Macroeconomic policies can significantly affect our lives, both positive and negatively. In this paper, we will refer to a few basic concepts such as the circle flow of income and expenditures and economic growth and see how they are affected by macroeconomic policies.
Acemoglu, Laibson, & List (2016, p. 123) explain there is a circular flow connecting households and firms. Families demand goods and services, as they supply capital and labor; on the other hand, companies demand capital and labor, while supplying products and services;
As supply and demand match, a flow of income and expenditure is established between the two groups, as they trade income for labor, or capital for services, or any other combination thereof. The income of households is seen as the expense of firms; families use this earned income in their expenditure of goods and service, provided by businesses. Hence, what is expenditure for households is income for firms. Thus, a circular flow is established between businesses and households. One is dependent on the other; where there no firms, there would be no demand for the capital and labor supplied by households, and no supply of goods and services demanded by them.
We can safely state that any macroeconomic policy that affects one side of the flow will necessarily change the other as they are connected and interdependent. For example, a tax break to individuals will result in a higher demand for goods and services provided by companies. Likewise, a rise in the corporate income tax will mean firms will demand less labor from households as companies have less available capital because of the higher tax burden. This is a simple example of how employment is affected by government policies: a tax hike to corporations will likely mean an increase in unemployment.
Another important concept, related to employment and labor, is productivity. Mankiw (2012, p.14) posits that the differences in living standards among countries are greatly due to differences in countries’ productivity, which they define as “the amount of goods and services produced from each unit of labor input” (Mankiw, 2012, p.14). This is a concept that fits well with general intuition: wherever workers can produce a high amount of goods and services per hour, they and their families will enjoy a high standard of living. On the contrary, countries with less productive workers will suffer from poverty. A macroeconomic policy to increase labor productivity – such as education incentives – are likely to generate economic growth. We can raise a more interesting macroeconomic question, though: why are there nations more productive than others?
Acemoglu, Laibson, & List (2016, p. 207-208) dismiss the geographical and cultural arguments for country development and posit the institutions hypothesis for economic growth. The authors reason that different nations have various institutions (laws, traditions, costumes, governments, agencies, etc.), and these create distinct types of incentives. Such incentives will determine – more than any other factors – the degree to which nations amass factors of production and embrace newer technologies.
An easy way to explain it requires us to look into countries’ behavior concerning piracy and protection of intellectual rights. Most developing countries in South American or Africa have anti-piracy laws, but they are poorly enforced, and their permissive institutions allow the intellectual rights to go unprotected. As a result, little technological innovation comes from those countries, as there is no incentive to innovate (in the sense that someone can steal your ideas and get away with it). In contrast, developed economies such as the United States or Germany do protect intellectual rights, and, as a consequence, they display a significant degree of innovation. Yet this is another example of macroeconomic policies, which affect innovation and growth.
Acemoglu, Laibson, & List (2016, p. 208-209) ask the readers to consider the ‘natural experiment’ provided by North and South Korea. Once a single and very homogeneous country (both in terms of geography and culture), the institutions of the North changed dramatically after 1947 with the rise of a communist dictatorship, that remains strong to this day. South Korea, on the other hand, as a major theater of the Cold War, had positive and liberalizing reforms, which turned it into a very advanced capitalist society. Different macroeconomic institutions account for South Korea being over ten times richer than its Northern sister Acemoglu, Laibson, & List (2016, p. 208).
The academic understanding of economic change and growth is essential. Douglass North, whose work on the institution hypothesis won him a Nobel prize, claims that with such knowledge “we would be able to account for the long history of sustained growth of the United States and Western Europe, the spectacular rise and demise of the Soviet Union, for the contrasting performances of the rapid economic growth of Taiwan and South Korea and the dismal record of sub-Saharan Africa economies.” (North, 2005, p. vii)
As important as it is, such knowledge is yet imperfect. Mankiw tells us that “economic fluctuations are irregular and unpredictable” (Mankiw, 2012, p. 488), and when Gross Domestic Product (GDP) grows rapidly, households and firms benefit and can consume and invest a lot. Hence, the amount of supplied goods and services increase. Mankiw defines aggregate supply as “the quantity of goods and services that firms produce and sell at each price level” (Mankiw, 2012, p. 493). Whenever there is a recession, aggregate supply falls, sometimes very sharply, bringing grief and even despair among households and firms. Some economists suggest that the Great Recession of the late 2000s was due to poor macroeconomic policies that wrecked the real estate market, in a governmental attempt to provide affordable housing for poorer Americans (Rajan, R. G., 2010).
In conclusion, we can appreciate there are many instances in which macroeconomic policies affect everyone’s lives. Some of these effects can be positive – such as institutional development in South Korea leading to economic growth – and some are negative, as the unforeseen recession due to the housing stimulus. Our economic knowledge, albeit imperfect, may serve us as a guide to these strange waters.
References
Acemoglu, D., Laibson, D. I., & List, J. A. (2016). Macroeconomics. Boston, Mass.: Pearson.
Mankiw, N. G. (2012). Essentials of Economics. Mason, OH: South-Western Cengage
Learning.
North, D. C. (2005). Understanding the Process of Economic Change. Princeton,
NJ: Princeton University Press. Retrieved from Questia.
Rajan, R. G. (2010). Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Princeton, NJ: Princeton University Press. Retrieved from Questia.
