Significant increases in the national debt, with no relief or plans to deal with the problem, and its effect on the economy
An increase in national budget, with no relief or plans to deal with the problem, will result in a deficit, or more spending with less national input. Repercussions for a budget deficit can mean more borrowings for the national government from the private sector, such as the selling of bonds or gilts to the private sector.
The debate over the budget deficit has two opposing views. The first one is that the deficit is destructive to the economy, considering that large budget deficits raise interest rates, threatens private investors, and slows down economic growth (Thai as cited in Al-Khedair, 2001). Some analysts argue that the deficit and its subsequent debt will not only affect the economy but the entire country. Figgie and Swanson (as cited in Al-Khedair, 2001) indicated that the increasing budget deficit and the resulting government debt are the biggest problems that face the United States. There must be, according to opponents of budget deficits, a constitutional amendment to balance the budget, privatize some government programs, and cut some social programs.
Proponents believe that a budget deficit is a natural phenomenon and it does not have any negative effect on the economy. These analysts argue that “larger budget deficits generate savings” and can have no effect on interest rates (Thai as cited in Al-Khedair, 2001). Budget deficits can have revitalizing effects in the many sectors of the economy, can boost employment and real and after tax incomes. Moreover, deficits can be eliminated by faster-than-expected economic growth.
There is a great deal disagreement among economists and political scientists on how the budget deficit affects the economy. This discrepancy shows a problem at both the theoretical level and the practical side. Theoretically, there is no consensus on the effects of the budget deficits and can lead to different policy implications. The policy implication is that the government needs to balance its budget. As for the implications of accepting the deficit, the government may not need to worry about the deficit and may keep on spending. Therefore, the issue at stake here is whether governments should or should not reduce the budget deficit.
The federal government enacts new tariffs and quotas on all imports.
In international trade, free trade is out of the question. Trading countries employ both price constraints in various forms, including import tariffs and quantity controls that take the form of import quotas or voluntary export restraints (VERs) (Franck, 2002). VERs can lead to higher prices in the importing country because of the scarcity due to quantity reduction. Since these restraints are administered by the exporting country, the price differentials (or tariff equivalent revenue) will be taken by the exporters. Per unit profits for exported goods will be higher, leading to a potential wealth transfer from consumers to exporters (Melvin, 2001).
The quotas build barriers to exports. As the amount of exports is artificially restricted, foreign producers are unable to export as much as they wish and are even forced to reduce production. A lack of sizable alternative markets could result in exporting firms experiencing a reduction profit. The two effects of quotas in the exporting county may offset each other, such that the net impact may or may not be serious depending on the firm and industry characteristics (Suh, 2000).
Voluntary quotas require an organization to allocate shares among exporters. That is, the quotas induce a new economic institution in the exporting country which may assign quotas to the participants by an arbitrary set of rules. The interest group theory of regulation suggests that any changes in rules and conditions are necessarily affected by the influence of interest groups (Posner as cited in Suh, 2000).
If goods are not homogenous, quotas imposed on the product category affect the relative prices between qualities and the composition of exports. Since there is limited quantity on exports, prices are volatile. There is a change in the prices, as those with lower value become more in demand than the high-value ones. This issue has generally been overlooked by policy makers. More importantly, if the restricted goods are necessities, the effects of quotas may be regressive between consumer groups.
Exporting countries prefer voluntary export restraints to ad valorem tariff increases imposed by the importing country because they provide an extra margin of maneuverability. In addition to the scarcity premium accruing to exporters, trade restrictions can be partially circumvented by changing product specifications.
The general public does not trust the economic managers
Ineffective leadership is considered one of the most critical problems facing impoverished nations. When people lose confidence in their leaders, the economy suffers.
The economic performance of a country depends on economic actors’ expectations regarding the economic situation, even if it may remain unclear to what extent expectations themselves causally affect the real economy rather than “merely” being good predictions (Büthe, 2002). Anecdotal evidence tells of political decisions, changes in government, and electoral uncertainty that affect the expectations of the general public and the business sector about a country’s economy. Some observers claim that the ability of the state to control economic activity within and across borders is greater than ever, notwithstanding decisions to increase trade and financial openness (Thomson Krasner, 1989 as cited in Büthe, 2002).
There is evidence, however, that partisan politics affect the assessments and expectations of firms (Büthe, 2002).
In a survey conducted by the US National Federation of Independent Businesses (NFIB) on a monthly basis among random samples of its members, respondents were asked regarding their evaluation of the economic policies of the president. The jump in the ratings of the U.S. President’s economic policies immediately following the election of the first Republic President to follow the apparently most pro-business Democratic President in decades was surprising. Between December 2000 and March 2001, the average assessment jumped 1.36 rating points – an increase more than 33% greater than the total range of the ratings during the two Clinton presidencies combined. The data strongly suggest that economic expectations of firms in advanced capitalist democracies are partly a function of partisan control of the government. And if people lose confidence in those in power, it will affect the economy.
It is, however, contrary to the fact that much of the literature in international and comparative political economy suggests that globalization is rendering political factors, and the party affiliation or composition of governments in particular, ever less important. Especially for business, i.e. firms in the aggregate, which is regarded a privileged group by much of the literature on democracy and capitalism, it should matter little and ever less which party controls the government. The irrelevance of partisan politics should apply all the more to advanced capitalist democracies, where neither the economic nor the political system is fundamentally in question (Büthe, 2002).
The federal government, in an effort to stimulate the economy, decreases taxes on all individuals except those earning over $250,000 per year.
Every time new tax legislation is introduced, there is an effect on labor supply which further influences the economy in general. When tax cuts are proposed, many people argue that lost revenue will be recouped through increased labor supply. When tax inreases are proposed, those same people argue that the government will receive little increase in tax revenue because people will choose to work less. But ultimately, there is little agreement on the incentive effects of a cut in marginal tax rates (Ivory, 1997).
Feldstein (1995 as cited in Ivory, 1997) found large effects on taxable income and mong high income taxpayers following the 1986 Tax Reform Act (TRA86); even among middle-income taxpayers there was a non-negligible change. High-income taxpayers are those who belong to $171,551-$372,950 income bracket which has a marginal tax rate of 33%, and those who belong to the $372,951+ bracket which gets a 35% marginal tax rate.
Decrease in income tax rate would mean higher take-home pay for individuals earning below the $250,000+ bracket. This means there will be more spending on the part of the taxpayers, and that would bolster economic spending on the part of the general population.
The level of investment decreases because of a lack of confidence in the economy
In the study by Büthe (2002), he used “business confidence” as dependent variable to measure aggregate economic expectations. “Confidence,” “sentiment,” or “climate” is often raised as an outstanding explanation in economic analyses: If economic actors act in a way that is inconsistent with what mainstream economic theory or “economic fundamentals” suggest, confidence is said to explain the divergence. Therefore, when FDI fails to affect a country after it has adopted business-friendly policies and received a clean bill of health from the IMF or World Bank, confidence among foreign, potentially investing firms is said to be low. When the Euro kept declining vis-à-vis other major currencies throughout 1999 and most of 2000, “investor sentiment rather than economic data” was said to “determine the currency’s fate” (Swann, 2000 as cited in Büthe, 2002). To be analytically useful, business (or consumer) confidence must therefore be conceptually and empirically distinguishable from – and logically prior to – the phenomena it is supposed to predict or explain.
Büthe (2002) conceptualized business confidence as the forward-oriented assessment of, or the expectation regarding, the general economic situation by private sector firms which is “formed prior to a given decision or action that will be affected by this assessment of the future economic situations. Business confidence, therefore, refers to the economic expectations of a particular kind of aggregate economic actor: private sector firms, or in the collective singular: business. Business confidence is attached to the real economy but providing a quite immediate measure of economic expectations (Büthe, 2002).
Business expectations are observable, fairly directly and independently of firms’ subsequent actions, through the statements of senior managers who speak and act on the firms’ behalf, i.e. through interviews or, more systematically, surveys. On the other hand, consumer confidence refers to the logically parallel assessment of households, observable through consumer surveys (Büthe, 2002).
Interest rates are kept artificially low by the Federal Reserve for several years.
The monetary policy proposed by the Federal Reserve is to keep interest rates low for a period of time to control inflation. Economists criticize many monetary policy issues into how they are being used. According to these economists, instead of a tool to control inflation, there should be focus on how monetary policy can promote financial stability and thus enhance economic development (Khayoyan, 2012).
The Keynesian concept is opposed to the working of the monetary policy, with its argument that in times of high unemployment, real interest rates cannot be influenced by any other factor. According to the Keynesian philosophy, fiscal policy is more effective than monetary policy in achieving financial stability (Friedman as cited in Khayoyan, 2012).
However, monetary policy became significant in the early part of the 1950s when policy makers proposed that changes in the money in circulation can influence aggregate demand, even if there is no change in interest rates. This is known as the Pigou effect. But many critics countered that the Fed, using the monetary policy, was responsible for the housing crisis after 2001. Still, there are many who argued that several factors led to the housing crisis, and not the monetary policy. Financial stability cannot be attained merely through monetary policy on interest rates, nor price stability. Interest rates kept low by the Fed can have opposing and unclear repercussion.
References
Al-Khedair, S. (2001). The impact of the budget deficit on key macroeconomic variables in the major industrial countries (Doctoral thesis, Florida Atlantic University). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/304301454/fulltextPDF/9EB21446F4C44731PQ/1?accountid=13957
Büthe, T. (2002). The impact of partisan politics, globalization, and institutional variation on the economic expectations of firms in advanced capitalist democracies (Doctoral thesis, Columbia University). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/276494354/fulltextPDF/7BD73FB752804F5BPQ/1?accountid=13957
Franck, D. (2002). International capital mobility and trade reform in the presence of tariffs and quantitative restrictions (Doctoral thesis, University of Georgia). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/304342299/fulltextPDF/58469217F5A6435BPQ/2?accountid=13957
Ivory, A. (1997). The effects on the 1986 Tax Reform Act on labor supply and taxable labor income (Doctoral thesis, University of Virginia). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/304387055/fulltextPDF/9C61510AF7324C8CPQ/1?accountid=13957
Khayoyan, A. (2012). The U.S. housing crisis: Analyzing the differing arguments of John Taylor and Alan Greenspan (Doctoral thesis, Claremont Graduate University). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/1036992081/fulltextPDF/4620AF36A2E42ACPQ/1?accountid=13957
Melvin, J. (2001). The nonequivalence of tariffs and import quotas. American Economic Review, 76(5), 1131-1134.
Suh, J. (2000). An incidence analysis of import quotas (Doctoral thesis, Washington University). Retrieved from http://ezproxy.sothebysinstitute.com:2195/pqdtglobal/docview/303145552/fulltextPDF/E1A7A4A08DB840F2PQ/1?accountid=13957
