Economic Role of Government


In order to ensure the successful performance of the state in the economic world arena, some governments prefer to restrict their roles in economic affairs both on local and worldwide scales. Others, vice versa choose the total control of the economy and defining the state economic course.

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In a market economy, such as the one stated by US Constitution, most economic conclusions are made by particular consumers and vendors, not by the government. Economists, nevertheless, classify six key functions of government in economies. Governments grant the legislative and social structure, support competition, offer community goods and services, reallocate benefits, correct the externalities, and alleviate the economy.

Citizens, groups of interest, and political heads oppose how seriously a scope of activities the government should execute within each of the named purposes. Over time, as the community and financial system have modified, government activities on the matters of these functions have enlarged. (Akerlof, 2003)

The role of government

In a market economy, commerce and customers make a decision of their own decision what they will consume and manufacture, and in which conclusions on the allotment of those sources are without government interference. Hypothetically this denotes that the manufacturer is required to decide what to produce, how much to produce, what prices to set up for consumers for those productions, what to pay workers, and so on. These conclusions in a market financial system are impacted by the forces of competition, supply, and demand. This is frequently distinguished with a premeditated economy, where central government concludes what will be manufactured and in what amounts. A market economy is also compared with the mixed economy where there are market processes through the system of markets that is not completely free but under some state control that is not widespread enough to comprise a deliberate financial system. In reality, there is no state that possesses a chaste market economy. Some market economy countries include China and the United States. (Deboer, 2000)

Macroeconomic role of government

Government policies are the most significant aspects of macroeconomics. As the government is a part of the circular income flow, it is in a position to take measures to attempt to impact parts of it to attain particular achievements. These objectives are generally the encouragement of financial expansion, low joblessness, and inflation control and trade balance. If the economy is regarded to be a central heating system that pumps hot water around the house, then the application of government policy can be regarded as a thermostat. If it is too cold, then action must be taken to make the surrounding situation warmer – more hot water to circulate, and vice versa, if it is too warm – actions for cooling down should be undertaken.

It is possible according to some interpretations for a market economy to have government intervention in the economy. The key difference between market economies and planned economies lies not with the degree of government influence but whether that influence is used to coercively preclude private decisions. In a market economy, if the government wants more steel, it collects taxes and then buys the steel at market prices. In a planned economy, a government that wants more steel simply orders it to be produced and sets the price by decree. (Togati, 1998)

The proper role of government in a market economy remains controversial. Most supporters of a market economy believe that government has a legitimate role in defining and enforcing the basic rules of the market. Different perspectives exist as to how strong a role the government should have in both guiding the economy and addressing the inequalities the market produces. For example, there is no universal agreement on issues such as central banking, and welfare. However, most economists oppose protectionist tariffs.

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In accordance with the followers of rational expectation theory, involuntary unemployment is not able to reign. It is argued, that manufacturers and buyers gather all the necessary data on the matter of financial circumstances and regulations, and define their activities in accordance to the rational and regulation anticipations shaped on the grounds of collected data. People do not retort to making mistakes in stating correct relations among their economic activities and state regulations on the one hand, and the outcomes that pursue after that. Alternatively, people always make correct predictions of the governmental regulations and modifications of the microeconomic environment. For instance, when government imposes the deficit of the budget, it expects that the interest rates will unavoidably rise. Consequently, citizens would try to take loans when the interest charges are lower in order to get protected from paying high rates. (Akerlof, 2003)

In accordance with the Keynesian theory of state budget deficit, this deficit originates the increase of the aggregate demand and will consequently endorse confidential investment. Alternatively, in compliance with rational expectations theory, an increase in the sphere of aggregate demand as a consequence of a budget deficit is offset by a decrease in private investment, so that national output, income, and employment stay non-impacted.

As the customers, employees, and manufacturers adjust to avoid the adverse effects of financial events and regulations, there is no necessity for the government to interfere with the financial system by the means of adopting the appropriate macroeconomic regulations. Thus, like Friedman and other economic researchers and followers of the rational expectations theory are resisting the activist role of the Government. It is rather complex to implement an activist policy effectively. They are of the notion, that is generally in full-employment equilibrium and citizens make self-regulations in their conduct to defend and uphold their interests. The government is not able to achieve any accomplishment in expanding the financial situation by the means of the only activist policy. As contrasted with the state personalities, they are in a much better condition to undertake counteractive measures to safe and defend their interests. (Togati, 1998)

As for the matters of stabilization and growth, it is necessary to mention, that perhaps most significantly, the central state government rules the overall rapidity of financial activity, trying to keep stabilized growth, high stages of service, and price solidity. By regulating expenditure and tax charges (tax policy) or supervising the money flows and controlling the application of credit (monetary policy), it can hold back or accelerate the economy’s rate of increase – in the process, involving the level of values and employment.

The world’s ideas on the matters of the best tools for stabilizing the economy changed substantially between the 1960s and the 1990s. In the 1960s, the government had great faith in fiscal policy – manipulation of government revenues to influence the economy. Since spending and taxes are controlled by the president and Congress, these elected officials played a leading role in directing the economy. A period of high inflation, high unemployment, and huge government deficits weakened confidence in fiscal policy as a tool for regulating the overall pace of economic activity. Instead, monetary policy — controlling the nation’s money supply through such devices as interest rates — assumed growing prominence. Monetary policy is directed by the nation’s central bank, known as the Federal Reserve Board, with considerable independence from the president and Congress.

Regarding the matters of centralized economy regulation (like in most East Asian countries), it is necessary to mention, that most researchers still admire the economic wonders that occurred in the post-war periods, revealing the great economic potential of the economies.

Until the recent time, there has not been any agreement among economists on whether government interference in the market process had a positive impact on the impressive economic increase in that region over the previous few decades. Some have forcibly stated that East Asian growth can primarily be explicated by the macroeconomic stability that offered appropriate motivations for investment and keeping as well as high personal capital accumulation., while the intervention of government in specific industries was at least irrelevant, or even had a harmful and destroying impact on the allotment of resources. In this notion that this regard endorses only those government undertakings that assist the financial expansion and the effectiveness of markets, it was submitted to as the market-friendly regard by the World Bank’s World Development Report 1991.

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The issuing in 1993 of the research devoted to the East Asian Economic Miracle, is generally viewed as the watershed in the mentioned above discussion. The World Bank had been legitimately committed to the market-directed, noninterventionist growth advance in its loan conditionality and policy discussions. Therefore, the subsequent admittance of the research came as innovative: every of the High Performing Asian Economies supported macroeconomic stability and achieved three components of the increase: accumulation, efficient allotment, and quick technical catch-up. They did this with combinations of policies, ranging from market-oriented to state-directed that ranked both across the financial systems and all over time. (Yoshikawa, 2005)

Microeconomic role of government

Microeconomics generally entails a variety of concentrated spheres of research, lots of which draw on methodologies from other spheres. Many used works apply little more than the grounds of charge theory, supply, and demand. Industrial corporations and policy examine themes such as the entry and exit of companies, modernism, and the function of brand names. Legislation and the financial system apply microeconomic standards to the assortment and enforcement of competing for lawful governments and their relative effectiveness. Labor economics inspects salaries, employment rate, and labor market activities. Public investment (also regarded as public economics) inspects the plan of government tax and spending regulations and the financial impacts of these policies (e.g., communal assurance agendas). Political economy researches the role of political organizations in defining policy conclusions. Health money-makings examine the association of health care structures, comprising the function of the health care labor force and health indemnity projects. Urban financial systems, which studies the confronts challenges by cities, such as are slumps, air, and water contamination, traffic blocking, and dearth, draws on the fields of urban geography and sociology. The sphere of monetary economics examines subjects such as the construction of most advantageous portfolios, the rate of return to finances, econometric analysis of safety revisits, and corporate monetary performance. (Bardhan, 2003)

Personal incomes depend on the supply and demand for that person’s labor, which in turn depends on natural ability, human capital, discrimination, and other factors. As labor earnings make up a large proportion of total earnings, wages are largely responsible for determining how the economy’s income is distributed among the various members of society.

The allocation of profits hoists some essential matters about the position of financial regulations. The invisible hand of the marketplace may distribute sources effectively, but it does not guarantee that sources are distributed moderately. Consequently, lots of financial researchers, although not everyone, consider that the government should reallocate profits to gain greater impartiality. Nevertheless, in doing so the government has to accept exchanges with other objectives. When the government ratifies regulations to make the allocation of income more evenhanded, it disfigures inducements, changes conduct, and makes the distribution of reserves less competent.

Lots of policies aspired at assisting the poor in developing countries can have the unintentional result of discouraging the poor from avoidance scarcity on their own. For instance, let’s assume that the government grants each family an annual income of USD 15,000 (in any national currency equivalent). No matter what the family earns, the government compensates the disparity between that income and 15,000. According to this policy, any individual who would earn less than 15,000 by working has no motivation to find a serious and high-income job. For every dollar that the person would get, the government would decrease the income hold up by a dollar. The person tackles an effectual marginal tax charge of 100%. (Deboer, 1998)

While the offered instance is extreme, wellbeing advantages have to be decreased away as profit increases. One way to decrease the impact this has on inducements to work is to decrease benefits more steadily as income increases. Nevertheless, this greatly raises the charges of programs to struggling with poverty.

Another advance is to restrict the number of years that an individual may gather welfare. Followers of this approach dispute that it would diminish the unpleasant inducement consequences of permanent wellbeing. Nevertheless, critics state that it can thrust lots of families below the poverty line.

Remember that policy creators challenge a trade-off between parity and quality. Regulations that reprimand the successful and reward the unproductive decrease the encouragement to be successful.

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It is also should be stated, that the increase of mass education movement may launch an opportunity for all and decrease the gap in profit disparity. Second, a social strategy put forth by the administration as a country turns out to be rich may elucidate the refusal in inequality as the government offers relocates, welfare, retirement allowance, health care, in an effort to reallocate income throughout various stages of income-earning groups. (Else, 2000)

Difference of the Government’s Role in Economics

In the hunt for a more safe, stable, and sustainable world, developing countries search to expand their human, institutional, and infrastructure capability. To do so they require a firm ground of technologically educated people in order to efficiently improve their financial systems and quality of life. Such ground of competent engineers and technologists will assist the infusion of foreign assets through the attraction of transnational corporations to invest in the developing country, help in creating the most of foreign support funds, and offer the source for business expansion by local industrialists. In a synchronized advance, the world community is mounting key attempts at technological capacity creating in developing states.

As for the matters of developing countries, it is necessary to mention, that due to insufficient aggregate demand (entailing private expenditure, government consumption, investment expenditure, and export demand) total output links leading to financial depressions. But the government has economic policy instruments to avoid downturns. Keynes in his researches covered the way out of economic downturns giving a key function to play by the administration through expansionary fiscal strategy (maintained by expansionary monetary policy) in order to encourage production. When aggregate demand increases, production spheres react by accelerating growth momentum. The keynesian financial policy was well-get and widely applied after the 2nd World War.

As Keynes himself expected, these regulations with government interference to raise aggregate demand and to maintain reallocation kept the capitalist market financial systems in the middle of the then Cold War between the USA-led capitalist coalition and the USSR-led socialist camp. It is necessary to give all credit to Keynes for adding a new measurement to a capitalist market financial system that is supple enough to be active. If not for that today’s world would have been a despondent one with stationary socialism overcome the capitalist world comprising the freshly self-sufficient states in the expanding world. (Wilson, 2002)

Another matter is that the worldwide inflationary circumstances, enlarging public expenses in the USA subsequent to the Vietnam War, and the surplus supply of dollars that ultimately led to the collapse of the present exchange rate value in the early 1970s, also permitted developing countries to get higher unit charges for their exports. That defused, to a large level, whatever propensity there was towards dilapidated terms of trade for developing states, which had earlier suggested the theoretical grounds of the import-replacement tactics.

The most significant fact is that the consequences of the oil crisis, first in 1972-73 and then in 1978-79, modified the whole system of worldwide capital streams, as leftovers from oil money hunted for vents of consumption as loans or investment. Lots of developing states were capable to admit international markets at insignificant real interest charges, and in spite of the declining flow of concessional help to developing states, there was an essential rise in the flow of international finances, particularly as loaning funds to these states. The squirt in the flood of foreign direct investment appeared much later, around the 1990s, but the transnational associations that were the key guides of such investment were experiencing essential changes in the origin of their operations. They were turning to be progressively more footloose, with various levels of their activities spread out in various states. Intense opposition among the corporations in the demand and supply of technology as well as of inputs and outputs were decreasing their monopoly leases on these actions. This had permitted several developing states to make use of transnationals to advance their abilities. (Niskanen, 1997)

In retort to the modifications in the worldwide economic surroundings, developing states were progressively more changing their regulations and moving towards globalization. It is after the debt crisis of the early 1980s, nevertheless, that this procedure was accelerated and many developing countries began to adopt programs of reforms that made augmented globalization or integration with the world financial system their stated key aims. By the end of the 1980s, the policy pattern of most developing states had experienced a change, moving from narrow-minded, import-oriented, regulatory administrations to outward-looking, export-promoting market-directed policies. As a result, for most developing states the distribution of foreign trade in GDP, the split of foreign capital in total savings, and all other indicators of globalization kept on growing. By the mid-1990s, several increasing states had almost fully incorporated their trade and expenses systems with the global financial system, making current as well as principal accounts fully adaptable. Others kept some constraints on capital accounts while making current financial credits almost totally exchangeable. Nearly all developing states entered the World Trade Organization (WTO), subjecting them to the regulation of unbiased trade liberalization. Even those states that did not completely open up their trade and payments structures had to accept that whatever constraints they kept would only be temporary and that they would have to regulate in time to the total insinuations of globalization.

Developed countries characteristically have well-arranged markets with personalities and firms changing their behavior in return for price indicators. Markets that counter to changing climate dangers will encourage alteration in the private sector. Adaptation is probable to be most receptive to market indicators in spheres controlled by traded goods, such as farming, woods, and energy. Government action may be necessitated to set up more efficient pricing instruments to hearten more competent use of goods such as water where possessions rights are often badly classified. Insurance offers another important instrument through which market indicators can drive variation. Insurance has a long history of driving risk supervision through pricing jeopardy, providing inducements to reduce risk, and grand risk-related terms on regulations.

By precisely gauging and pricing today’s climate hazards, insurance can help incentivize the first steps towards alteration. The extra cost of indemnity can act as a deterrent to creating high flood risk spheres. Market indicators of these kind-hearted persons or firms to decrease their nowadays risk to weather injure, due to the rate saving connected with taking steps to supervise climate hazards. Encouraging action that recovers society’s pliability to the current climate today should enhance heftiness to climate alteration in the future. Over time supplementary adaptation may be necessitated to deal with longer-term consequences of climate change. (Steiner, 1953)


This paper aimed to study the role of government in the economic growth and performance of a country. As distribution mechanisms for the capitals are supposed to be less efficient, there is a reason to suggest that the role of government is different. This paper has examined the significance of variables classified as probable determinants of expansion in obtainable academic resources. The general ending of the paper is that the ways of government financing issues are more for financial expansion than do government expenditure regulations, as the role of government expenditure for growth is not generally essential. The outline for outflow is similar for both developing and developed states, and the only exception, which is essential, is the complementary effects among public and private capitals that are observed within the developed states.

Regarding the role of government financing, financial income, and the state budget excess are essential classifiers of financial advance.


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