able to cut taxes and ratchet up defense spending,
Liberals got to keep their programs, and so the deficit began to grow. While there
was a round of sensible deficit reduction during the Clinton presidency, when
fiscal Conservatives pressured Clinton and the Democrats into paying down the
debt during the economic boom, this resolve vanished thereafter, with neither
Conserva tives nor Liberals willing to make the necessary sacrifices. Thus, when
the recession hit in 2008, the debt was already skyrocketing, and Keynesian spending
patterns took the US back to World War II highs. On the other hand, the challenge
of supply-side economics at the macro-level is one of remembering that it only works
on an economic upswing, and that downturns are inevitable. Indeed, the excessive
enthusiasm of supply-side economics can lead to a short-term policy-making
perspec tive, unrealistic assumptions for the long-term, and excessive austerity when
the economy is most fragile.

126 Introduction to Business–Government Relations

Trade Policy

One of the big changes to the economy has been the extent to which it has become
globalized. This is such an important issue that Chapter 11 is entirely devoted to
it. In this chapter we will outline some definitions and some government business
interactions.

Trade policy refers to rules about transactions involving money crossing national
borders. Since each country tends to have its own currency, to buy and sell across
borders usually requires an exchange of those currencies. Usually this is just an
electronic transaction. If the US buys more from foreign markets than it sells to
them, the economy is said to be in a trade deficit. The US last ran a trade surplus
in 1975. The economic impact of this deficit is another one of those debated issues.
Essentially, as long as other countries accept dollars, it is unlikely to have any great
impact.

Despite the general economic debate, to the extent that US consumers buy more
products from outside the country, we reduce demand for US products and thus
reduce US employment. If this is not balanced by products that we sell overseas,
it can have an ongoing effect on national employment. Most of the jobs that have
been lost overseas have been low-skilled jobs in labor-intensive industries. Labor
intensive means more of the cost of a product is taken up by personnel costs. Capital
intensive means more of the cost is taken up by technological (machine) costs.

As long as labor costs in some countries continue to be significantly lower than
the United States, industries that use a lot of unskilled labor will tend to establish
themselves in those countries. This is seen as part of normal market forces, which
are assumed to balance out in the long run. The government may decide to intervene
in trade for several overlapping reasons: because of unfair market practices, to
protect US jobs, or for national security reasons.

Unfair labor practices occur when governments protect their local industries vis-
à-vis similar industries in other countries. This can happen in a variety of ways. The
most typical and easiest to see are tariffs. A government can protect an industry
through tariffs on competing imports, and so these practices are called “protectionist”
policies. Government may also help a local industry through tax breaks, through
government-sponsored research or subsidized transaction costs. Or a country may
not impose a tariff but instead limit the number of such products allowed to be
imported and sold locally (quotas). A government may simply have a local mandate
to protect jobs, regardless of whether the competitive practices are unfair or not. There
may be a government-sponsored campaign to “buy local” and requirements that
imported products be labeled with their country of origin—which can be challenging
in a globalized production process. Finally, there may be a self-defined national
security reason to protect industries (e.g., a fear that if we depend on another country
for all production of product X, they might at some point withhold it from us). So
we must preserve our ability to produce our own, even at a higher cost. For example,
because of past oil embargoes from Middle Eastern countries, the US established a
National Petroleum Reserve where oil is stockpiled in the event of an interruption.

The concept of market efficiency has been promoted worldwide, and since the
end of World War II in the late 1940s there have been international agreements and

Economic Policies 127

organizations that have striven to reduce tariffs, and promote a free market

globalized economy. The US has been a leader in this effort to provide a more

capitalist-oriented, global, economic system. Nonetheless, the US often violates

its own precepts or has internal disagreements about the ideal parameters of

trade in a complex world. For example, like many countries, the US continues to

be mildly protectionist towards its weaker agricultural products, some goods such

as footwear, and is highly protectionist towards its vast military-industrial complex.

See Chapter 13 for an in-depth treatment of these various organizations.

Capital Flow Policy

Capital flow policy refers to the ability of capital to move from one national

economy to another without excessive regulations and restrictions. It generally does

not refer to equity ownership in stock markets (i.e., passive portfolio ownership).

Measures that impede capital flows include investment outflow restraints, foreign

direct investment (FDI) caps, land ownership embargoes, and currency exchange

restrictions.

Restricting citizens from investing in foreign companies or select foreign

countries is diametrically against capitalist principles. With the dominance of the

market orientation in the world today, few major economies, other than some such

as China, Iran, and Nigeria, still restrict outflows substantially. However, developing

countries have a special problem in this regard because the richest people in the

country may prefer to invest abroad rather than in their own country where it may

be desperately needed, or they may simply be highly protective of their money. This

syndrome is called capital flight.

Investment inflows provide capital for businesses to expand. Investment caps limit

the amount of money that can be invested by foreign individuals and corporations

in companies in certain industries. Industries that are commonly capped at 49 percent

or below around the world, and include domestic transportation (especially airlines),

energy companies, and banks. For example, the US caps foreign direct investment

in airlines and media. In absolute terms, the United States has the greatest amount

of FDI; other major FDI hosts are China, the UK, Germany, Belgium, France,

Canada, Switzerland, and Singapore. As a percentage of their economies, numerous

countries outstrip the US, with Singapore and Switzerland leading the way.

While land ownership embargoes and challenging regulatory processes on foreign

ownership are technically a small part of financial flows, they do tend to greatly

enhance or discourage the open market climate for business and investment.

Currency exchange restrictions are also a small part of the global economic

system, but like land ownership restrictions, tend to encourage or discourage

the open market climate of a country. Most countries have eased currency exchange

restrictions, except for declaration purposes to reduce international money

laun dering.

Overall, US policies related to capital flows are quite open, resulting in a

moderately high rating in relation to other countries. (See the US International Trade

Commission for more information on US FDI data.)

128 Introduction to Business–Government Relations

Economic Policies at Different Levels of Government

Most of the issues that have been addressed in this chapter have related to the federal
government. The federal government has the largest tax and spending impact. The
federal government has the constitutional role of printing money and controlling
its supply. The federal government has sole control of interactions with other
countries and with interstate commerce. In addition, the Constitution, with its
“Supremacy Clause,” states that federal policy takes precedence over state and local
policies.

However, state and local governments still have large impacts on both business
and local economies. State and municipal governments spend money and can
stimulate economic activity through tax incentives or subsidies. They can further
impact business through regulations, planning, and permitting. These topics are
explored in depth in Chapters 8, 9, and 10.

ANALYTICAL CASE: POLICIES

The President is up for re-election. Both the President and the opposing party
candidate are asked to present their “jobs policy.” The President presents a plan
that includes raising the minimum wage, creating a job training program to help
workers transition to new skills, increasing student aid, and increased spending on
state infrastructure.

The opposing candidate presents a plan for deregulation, including dismantling
the EPA and the Consumer Product Safety Commission and drastically cutting
governmental spending. Both policies have pros and cons.

They will both affect the economy in different ways. Predict some of the intended
and unintended consequences of these proposed policies (assuming they actually
become law as intended). Create a 2×4 table that lists the pros and cons of the two
candidates’ “jobs Bills.”

Questions for Discussion and Analysis

1. How will the two policy approaches affect supply and demand?
2. How will they differently affect the money supply, and what impact will that have?
3. What intended and unintended consequences may result from the different

policies?

Economic Policies 129

130 Introduction to Business–Government Relations

SUMMARY AND CONCLUSION

An overall, detailed table summarizing the five microeconomic and seven macro –
economic government policy trends we have discussed in this chapter is provided
below in Exhibit 4.8.

PRACTICAL SKILL

Finding Economic Data

An important element of planning your business is understanding market
conditions. Some data is particular to the product, but other data is about
the economy in general. The federal Bureau of Labor Statistics is a key
source for data. State offices may also collect statistics. The BLS breaks
down employment and unemployment rates by state and local area,
computes the consumer price index, and includes economic data.

Skill Exercise

Select a city or county. From BLS databases http://www.bls.gov, report
the five-year trend of:

1. The unemployment rate
2. Inflation
3. Local wages
4. Average education of workers.

Capital flight syndrome
Capital flow policy
Cartel
Caveat emptor
Command economy
Crony capitalism
Debt policy
Expenditure policy
Fiscal policy

Information symmetry
Interstate Commerce

Act
Macroeconomics
Microeconomics
Monetary policy
Monopoly policy
Price fixing
Property rights policy

Public corporations
Recessionary policy
Regulatory policy
Revenue policy
Sherman Anti-Trust Act
Size-of-sectors policy
Sovereign wealth fund
Too-big-to-fail
Use of the bully pulpit

KEY TERMS

http://www.bls.gov

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ly

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is
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a
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.
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g

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c
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re
e
o

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r

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ri
c
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n
s

o
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c

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p

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a
l
flo

w
s—

N
o
r
e
st
ri
c
ti
o
n
s

o
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o

u
tfl

o
w

;
lo

w
r

e
st
ri
c
ti
o
n
s
re
st

ri
c
te

d
o
u
t
o
r

in
—

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c
ro

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l
b

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rd

e
rs

o
n
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n
flo

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ty

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—

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u
t

o
r
in
—
a
c
ro
ss
n
a
ti
o
n
a
l
b
o
rd
e
rs

Economic Policies 133

Notes

1 Here we are interpreting microeconomics as classical economics.

2 See the Harmonized Tariff Schedule (HTS) administered by the US International Trade

Commission (USITC): http://usitc.gov/tata/hts/bychapter/index.htm.

3 This data comes from the White House historical tables: http://www.whitehouse.gov/omb/

budget/historicals.

4 The statistics come from the US Census.

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