By Mahathi Kattamuri, Grade 12

Government economic policy should be directed towards increasing living standards, employment, health, education and sustainable development. It should not concentrate on fixing prices, raising taxes, and regulating bank lending. Discuss whether there is any truth to this statement.

Government economic policy is subject to a dual classification: demand-side, or supply-side. Demand side policies can involve two mechanisms, termed fiscal and monetary policies. Fiscal policies rely on government spending and/or taxation; monetary policies, on the other hand, rely on exchange rate controls, money supply, and/or interest rates. Government intervention--the active interference of the government in the market--is generally seen when markets fail; it is a response to market failure (if markets fail to achieve efficiency when left to operate freely).

Focusing all economic policies towards increasing living standards, employment, health, education, and sustainable development may have its own benefits. Firstly, targeting some of these objectives contribute towards a more productive workforce. Greater educational standards in the country will increase the level of skill that any entrant to the workforce will possess and can also lead to worker specialization. Better healthcare institutions ensure a fit and able workforce. Increasing the general standard of living again may attract more people to take up education--it may even enable previously poor parents to send their children to school---and join the workforce. This alone can greatly improve the country’s economic situation; the logic behind this argument can be distilled into two key points. One, a more productive workforce means that any production that firms engage in is likely to be of higher quality, and will use up less resources. Costs of production are likely to decrease as a direct consequence of the fact that each worker will make better use of the resources at their disposal, and firms may even choose to pass on these lower costs to consumers in the form of lower prices, thus increasing the consumer surplus and improving economic efficiency. Aggregate demand may rise: either because quality has gone up, or because higher profits for firms means more employment and higher purchasing power for the population as firms expand. The increase in output and quality may also increase demand for the country’s exports (provided the demand for exports is price-elastic, as per Marshall-Lerner’s condition) and may also help improve the balance of payments stability for the country. A second reason why greater productivity is going to greatly advantage the country is that it attracts foreign direct investment. Internationally-reputed firms, such as established MNCs, may set up production in this country because it wished to make use of the highly skilled, able workforce, which leads to more job creation and consumer choice.

Directing government policy towards increasing employment (till the full employment level) also presents many of the same benefits. Higher employment rates mean higher purchasing power. It also reduces the stress on the workforce to provide for the dependent population. Targeting sustainable development has heightened relevance in today’s world: we are at a crossroads that requires us to make a choice between consuming to the fullest today or preserving the future generations’ ability to consume at all.

Furthermore, focusing on government intervention such as price fixing, regulation, or taxes is likely to impose a deadweight loss on society. It represents an opportunity cost that could have been avoided by attempting to meet the same objectives through other mechanisms. For instance, instead of fixing prices in the labor market (minimum wage), the government could work towards better employment policies (as mentioned above) that may achieve the same target. Moreover, taxation often has disincentivizing effects on the working population (as predicted by Laffer’s curve) and in extreme cases, it might even lead to the working population emigrating from the country in search of better opportunities.

However, focusing solely on these policy measures may have grave consequences for the economy. While they certainly do increase productivity, they may also contribute to inflation, that, if unchecked by the other policy measures listed on the other side, would have drastic consequences for the economy. Higher aggregate demand, caused by an increase in employment, leads to demand-pull inflation and this leads to inflationary noise, menu costs, shoe leather costs, uncertainty, less investment, and so much more. Moreover, in some cases, government intervention is necessary. To protect the rights of workers, a minimum wage legislation may be the best tool a government has at its disposal. Without concentrating on the regulation of bank lending, it is highly possible that banks start to make bad loans. In India especially, bad loans have been posing serious problems for the economy, where defaulters often escape the country and it takes a lot of government resources and time to bring them to justice. Bad loans reduce confidence in the economy and this could lead to slower economic growth as investment ceases. Lastly, tax revenue forms a big part of total government revenue, and to stop focusing on raising taxes would throw the government into a budget deficit, especially if it needs to continue spending.

Therefore, while government intervention has its drawbacks, not at all focusing on the objectives of fixing prices, raising taxes, and regulating bank lending can be very dangerous. This question essentially comes down to whether the government should focus on macroeconomic policy or intervention, and as discussed above, there is a positive side to both views; this also depends on the kind of impact that the government is hoping to have on the market.