Topic 3The UK Economy (Macroeconomics)

THE ROLE OF GOVERNMENT IN THE

ECONOMY

REVISION (Pg 41-44 – The UK Economy Topic 2)

Basic Economic Problem3 types of Economy

Command Market Mixed

ECONOMIC SYSTEMS

Providing public goods and services e.g. Defence

Providing merit goods and services e.g. Education

Controlling and regulating the private sector e.g. H&S Legislation

Dealing with market failure

Controlling overall economic performance e.g. unemployment

Redistributing income e.g. Tax & Benefits

SUMMARY OF THE GOVERNMENT’S ROLE IN THE UK ECONOMY

Topic 3The UK Economy (Macroeconomics )

INCREASING ROLE OF THE PRIVATE SECTOR

This policy is to sell assets which are owned by the public sector.

It has included the sale of nationalised industries such as coal and the railways.

Other examples - British Airways, British Telecom and British Petroleum.

The government also deregulated some industries to make competition easier.

PRIVATISATION

1. Stock Market Flotation – became PLC’s. E.g. British Airways and British Telecom.

2. Sale by Tender – a minimum price was set for the asset and buyers bid for shares. The person who had the highest bid got the shares. E.g. Britoil

3. Private Sale – assets are sold to a single buyer. E.g. Rover to British Aerospace and then BMW. Also council houses to tenants.

METHODS OF PRIVATISATION

CONTRACTING OUT

Services that were normally provided by local government such as school cleaning, are contracted to pr ivate firms to do. Also called COMPULSORY COMPETITIVE TENDERING .

PRIVATE FINANCE INITIATIVE (PFI)

PFI involves private sector firms being invited to pay for and build projects such as schools, prisons and hospitals. The government takes out a long term lease and pays for the service over that time with tax revenues.

DEREGULATION

This is when the government removes regulations that have stopped competition happening in a market. E.g. removing the sole right for BT to provide telephone services.

OTHER METHODS

To improve efficiency Technical efficiency - competition will help cut costs and

improve quality. Allocative efficiency - resources are more likely to be used

to produce what people want.

To reduce government interference in the market Ministers are not making commercial decisions, which were

often done for political reasons. Allows industries to diversify.

AIMS OF PRIVATISATION

Reduce the power of Trade Unions Nationalised industries were monopolies, so a strike

affected consumers Firms now couldn’t submit to pay demands and ask the

government to fund it

Reduce government borrowing Firms which make losses cannot borrow from the

government. Firms now have to raise capital themselves. With PFI the government doesn’t need to find the money

itself.

Political motive Privatisation was a very popular policy with voters.

AIMS OF PRIVATISATION

Inefficiency Some firms have been forced to become more efficient

because of competition. However, there are monopolies where there is only one firm and so don’t have the same incentive to be efficient. E.g. Water

Excess Profits Firms that had a huge degree of monopoly power have

made huge profits at the expense of consumers. E.g. British Gas and BT

Job Losses and Poorer Working Conditions There have been a large amount of redundancies to become

more efficient.

PROBLEMS WITH PRIVATISATION

Reduced Services Since privatisation a lot of loss making services have been

withdrawn. E.g. rural bus routes and rural post offices. There can no longer be cross-subsidisation.

Widening of Share Ownership The aim of privatisation was to get more people to become

shareholders. This did not happen to the extent hoped. Many sold them quickly for profit Most shares are owned by large financial institutions.

Assets sold too cheaply Critics of privatisation have said that the government sold

industries too cheaply, resulting in a loss of revenue for the government. E.g. BT

PROBLEMS WITH PRIVATISATION

If a firm operates in a market with a lot of competition, there is no need for government regulation.

However, with little competition then regulatory agencies have been set up to oversee the industry. Oftel (telecommunications) Ofgem (gas and electricity) Ofwat (water)

Objectives To protect consumers of exploitation To encourage efficiency and innovation To promote competition

GOVERNMENT CONTROL OF PRIVATISED INDUSTRIES

Price Regulation – regulator fixes a maximum price. Usually RPI less a certain percentage

Yardstick Competition – split into geographical areas with different companies operating e.g. electricity and water. The regulator will compare the performance of each company.

FORMS OF REGULATION

Topic 3The UK Economy (Macroeconomics )

PUBLIC SECTOR EXPENDITURE

Capital Spending Helps create productive capacity e.g. hospitals,

infrastructure.

Current Spending Day-to-day running costs of the government e.g. paying

workers

Transfer Payments This is a payment to an individual or firm were there is no

economic benefit given in return. E.g. pensions, unemployment benefits.

TYPES OF PUBLIC SECTOR SPENDING

Public Goods will benefit everyone in society. E.g. Defence and street lighting

A public good cannot be provided by the Private Sector because it would difficult to get consumers to pay for them.

Merit goods are ones that are desirable but if left to the Private Sector would be under-developed. E.g. Healthcare, education.

These goods are given to people who need them either free or at a reduced price.

PUBLIC AND MERIT GOODS

The total spending by the government has been increasing in recent years. This had been mainly due to increased spending on health, education, transport.

Less has been spent on budgets such as defence and housing.

Social security spending has increased as we have an ageing population. However big cuts have been pushed through in welfare since 2011, particularly on unemployment benefits.

TRENDS

Income Tax can be reduced and therefore create incentives to work more and give more freedom to consumers on what to spend their income on.

Government borrowing would be reduced.

Resources can be released to the Private Sector, which will utilise them better.

WHY CUT PUBLIC SPENDING?

Public Spending is often on UK produced output and therefore creates employment

Cutting capital spending might reduce the country’s infrastructure.

Resources released to the Private Sector might not be taken up so left unemployed.

Lower income groups may be worse off, through reduction in benefits, housing and transport.

WHY NOT CUT PUBLIC SPENDING?

Topic 3The UK Economy (Macroeconomics)

TAXATION

These are taxes which are taken directly from individuals and firms. They are taxes on income and wealth. Collected by HMRC

Examples Income Tax National Insurance Contributions Corporation Tax Council Tax Inheritance Tax Stamp Duties – paid when buying house

DIRECT TAXES

These taxes levied indirectly. The payer of the tax normally passes the burden on to the consumer. Collected by HMRC.

Examples VAT Duties – alcohol, tobacco, fuel Airline Tax Road Tax

INDIRECT TAXES

Adam Smith laid down 4 principles (canons) of a good tax.

1. Equity – should be related to ability to pay

2. Efficiency – taxes should be reasonably inexpensive to collect

3. Certainty – taxpayer should be clearly aware of how much is due, when and where

4. Convenience – taxes should be payable at a time and place that suits the payer.

WHAT MAKES A GOOD TAX?

Progressive TaxTakes into account the ability of people to pay. A

progressive tax takes a larger percentage of income as income rises. E.g. Direct Taxes

Regressive taxes take no account of the ability of people to pay.

E.g. Indirect Taxes such as VAT.

PROGRESSIVE AND REGRESSIVE TAXES

Cuts in business taxes trying to encourage investment by firms. Lower rate than

other European companies so attracting investment.

Shifts from direct to indirect taxation . Started by the Conservatives in the 1980s (see notes). Tax

on spending rather than earning.

1997–2010. Labour Government attempts to readdress some of these

issues.

TRENDS IN TAXATION

Case for CutsTax revenues increase.

By cutting rates you might stop people evading tax.

Incentives to work increase. Cutting marginal rates of

cut means people will keep more of their income.

Laffer Curve See notes

Case Against CutsTax revenue may not

increase more leisure time than work

Demand in the economy may be over stimulated Leads to inflation.

Inequalities in income and wealth will widen . Progressive to regressive

INCOME TAX

Topic 3The UK Economy (Macroeconomics )

PUBLIC SECTOR NET CASH REQUIREMENT

This is the borrowing by the public sector. The public sector will need to borrow when expenditure is greater than income.

PSNCR is measured in £ billion and as a percentage of GDP.

Financed by selling bonds, gilt edged securities and treasury bills to financial institutions and citizens.

If PSNCR is negative then the government has more income than expenditure and so can repay debts.

PSNCR

BUDGETThis is what the government plans to spend and how it is

going to fund it. It is presented once a year to parliament.

When the government spends more than its income it is called a BUDGET DEFICIT.

When it earns more than it spends it is called a BUDGET SURPLUS

NATIONAL DEBTThis is the total amount that the public sector owes to

those who have loaned it money.

When there is a PSNCR, then national debt will increase. When there is a budget surplus then there will be a reduction in

national debt.

THE BUDGET & NATIONAL DEBT

Crowding out – high government borrowing may starve the private sector of funds for investment.

Interest rates may have to rise to encourage lenders to lend money to the government

Inflation may occur – Monetarist view

National debt is increased – high taxes/spending cuts to repay

PROBLEMS WITH A HIGH PSNCR

Notes are outdated (1992 – 2000!)After reading your notes compile a trends report from

2000 onwards.

UK TRENDS (SEE NOTES)

Topic 3The UK Economy (Macroeconomics )

GOVERNMENT ECONOMIC

OBJECTIVES

The government in a mixed economy is there to:

Provide goods and services that cannot be produced by the private sector

Regulate the private sector to protect consumers, employees and the environment

Set objectives of economic policy and choose policy instruments.

Objectives

Microeconomic – these are objectives that relate to the performance of a part of the economy.

Macroeconomic – these relate to the performance of the economy as a whole.

ROLE OF THE GOVERNMENT

MICROECONOMICSTo prevent market

failure

To distribute income and wealth more fairly

To reduce regional disparities.

MACROECONOMICSTo achieve economic

growth

To achieve low and stable inflation

To reduce unemployment

To keep the Balance of Payments in balance.

OBJECTIVES

There are a number of problems that face governments when trying to achieve economic objectives:

Conflicting advice Inadequate information Time lags Policy constraints Political pressure Conflict between policy instruments

RECONCILING CONFLICTING OBJECTIVES