How do governments impact the economy?

Taxes, welfare, immigration, conflicts - all types of government policy have big implications for the economy. And they affect almost everything in the lives of everyday people - from housing and employment to the price of food. For better or worse.

We interview the world’s leading economists to discover the real power of politics within the world’s financial system.

"We’re all responsible for the policies our governments make, and the better informed we are, the better our governments will perform. So, I suggest we all become better citizens."

The problem with politicians: they’re only human

Talking of becoming better citizens, Nobel Laureate James M. Buchanan pioneered a new field of economics called 'Public Choice'. He was the first to realize that, unfortunately, politicians are only human, with flaws that can muddle their decision-making. But economic models had never taken this into account, which explains why politics sometimes didn’t work out as predicted.

"The science of economics should teach us not only how to increase the wealth of all of us, but to share the wealth more equally than we do.”“[Politicians are] motivated like the rest of us: sometimes by their own private interests, sometimes by the public interest. That gives you a feel for why the political structure sometimes doesn’t work as perfectly as predicted."

Considering the powerful self-interests that drive us all, how much freedom should politicians have? He dedicated his life’s work to finding the answer.

How can governments work more effectively?

With these imperfect humans at the helm, Nobel Laureate Finn E. Kydland explored ways in which governments can make better decisions. He realized that policies with long-term commitment are key. The problem? It’s almost never in the interests of politicians to make them.

"If the government finds itself in an emergency situation, they will have an incentive to focus more on the short run and abandon the continuation of their policy, which is very bad for society."

Policy often forgets the poor

Politicians in governments have to cater for a wide range of people with vastly differing needs. So is it ever possible to help everyone? Governments generally want ‘just enough’ growth - not so much that inflation gets out of control, and not so little that the economy grinds to a halt. They can raise or lower interest rates to control it, but when rates get too low, central banks often pump cash directly into the economy to compensate. This is known as quantitative easing. But who really benefits from these efforts? According to Nobel Laureate Joseph E. Stiglitz, it’s always the rich, and almost never the poor.

"It basically floods the economy with liquidity. In fact, investment is lower, which props up stock prices. And who wins when the stock price goes up? Those who own the shares. Who is that? The people at the top. What about the poor retirees depending on government bonds for their retirement? Their interest rates have gone down. This is a policy that has not led to more growth but more inequality."

So what can governments do to help the poor?

There are promising long-term solutions out there. Nobel Laureate Edmund S. Phelps is a fan of subsidies to low-wage jobs.

"I’m trying to figure out what it’s like to be in the working poor; what they want in life and what satisfactions they’re getting."

Based on his research, he argues that these employment subsidies would encourage companies to hire more low-wage people and up their wages. Is it just a pipe dream? Or the next welfare revolution?

The basic income debate

But wait, there’s more. What if there was a way to guarantee a basic income for the less fortunate? Nobel Laureate Paul R. Krugman supports the idea. He believes people shouldn’t just be able to merely survive on their income - but live. With redistribution and taxes, governments could give a salary to the less fortunate, paid for by taxes of the more fortunate.

"There’s no evidence that countries that do this pay any real price."

How can governments create a better future?

According to Nobel Laureate Robert F. Engle, debt and government go hand in hand. And when the government borrows money, it’s not just investing in buildings and land, it’s investing in the future. But when interest rates are so low, should the global economy be spending its resources trying to repay debt? Engle doesn’t think so.

"Does the next generation really want to inherit a country that has let its roads fall apart and its bridges fall down but has no debt? That’s not what the next generation wants. It wants to have a vibrant economy where the debt is more or less managed as a proportion of the output."

Should we worry about an international debt crisis?

With this issue never far from our collective worries, should we expect a repeat of the economic problems of the past? According to Nobel Laureate Sir Arthur Lewis: Yes. But we shouldn’t necessarily be afraid.

"In the 1840s and 1870s there were huge international debt crises. They are the things that we live with… So you don’t need to think that because of a crisis last year, and the year before that, the world will end or the economic system will fall down - it’s not like that."

Is austerity the answer to market failure?

Let’s take Southern Europe, which has had a complete market failure, accompanied by a spike in unemployment. Nobel Laureate Sir Christopher A. Pissarides believes the policy that tipped the region into crisis is similar to the one that led to the Great Depression.

"The institutions that could provide funding for Greece insisted on wage cuts, spending cuts and pension cuts by the government, that effectively reduced the level of demand in the economy. Once you reduce the demand, there’s no incentive for anyone to invest. There’s no incentive for producers to carry on producing at the same rate, because there’s no demand. Therefore, there was a big shock on the demand side; that reduced demand so much, the supply side came down as well, and therefore there is no job creation in the country."

Is foreign aid a waste of money?

There will always be countries in need of aid. Unfortunately, sometimes those countries are ruled by bad-acting governments, and financial support sent from ‘rich’ nations never reaches the people it’s intended for. In these cases, it simply lines the pockets of those in power. It can even help manufacture dictators.

As Nobel Laureate Sir Angus Deaton explains in this film, there are better ways to help those in need if we’re really serious about making the world a better place.

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