THE ROLE OF GOVERNMENT IN A MARKET ECONOMY
Introduction 2
What is Different Happened in 2008? 3
The Monetary Policy’s Contribution 6
Looking for Guilty Agents or Guilty Ideas in the Economies 7
An Important Example for the Developing Countries: the Egyptian Economy? 8
Conclusion 9
References 12
THE ROLE OF GOVERNMENT IN A MARKET ECONOMY
Introduction
The first economist believed in the full competition. Adam Smith expressed that there is a perfect system in the economy similar to the perfect system in the universe. As the God does not intervene the system in the universe after the creation, the state or any other power should not intervene the markets because the price mechanism in the markets runs perfectly. Any intervention to the market might create inefficiency.
The ideas of Adam Smith and his followers (the classical movement in the economics) determined the mainstream policies until the beginning of the 20th century in the developed countries; however, in 1920s something terrible happened. The price mechanism in the markets could not fix everything in the markets, and the big economies like the American Economy and the British Economy faced a big market mechanism failure. The economists named this failure as the great depression. It was a great depression because the price mechanism made many people suffer for many years. The workers in the big economies produced a lot, especially the farmers; however, the prices became so low that the suppliers preferred dumping their products into the sea instead of selling them in the market. The farmers could not make enough to pay their bills and credits, and subsequently many of them bankrupted.
At this point, the economists from the classical school could not find any solution, and a British economist, John Maynard Keynes, suggested a solution that made him famous in the science of economics. Keynes simply was suggesting giving a saving kiss to the economy by increasing the government spending. The increase in the government spending would stimulate the demand in the country, and the prices would go up, and the producers were going to produce again. His suggestion worked at this time; however, in 1950s, the same policies caused a large problem for the developed economies.
Increasing the government spending followed by another group of policies providing many social rights to the workers and the retired workers. The labor unions became very powerful. Therefore, when the workers got a right, it was impossible to get it back. The same story worked in the wages. The increase in the wages was possible; however, any decrease in the wages was impossible. Subsequently, the government needed to spend a lot of money for the social rights in 1950s, and the governmental savings were used inefficiently. This situation created a crowding-out effect.
Consequently, there are two mainstream schools in the conventional economics. One of them supports the idea of free market mechanism while the other one believes that the free markets cause troubles at certain time intervals. Until 2008, the economists following these schools have developed many theories, and some other economists suggested some mix strategies for the markets that included the state intervention and the free market features. The global financial crisis began in 2008 has introduced new unknown threats to us. The free markets failed terribly, and simple government interventions could not solve the problem. In this essay, a new era for economy management after 2008 will be analyzed with the rational reasoning.
What is Different Happened in 2008?
The global financial crisis in 2008 was a result of a failure in the sub-mortgage markets in the USA. The consumption-centric American economic growth policy had a big failure in 2008. The Americans were getting easy credits to buy expensive houses until 2008; however, the crisis has indicated that the buyers who have debts more than their incomes might have caused a big crisis that influences the entire world. This crisis was a special one because still no economist or economy management could create a good solution for this crisis. From another point, the economists and the economy management professionals could still not comprehend the crisis fully.
What has happened after 2008? The people could not pay their loans back to the financial institutions, and the large ten financial institutions in the US have almost bankrupted. The US government has started the bailout policy and provided direct financial supports to those institutions. The bailout strategy saved these institutions at the expense of spending government savings and increasing government debts. Many American citizens and some economists criticized this strategy.
The Keynesian policies in 1950s were blamed for increasing the inflation and the interest rates. When the government increases its spending, then the government has to find financial resources to be able to do the spending. The easy way is to sell short term government papers to the public, and get loans from the people. The government needs to pay a relatively higher interest rate to convince people to lend their savings to the government. As a result of this, the interest rate in the financial markets increases and the increase in the interest rate causes a decrease in the investments and even in the production.
The recovery strategies followed by the American government is slightly different from the policies in 1950s. Both caused an increase in the government spending; however, in 1950s, the government spending was to stimulate the demand in the economy; however, the bailout policy after 2008 was to save the large companies.
The Keynesian school made an essential contribution to the science of economics: expectations. According to the Keynesian school, the demand is a function of the previous years' demands. Thus, the agents in the economy review the macroeconomic statistics in the past and make predictions about the future. The rational expectations school developed this idea by developing a methodology to make relatively better predictions for the future by taking all the past and present information into consideration.
The policies after 2008 and the policies in 1950s caused an increase in the government spending; however, the expectations among the people are different between these two terms. Thus, the results from these policies have become different. In 1950s, the Keynesian policy was partly successful at stimulating the demand at the expense of causing a crowding-out effect on the private investments while the policies after 2008 were not successful at stimulating the demand. The difference between the two policies in two different terms stems from the difference in the expectations.
Why are the expectations different? Between 1930 and 1950, the economies were not so developed compared to the modern times. Increasing the government spending could increase the demand because the economies had the potential to grow up. The governments could open new international markets for the producers, or the markets inside the country were not fully satisfied. Subsequently, it was possible to enlarge the markets, and create a high level of effective demand for the following years. However, in our modern time, the American multinational companies invaded many of the markets in the international arena. Also, the American producers have lost some advantages to the developing Asian countries like China, Taiwan, and Malaysia. Many American multinational companies have moved their production facilities to these countries. Consequently, it is truly hard to enlarge the markets at the current time. The economic growth is stuck in a circle for the US Economy; it is comparatively more difficult to solve the crisis puzzles in the US.
As a final and important point about the economies, there are the relatively more pessimistic agents in the economy. Even though, the upscale people are relatively more optimistic, many people have lost their beliefs in a full recovery.
The Monetary Policy’s Contribution
Contrary to the general assumption about the Keynesian school, the Keynesian school suggests using monetary policies to fix the problems in the markets simultaneously with the fiscal policies. Especially, after 1950s, the economies faced the reality of stagflation. Stagflation problem could not solve through using only fiscal policies; the new Keynesian school and the neo-classical economics school have developed some new strategies those were including the implementation of the fiscal policies and the monetary policies simultaneously. These mix policies could solve the stagflation puzzle until 2008.
The central banks in the different countries have always been blamed of being late implementing the necessary monetary policies. During the Great Recession, the public expected that the Federal Reserve made a monetary expansion stimulate the markets; however, the Federal Reserve preferred staying away from the monetary expansion. The same story happened almost for all the crises in the past. After 2008, the central banks in the different countries were cautious for inflation, and they did not implement any expansionary monetary policy.
The most important aspect of the crises in the world is the increasing inflation. Each economic or financial crisis the economies experience cause relatively higher level of inflation. Subsequently, the central banks become more hesitant about implementing an expansionary policy.
Consequently, many of the central banks continue playing a passive role during the crises times, and the governments have to take the most of the responsibility. The monetary policy might play an essential role in solving the crises puzzles; therefore, in the following years, the public discusses the efficiency of the central banks relatively more and more.
Looking for Guilty Agents or Guilty Ideas in the Economies
At the beginning of the crisis, the American public discussed on who were responsible for the global financial crisis. There were two main groups who could be responsible. The problem started in the mortgage markets. Some people were trying to buy very expensive houses through getting long term credits from the financial institutions even if they knew they did not enough economic power to pay their loans on time. On the other side, some house owners and the real estate businessmen tried to use the advantage of the high level of demand for the houses.
Both sides were truly greedy. Some people from the middle-income class wanted to buy some luxury houses, and they were willing to pay very high prices for these houses. On the other side, the house owners and the real estate businessmen were very happy to sell their house at very high prices. Both sides were expecting that the real estate prices and house values would increase in the future more and more.
The basic rule in the science of economy is "There is no free lunch in economics." This statement has very deep meanings. When the people who are working and spending effort in the economy make less income, and the people who receive rent, interest gains, and some other income from the unproductive sectors make relatively more income, and then this economy faces many problems. In another word, the people are truly working should be promoted in a healthy economy.
The crises have proven us that the real solution for the crises in the past has been to increase the production in the economy. Increasing the real sectors in the economy can solve the puzzles of inflation, stagflation, and many other troubles. Greed promotes the emotion of making income without spending effort in a real sector.
An Important Example for the Developing Countries: the Egyptian Economy?
The population of the Egypt has increased around 5-6% annually in the last a few decades. The Egyptian Economy could not increase the number of the available jobs for the young generation. As a result of this, an economic stress has caused a social stress in Egypt. There are some reasons behind why the Egyptian Economy could not produce enough jobs for the youngsters: 1) happiness of government jobs, 2) not matching skills to the needs of the labor market (wrong education policies), 3) wrong use of fuel subsidies, 4) democratization problems in the country, and 5) not rule-based business environment. Subsequently, the Egyptian Economy is not a well-structured economy to cope with the needs of a rapidly increasing population.
The Egyptian governments have followed a populist way for increasing the number of the available jobs through increasing the job opportunities in the public sector. Whenever the Egyptian society has requested more jobs in the economy, the governments played a populist game. However, these policies have increased the weakness of the Egyptian Economy for creating new jobs.
Another important issue, the education system in the Egypt has produced many professionals those were not needed in the Egyptian Economy. That is a common problem in the developing stories.
Egypt has rich fuel resources. As known from the other examples of the developing countries with the abundance of the natural resources, the Egyptian Economy could not develop the dynamics for a healthy economic structure and labor markets. The businesses in the Egyptian Economy could not develop the necessary business environment.
The democratization of the Egyptian political system has failed in the recent time. The Army strike in the country and the continuing conflict is creating a big mess. The instability in the Egyptian political life is increasing the insecurity and uncertainty in the economy. These occurrences are weakening the Egyptian economy more and more.
The Egypt could not develop a healthily working political and economic structure. The Egyptian government’s interventions in the past caused more problems in the economy. The instability in the Egyptian politics prohibits for the governments to create the appropriate interventions to the Egyptian Economy. Even, one can claim that the government needs to neutralize the political influences on the Egyptian Economy. The Egyptian Economy is a completely different case from the Western Economies, and the Egyptian Government needs to work relatively more on the development of the economic structure in the economy. In another word, expansionary policies or any other similar economic policies are completely out of vision for the Egyptian Economy.
Conclusion
The last crisis has proven us that the conventional fiscal policies and the conventional monetary policies cannot be the solution of the crises in the future. The economy managements in the developed countries have to develop new mixed and more complex strategies to solve the puzzles in the futures.
Consequently, there is no easy solution for the crises in the future after 2008 as there is no free lunch in economics. The economic policies should concentrate on developing the production and the real sectors in the economy. However, that does not mean a supply-centric economic policy. The new generation economic policies need to take the individuals' behaviors, as well as the development of the real sectors into consideration. The world population is increasing and managing the economies in a highly populated world is comparatively harder.
References
Cogley, T., & Sargent, T. (2005). Drifts and volatilities: Monetary policies and outcomes in the
Post WWII US. Review of Economic Dynamics, 8(2), 262-302.
Drezner, D., & Mcnamara, K. (2013). International Political Economy, Global Financial Orders
and the 2008 Financial Crisis. Perspectives on Politics, 11(1), 155-166.
Kenway, J., & Fahey, J. (2010). Is Greed Still Good? Was It Ever? Exploring The Emoscapes Of
The Global Financial Crisis. Journal of Education Policy, 25(6), 717-727.
Plumer, B. (2013, July 3). The economic roots of Egypt’s crisis. The Washington Post. Retrieved
October 15, 2014, from
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/07/03/the-economic-roots-of-egypts-crisis/
Wray, L. (2004). Contemporary post Keynesian analysis. Cheltenham, UK: Edward Elgar.
