Economic Policy Making GOVT 2305. The term economic policy refers to the various policies that relate to the development and promotion of the economic.

Economic Policy Making GOVT 2305

The term economic policy refers to the various policies that relate to the development and promotion of the economic system in the U.S.economic policy

In this section we’ll walk through the development of economic policy in the United States and look at the current issues associated with it. We’ll conclude with a look at the various actors involved in the creation of economic policy and note which interests tend to dominate it. Economic policy is not neutral – some interests are better served than others.

For some history, click here on these blog tags. economic policymaking fiscal policy monetary policy economic policymaking fiscal policy monetary policy

Constitutional History

If you remember from earlier sections in this class, one of the driving forces behind the establishment of the current constitution was the effort of the commercial classes – the Federalists - to enhance the viability of business interests. They sought to create a commercial republic.

Competition between the states, in their opinion, undermining the ability of the nation to prosper. This explains a number of the delegated powers granted to the national government in Article One, Section Eight. It also explains some of the limits placed on the powers of states in Article One, Section Ten.Article One, Section EightArticle One, Section Ten

As a result, states were prohibited from engaging in activities which could undermine the collective economic viability of the nation. Key commercial powers were given to the national government so they could be uniformly applied across the nation.

But states also retain certain powers to provide services and regulate industry within its borders. These fall under the heading of the reserved powers guaranteed to the states in the 10 th Amendment. We discuss these in GOVT 2306 when we cover state economic policymaking, with a special emphasis on Texas.

Free Market Economics

Remember that the United States was founded the same year that Adam Smith published An Inquiry into the Nature and Causes of the Wealth of Nations. This is significant because the United States’ economic system is based in large measure on the principles Smith advocates in that book.Adam SmithAn Inquiry into the Nature and Causes of the Wealth of Nations

A key theme in Smith’s work is that governmental interference in the marketplace constricts industrial growth, and with it an increase in a nation’s wealth and a long term enhancement of the well being of its citizens. The public good is better achieved by allowing people the ability to complete freely in a free market.

A free market provides greater opportunities for needs to be addressed by allowing decisions to be made by participants in the marketplace. It also allows for the entrepreneurial nature of private persons to be unleashed.

Smith assumed that people are naturally inclined to trade: “The propensity to truck, barter and exchange one thing for another is common to all men, and to be found in no other race of animals.”

The wealth of a nation – and the well being of the population – is more likely to be obtained if people are able to make economic decisions, that is if the process is decentralized. Centralized decision making constrains economic growth.

Among those decisions made by individuals in the marketplace was the decision to create a division of labor in the production of goods. This increased efficiency and productivity. The same number of workers – with fewer skills – can produce a greater number of items.

A nation’s wealth is not based on how much gold it holds, but in how productive its workforce is.

Mercantilism

Note that many of the arguments used against mercantilism are used later against socialism and communism, which are also economic systems that include centralized controls. In fact a question we will raise soon is what aspects of the economy should be centrally managed and which should not.

Property Rights Capitalism

Smith’s arguments are based on the primacy of property rights, which were also a concern of the framers of the Constitution. Many were among the minority of the population who were large scale property owners. They were concerned about actions on the part of some states to redistribute property following the revolution.

Remember this phrase from Fed 10? “A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project, will be less apt to pervade the whole body of the Union than a particular member of it... “

Federalists were concerned that their rights were likely to be violated by the populist majorities in the states. The design of the national government would check those majorities by breaking them apart.

The existence of property rights implies that people are able to possess capital. The free market allows people to invest that capital as they choose.

Smith is often claimed to be the founding father of capitalism. He pointed out the benefits associated with it. founding father of capitalism

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” – Adam Smith

Remember that James Madison assumed that people would be motivated primarily by their self interest. Adam Smith argued that this compulsion has it benefits. The idea that people are primarily motivated by their own self interest is implicit in at least one of the delegated powers in the Constitution.

The patent clause: “The Congress shall have the power... to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries”

This assumes that people are motivated to create by the promise of creating wealth for themselves.

But even the Federalists wanted some services provided by the national government, meaning that they are meant to promote the common good – or the general welfare. Defense Central Banking

This explains the development of the early executive agencies. Particularly the Treasury Department, which was originally headed by Alexander Hamilton who wanted to aggressively use national power to promote economic development.

He produced three reports to Congress which outlined his goals for the American economy and how best to pursue them. Many activities of the national government through the 19 th Century were based on Hamilton’s recommendations.

First Report on the Public Credit First Report on the Public Credit Here Hamilton makes recommendations designed to enhance the credit worthiness of the nation. He urged that government securities be redeemed at face value and the national government assume all state debt assumed during the revolutionary war.

Maintaining a high credit rating remains a concern

Second Report on Public Credit Second Report on Public Credit Here Hamilton argued for the establishment of a national bank. This would act as a central bank that would issue federal bank notes and provide stability and flexibility for the financial system.

This led to the chartering of the First and then the Second Bank of the United States. FirstSecond Bank of the United States

Adam Smith argued that a banking industry is necessary to enhance productivity. “It is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country.”

This was a controversial proposal. Proponents of limited government protested the bank. The constitutionality of the bank was challenged, but upheld in a major early Supreme Court case: McCullough v Maryland. McCullough v Maryland

The bank was not authorized in the Constitution, but was instead argued to be justified by the necessary and proper clause. It would continue to be politically divisive. Federalists supported it, Democrat- Republicans did not. In 1832 Andrew Jackson vetoed a bill re-chartering the bank.vetoed a bill re-chartering the bank

After a brief boom following the veto, in 1837 the US had an economic crisis that lasted until the mid 1840s.1837 the US had an economic crisis

One of the arguments in favor of central banks is that they can help prevent – or at least lessen the impact of – financial panics. We will discuss this further when we look at monetary policy.financial panics

The Federal Reserve System acts as a central bank today.Federal Reserve System

Report on Manufactures Report on Manufactures This is the third report produced by Hamilton. In it he argues that the national government should actively promote the growth of manufacturing. Tariffs on imports should be imposed in order to raise revenue in order to provide subsidies for American industry.

He also argued in favor of investing in internal improvements – infrastructure- in order to make it easier for commerce to be transported.

The acquisition of western lands made internal improvements necessary. Later infrastructure projects included rail projects funded by land grants and an interstate highway system.rail projects land grantsinterstate highway system

Subsidies and infrastructure projects were controversial at the time and remain so. They were supported by the Federalists, and later the Whig Party and Republican Party, but opposed by the Democrat-Republican and later the Democratic Party. Current controversies exist regarding whether funds should be spent to replace aging infrastructure, and whether items such as bullet trains are worth developing.aging infrastructurebullet trains

The use of subsidies to foster specifics industries has become especially controversial, especially since those industries can develop sufficient political power to maintain subsidies even though they may no longer be necessary.

Case in point: Farm Subsidies.Farm Subsidies

The resulting relationships lead to the development of the iron triangles we discussed in a previous section. Sometimes they go be the name of the “______ industrial complex.”

The most famous of which is Eisenhower’s term, the “military industrial complex.” Other terms include the prison, charitable, medical, college, and others.military industrial complexprison charitablemedicalcollege

The point is that once a sector of the economy receives benefits – be they subsidies or other benefits – it is very difficult to get rid of them.

The American School of Economics

Altogether Hamilton’s proposals developed what came to be known as the American School of Economics, or the American System. It held that the national government should actively promote the development of American industry three ways:proposalsAmerican School of EconomicsAmerican System

Notable examples of government intervention in the period prior to the Civil War include the establishment of the Patent Office in 1802; the establishment of the Office of Standard Weights and Measures in 1830; the creation of the Coast and Geodetic Survey in 1807 and other measures to improve river and harbor navigation; the various Army expeditions to the west, beginning with Lewis and Clark's Corps of Discovery in 1804 and continuing into the 1870s, almost always under the direction of an officer from the Army Corps of Topographical Engineers, and which provided crucial information for the overland pioneers that followed; the assignment of Army Engineer officers to assist or direct the surveying and construction of the early railroads and canals; the establishment of the First Bank of the United States and Second Bank of the United States as well as various protectionist measures (e.g., the tariff of 1828). - sourcePatent Office Coast and Geodetic SurveyCorps of DiscoveryCorps of Topographical EngineersFirst Bank of the United StatesSecond Bank of the United States tariff of 1828source

1 – protective tariffs 2 – infrastructure development 3 – banking policies that promoted production not speculation

Two major changes have occurred in the years since. 1 - Protective tariffs have fallen out of favor since they are argued to suppress trade. American policy is more likely to be committed to free trade. 2 – The banking and financial sector is more willing to focus on speculation and is not necessarily oriented to wards enhancing productivity.

From the beginning, the US has been a capitalist economic system.

But capitalism has its negative aspects as well, which has led to an expansion of government over American history. A lot of the controversies in contemporary politics stem from this expansion. One consequence is greater economic inequality. This can lead to instability in society.

“No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.” – Adam Smith

Market Failure

It may be best to describe this expansion and the associated controversies by first looking at the concept of market failure.market failure

The ideal marketplace is argued to be able to provide goods and services efficiently.

It assumes (1) that demand will always be supplied, (2) that demanders of a good or service cannot be overcharged because there are always other places a good can be purchased, (3) that demanders and suppliers have the ability to make sensible decisions about what something is actually worth, and (4) that the costs associated with producing items will be efficiently borne by the consumers of that product.

This is not necessarily true. Markets are argued to fail in four significant ways, and each of these helps explain certain key areas where government engages in the marketplace. These are the four areas, the four things that make markets fail.

Monopolies Negative Externalities Public Goods Uneven Information

All of these undermine free market principles and can be used to justify governmental intervention. There is a school of thought that even here government should not intervene however. This is called laissez-faire. laissez-faire

Monopolies A monopoly – or its cousin the oligopoly – occurs when there is only one provider of a good or service. The lack of competition prevents people from going elsewhere to purchase an overpriced, or poorly made product, meaning that the producer can charge whatever they choose and make it as poorly as they wish. If the product is a necessity, this can lead to abuse.monopolyoligopoly

Monopolies undermine competition, which is the heart of a free market system. That being the case, the solution has been to allow the national government to break apart monopolies in order to ensure that competition exists.

The 1890 Sherman Antitrust Act prohibited anti competitive activities, declared trusts to be illegal and provided a mechanism for breaking it apart. Standard Oil was broken into 33 companies in 1911 due to the accusation that it was a monopoly.Sherman Antitrust Act

The action was found to be legal in the case of Standard Oil Company of New Jersey v. United States. It was based on the commerce clause of course.Standard Oil Company of New Jersey v. United States

The Federal Trade Commission has jurisdiction over both consumer protection and anti-competitive business practices. The Bureau of Competition has jurisdiction over monopolies, which is shares with the Antitrust Division of the Department of Justice.Bureau of CompetitionAntitrust Division of the Department of Justice

The FTC also has the power to oversee proposed mergers and denying them if they believe the merger would create a monopoly, or decrease competition. Click here for the FTC Guide to the Antitrust Laws.proposed mergers Click here

Negative Externalities An externality is a cost or benefit imposed on a party as a result of an economic transaction that they were not a participant of. Positive externalities benefit non-participants – these might happen when someone decides to purchase a rundown house in a neighborhood and improves it

Negative externalities occur when a transaction between two people – a demander and a supplier – imposes a cost on third parties. These can be any number of things, but the most common type is pollution.

Pollution is a by-product of the manufacturing of certain products, and generally occurs because the producer did not spend the money necessary to prevent it. The reason they did so of course was to keep costs low. The cheaper it is to produce the product, the cheaper the price and/or the greater the profits. Since clean up costs money, it results in greater costs of production, meaning a higher price or lower profits.

Producers tend to not like that, so they pollute if possible. But this means that the costs of production will borne by others, and they are unlikely to be third parties. These can be people who live near a factory, or whose water supply is affected by careless disposal of a by-product.

This violates a principle of the free market.

Environmental rules basically force the producers of goods to spend the money to minimize pollution by spending money on clean-up and passing those costs onto the consumers of the product. This is what justifies the existence of the Environmental Protection Agency for example. Environmental Protection Agency

Public Goods A public good has two characteristics. It is non-excludable and it is non-rivalrous. This simply means that its use by one person cannot negate the ability of another person to use it as well. This makes it different than a private good the consumption of which can be limited.

Think of the difference between a hamburger and a street light.

Is a Laissez-Faire system a free market system?

Some background on the US economic system.

The United States has a capitalist economic system. economy is mixed. It contains a balance between goods and services provided by the public and private sectors.public private

Striking that balance is a source of constant conflict. Conservatives – generally support private enterprise – liberals (with exceptions) support the public provisions of good and services.

Question: Are certain goods and services best provided by the public sector? And are other goods and services best provided by the private sector? The ongoing question about universal health care is an example.

More importantly, how can it be determined which is which? And is that decision made dispassionately on objective criteria or is it driven by political self insterest?

Examples of publicly provided services: military protection police and fire protection education public utilities health care for the poor and elderly

Examples of privately provided services: Design, manufacturing and sale of consumer products Agriculture

Many of these services are provided by business large and small Wal-Mart Microsoft Apple Exxon-Mobil

Both the private and public sector have advantages and disadvantages.

An advantage of the private sector is its efficiency and rapid response to changing circumstances, but it tends to only provide services to those who can afford it. An advantage of the public sector is stability and that goods and services are provided equally, but it can be inefficient in doing so.

In many places, the economy of the US is mixed.

Some items can be provided by both the public and private sector, which can lead to conflict.

The recent fight over health insurance is a perfect example. Should the market, solely, determine who gets health insurance, or can government step in and ensure that insurance should be made available to everyone?

Over the course of American history, national, state and local governments have expanded the range of services they provide.

Also: Social Security Medicare Medicaid

Since the 1930s, government has stepped in to provide services the private sector had no interest in providing. This will be a subject we will cover in more depth when we discuss the executive branch.

These also happen to be some of the most expensive programs run by government.

Social Security Medicare Medicaid

Some arguments (political and economic) are made that these services ought to be provided by the private sector because they can perform them cheaply and more efficiently.

For example: In Iraq, could private contractors do a better job than the military? Blackwater

Can the private sector provide old age pensions and postal service better than government?

One of the economic functions of the federal government has been the promotion of the private sector.

The commercial powers in the Constitution were intended in may ways to foster business development by providing a solid financial foundation, basic security, and policies meant to absorb risk.

Bankruptcy Uniform Weights and Measures Patent Protection Post Offices

Hamilton Recommended a series of measures to Congress intended to spur commercial development

First Report on the Public CreditFirst Report on the Public Credit. Operations of the Act Laying Duties on Imports. Second Report on Public Credit. Report on the Establishment of a Mint. Report on Manufactures. Operations of the Act Laying Duties on Imports Second Report on Public Credit Report on the Establishment of a Mint Report on Manufactures

Protectionism

Technological development has often been subsidized by the national government. Often through the military.

Finance Steamships Telegraph Railroads Electricity Airplanes Radio Television Computer Aerospace The Internet Telegraph Railroads Airplanes Radio Computer Aerospace The Internet

For many industries, the national government is their largest client.

Proponents of these expenditures argue that they enhance basic research and establish the foundation on which consumer products can evolve. Example: the web.

Opponents argue that private enterprise can fund basic research, and that this funding fosters the development if sub governments and issue networks.

Chief example: Eisenhower’s Military Industrial Complex.Eisenhower’s Military Industrial Complex

An additional fight concerns whether transactions in the marketplace should be subject to regulations.

The private sector tends to not like regulations since they can limit profits. (unless they can capture the regulatory agency and regulate themselves)

As additional services are provided. The costs of government increases. This leads to problems associated with budgeting.

As we will see, over the past few decades, an imbalance has emerged between federal revenues and expenditures.

Question: Are certain goods and services best provided by the public sector? And are other goods and services best provided by the private sector?

More importantly, how can it be determined which is which? And is that decision made dispassionately on objective criteria or is it driven by political self insterest?

Examples of publicly provided services: military protection police and fire protection education public utilities

Social Security Medicare Medicaid K – 12 Education etc…

Examples of privately provided services: Design, manufacturing and sale of consumer products Agriculture

WalMart Microsoft Apple Exxon-Mobil

An advantage of the private sector is its efficiency and rapid response to changing circumstances.

An advantage of the public sector is stability and that goods and services are provided equally.