The Role of Government in the Economy

1. The Role of Government in the Economy Topic 3 The UK Economy (Macroeconomics)

2. Economic Systems REVISION (Pg 41-44 – The UK Economy Topic 2) • Basic Economic Problem • 3 types of Economy • Command • Market • Mixed

3. SUMMARY OF THE GOVERNMENT’S ROLE IN THE UK ECONOMY • 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 incomee.g. Tax & Benefits

4. INCREASING ROLE OF THE PRIVATE SECTOR Topic 3 The UK Economy (Macroeconomics)

5. PRIVATISATION • 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.

6. METHODS OF PRIVATISATION • Stock Market Flotation – became PLC’s. E.g. British Airways and British Telecom. • 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 • Private Sale– assets are sold to a single buyer. E.g. Rover to British Aerospace and then BMW. Also council houses to tenants.

7. Other Methods CONTRACTING OUT • Services that were normally provided by local government such as school cleaning, are contracted to private 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.

8. AIMS OF PRIVATISATION • To improve efficiency • Technical efficiency - competition will help cut costs and improve quality. • Allocativeefficiency - 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.

9. 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.

10. PROBLEMS with 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.

11. 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

12. GOVERNMENT CONTROL OF PRIVATISED INDUSTRIES • 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

13. FORMS OF REGULATION • 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.

14. PUBLIC SECTOR EXPENDITURE Topic 3 The UK Economy (Macroeconomics)

15. TYPES OF PUBLIC SECTOR SPENDING • 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.

16. PUBLIC AND MERIT GOODS • 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.

17. TRENDS • 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.

18. WHY CUT PUBLIC SPENDING? • 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.

19. WHY NOT 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.

20. TAXATION Topic 3 The UK Economy (Macroeconomics)

21. DIRECT TAXES • 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

22. INDIRECT 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

23. WHAT MAKES A GOOD TAX? Adam Smith laid down 4 principles (canons) of a good tax. • Equity – should be related to ability to pay • Efficiency – taxes should be reasonably inexpensive to collect • Certainty – taxpayer should be clearly aware of how much is due, when and where • Convenience – taxes should be payable at a time and place that suits the payer.

24. PROGRESSIVE AND REGRESSIVE TAXES Progressive Tax • Takes 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.

25. TRENDS IN TAXATION • 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.

26. INCOME TAX Case for Cuts Case Against Cuts Tax 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 • Tax 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

27. PUBLIC SECTOR NET CASH REQUIREMENT Topic 3 The UK Economy (Macroeconomics)

28. PSNCR • 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.

29. THE BUDGET & National Debt BUDGET • This 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 DEBT • This 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.

30. PROBLEMS WITH A HIGH PSNCR • 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

31. UK TRENDS (see notes) • Notes are outdated (1992 – 2000!) • After reading your notes compile a trends report from 2000 onwards.

32. GOVERNMENT ECONOMIC OBJECTIVES Topic 3 The UK Economy (Macroeconomics)

33. ROLE OF THE GOVERNMENT • 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.

34. OBJECTIVES MICROECONOMICS MACROECONOMICS To achieve economic growth To achieve low and stable inflation To reduce unemployment To keep the Balance of Payments in balance. • To prevent market failure • To distribute income and wealth more fairly • To reduce regional disparities.

35. RECONCILING CONFLICTING 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