Government economic policy - Essay Example

?Governments all over have targeted goals they want to achieve. These goals, which are referred to as objectives, are not a constant but can change from time to time in keeping with economic circumstances. These objectives are crucial to the welfare of the overall economy, and how they are managed will determine not only the economic prosperity of the nation but also welfare of its citizens. The activities carried out by a government to guide the economy towards achieving these objectives are broadly referred to as its economic policies. The policies of governments can be referred to as macroeconomic policy while the policies of smaller entities like business organizations are called micro economic policies. Both these sets of economic policies have a dynamic relationship with each other and affect each other significantly. Economic Objectives and Policies Traditionally there were four economic objectives that were espoused as standard. These are (1) Full employment or conversely stated low unemployment. (2) Stability of prices (3) A rate of economic growth determined as attractive by the government and (4) Maintaining the Balance of Payments in equilibrium. In its simplest form full employment measures those who are employed out of those who are employable. The actual equation used can differ from measure to measure. The most comprehensive is the International Labor Organization (ILO), which includes into its equation those in their youth and unemployed, women married to husbands who earn an adequate wage though both categories are ineligible for unemployment benefits. Included also are those who are sick and medically condemned. Interestingly they do not include numbers of those who get employed in cyclical or seasonal jobs such as tourism, and fishing and who get an adequate annual wage though employed only for seasons. The attraction in full employment as an economic objective is the potential it provides to maximize production while leading to enhance standards of living. The reverse side of the coin is that it reduces economic and thereby social dysfunctions. Managing inflation to an acceptable level is the objective of price stability. Price fluctuations influenced by inflationary tendencies have a debilitating affect on the economy. It impacts the exchange rate thereby affecting the competiveness of a countries goods and services in the international market. It also makes sound decision making and allocation of resources more tedious. Inflation is measured as the annual rate of change of the Retail Price Index (RPI). When inflation is kept low prices remain stable, which augurs well for all governments. The next objective refers to economic growth. It is deemed as attractive when the rate is both high and can be sustained. The measure used is the rate of change of countries Gross Domestic Product. The effect of inflation has to be negated for it to be an acceptable measure therefore what’s measured is real GDP, which is GDP with the effect of inflation negated. The final of the four traditional objectives is the maintenance of the balance of payments equilibrium. This could also be called maintenance of external stability, which in turn ensures confidence in the international markets of a countries economy. Managing the foreign debt of a country does this. In recent times there are other objectives that have been added on to the macro economy and they have to do with the management of the social and natural spheres through macro economic policy. One such objective is ensuring a more equal distribution of wealth in society and the second is the managing of the environment to endure that economic activity does not adversely affect the environment like the depletion of resources to levels where it cannot be replenished or pollution. Economic policy actions can vary from manipulation of interest rates by a central finance authority such as the Federal Reserve, regulating the expenditure of governments, taxes as well as interventions such as property rights of private individuals. An example of such policies can be considered by the actions of the federal reserve which could initiate “Raising the federal funds rate will dissuade banks from taking out such inter-bank loans, which in turn will make cash that much harder to procure. Conversely, dropping the interest rates will encourage banks to borrow money and therefore invest more freely.” This highlights the fiscal policy of a government, which in turn will influence the economic objective of ensuring and sustaining an attractive level of economic growth. The Effect of Government Economic Policies in business Organizations What has been stated so far can lead to the mistaken notion that governments always act rationally and with the sole intent of achieving its economic objectives. On the contrary governments are often forced to act due to political considerations or due to serious social issues. Either way the government policies impact business organizations in diverse ways. To understand further let us consider government fiscal policy. Fiscal policy refers to how the government uses it’s spending and its taxation to impact the economy. Wherever the government makes decisions on the good and services it will buy, the payment it distributes through transfers, or when it collects additional taxes it is involved in a fiscal policy activity. While any change in the fiscal policy is analyzed in terms of the macro economy it impacts the micro as well. A reduction in taxes for families with children will enhance its disposable income which will alter its spending pattern which will then increase the turnover of companies offering goods and services to this segment of society. “Fiscal policy also changes the composition of aggregate demand. When the government runs a deficit, it meets some of its expenses by issuing bonds. In doing so, it competes with private borrowers for money loaned by savers”(Weil). This can directly impact the housing market. If the returns from the bonds are more attractive than that reaped through the escalation of real estate, people will invest less in houses, which will affect the cash flow of organizations who have begun a project with a quantum of pre sold units with the rest to be sold as the development progresses. This in turn will have a domino affect on sub contractors as well as building material suppliers, mortgage banks all of which are individual business organizations. A Macro policy change has been felt in a range of business organizations as the macro and micro though theoretically compartmentalized, they are practically inter twined. Needless to say that this would effect employment where some will get rendered unemployed or their could be changes in the industries that employ people. All governments closely monitor unemployment trends and changes as they influence societal health in more than economic terms. Types of Unemployment Unemployment is a complex issue an d cannot be completely avoided in market economies where market forces decide which goods and services will be brought and sold and those that will not be. As such decisions are taken the amounts of jobs available in different industries begin to change and results in different types of unemployment, which are detailed below. 1. Frictional Unemployment: The time period in which a person is out of a job searches for another is called frictional unemployment. It is the flux situation caused by people moving between redundant jobs to needed ones. Economies will always have some frictional unemployment. Having organized labor markets, which function effectively, can minimize the effect of this. What is needed is information as to where and when jobs are available. The amount of frictional unemployment is inversely related the development of the economy. 2. Structural Unemployment This type of unemployment results when there is a mismatch between those in the labor market and the jobs that are available. It’s a problem of insufficient or irrelevant qualifications. The drop in the revenue contributed by a person in the labor force can drop below the minimum wage to cause structural unemployment as well. Training which ensures mobility across a range of trades can limit the phenomenon of structural unemployment. 3. Classical or Real Wage Unemployment: Caused by possible trade union action classical or real wage unemployment occurs where wages are higher than the optimum which ensures full employment and cannot be readily reduced. Such conditions are generally long drawn out and can have a medium term negative impact on economies. 4. Demand Deficient or "Cyclical Unemployment" A phenomenon, which occurs during recessionary periods, this type of unemployment is a direct result of a contracting economy where production too contracts’ reducing the need for labor. It can also occur due to technological advances, which makes the need for labor in certain factory processes redundant. 5. Seasonal Unemployment Certain forms of employment can be seasonal. Countries, which have a seasonal tourist season, or seasonal industry like fishing, could be familiar with this type of unemployment. When the tourist season is one more waiters, room service personnel might be needed who are not needed when the season passes. Affects of unemployment Almost all economic theoreticians agree that unemployment left unchecked will adversely affect businesses as well as the economy at large. To businesses, which have spent significant amounts of money in training their staff, unemployment represent wastage of scarce resources, which can otherwise be put to use for the purpose of enhancing profit. Further long lay off periods tend to de-skill those who are currently skilled involving a further training cost. Employees who have been without active engagement for an extended period tend to have low motivation and energy, which is not helpful when re employed. Large unemployment ratio also means that demand for goods and services will dwindle which will then result in further deterioration of turnover and profit to organizations. The non-utilization of scarce economic resources reduces the growth potential of an economy, which further affects direct investment attracted by the said economy. An economy which is experiencing high unemployment is producing goods and services well within its capacity with the consequence of non recovery of work hours that could have been employed being lost. High unemployment also means that taxes that can be collected by the governments reduce forcing governments to borrow more. Such extended periods by virtue of declining incomes and spending, forces poverty to rise as well as income inequality to become more acute. Generally younger workers are more mobile and as such recovery after high levels of unemployment’s see an aging workforce remaining, reducing their ability to quickly snap out of the problem when the economy turns around. There is ample proof that unemployment carries with it severe social and economic costs. They are at their greatest when it is long term and structural. Governments constantly think of ways therefore to overcome such dark periods in the quickest possible time. Different Causes of Inflation Of all factors that affect the objective of price stability there is non so pervasive as inflation. For this purpose developing nations attempt to keep inflation down to single digit levels whereas developed economies are often successful in ensuring it is controlled marginally above zero. By definition the rise in prices that diminishes the purchasing power of economies is called inflation. The most flimsy of reasons for inflation is that which is caused a demand pull as a consequence of governments printing money to overcome political difficulties. Monetarist believe that the fundamental causes of inflation are monetary, especially when the monetary controllers permit an excessive growth of supply as when money is printed beyond that needed to pay for the volume of transactions being produced through the economy. It causes money to demand goods from an economy, which has not grown causing inflationary tendencies. A further demand-pull inflationary possibility is the depreciation of the exchange rate, which increases the price of imports and reduces the foreign price of economies exports.  This results in consumers buying fewer imports, while foreigners can purchase more exports.  Issues in production like the rise in cost of materials or transport, which will drive prices higher causing inflation, can also cause it. This would also be the cause when labor costs increase specially due to political contingencies without the cost of labor being decided by market forces. Government taxation too could be causative as manufacturers raise prices to protect profits which otherwise would be cut by the extra revenue the government has decreed. This would especially be true in goods, which tend to be inelastic like fuel. The key influences that impact inflation can be summarized as follows. Increased average earnings by causing enhanced demand for the same quantum of goods and services is a primary factor. If a rise in productivity is lesser than earnings the result would be inflation again. Another key is the rise in the unit labor costs. Pressure that would lift prices could come from higher import costs. Effects of Inflation One of the primary responsibilities of a Central Bank or Federal Reserve is to control inflation as it is generally seen to be contributive to a plethora of social and economic issues. The impact of inflation can vary according to the degree that it was anticipated. When a period of inflation has been anticipated it is normative for businesses to take preventive action, which will limit its negative impact. Companies tend to alter their prices and financial institutions their interest rates when this occurs. “Forwards Markets” exist for this primary purpose of protecting business through negotiating effective hedging which limit the risk of future inflation. Fuel consumers often purchase their stocks way before they are actually required as a protection against world oil price escalations. Such protective measures are not available to organizations when the inflation had been unanticipated often due to erroneous forecasts of inflation. Inflation can also hurt in non-monetary functions such as business planning. This is because budgeting has become a tedious exercise due to the lack of certainty induced by price inflation as well as cost inflation. This invariably reduces planning capital investments with confidence. Lower levels of investment causes further negative effect on the growth potential of the firm. As an economy if one country has more adverse inflation than its competitors it loses its international competitiveness, which spirals out to a further deterioration of the balance of payments and trade performance. Market share can be lost after years of development. As such most economies believe that price stability is fundamental to economic growth and spend enormous time and effort in guiding their level of inflation. Effects of International Trade on business Organizations With the integration of the world economy in recent years the effect of international trade and of rapid development in communications on businesses have become extremely important. Business decisions today have to be taken in real time based on the contingencies in China or in the Middle East. Information on global markets have been reduced and can be fitted into a single sheet causing stock decisions to be taken as events unfold in producing countries thousands of miles away. Further market forces that govern supply demand and prices for a product are no longer intra state. With rapid development in transportation global forces impact prices of goods and services even if the whole of it is produced within a particular country. Industries have had to close down in many countries due to cheaper imports from countries like China. Due to non-tariff barriers production centers for consumer durables are changing from developed economies to producing them within the country for which it is intended provided the markets are large. Off shore customer service centers are reducing the costs of customer service resulting in jobs being transferred out of countries. The effect on business organizations has still not been fully realized as yet. There is no longer the possibility to have a settled business strategy, as the scenario is that of rapid change. Businesses would have to come up with strategies and solutions, which are designed for quick changes even of large-scale production facilities. An option is to develop conglomerates, which incorporate suppliers, manufacturers as well as retailers so that loyalty is built into them. Market knowledge of both materials and finished products has to be top notch in order to be ahead of developments. Timely information with efficient decision-making ability will have to be the coveted asset for organizations, as international business becomes the norm of almost everything. Citations Weil, David. Fiscal Policy, The Concise Encyclopedia of Economics 2nd Edition http://www.econlib.org/library/Enc1/FiscalPolicy.html of 27/9/11 Read More