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.

Are our voting systems democratic?

In Europe, the Brexit vote is an example of the voices of a generation not being heard. Seventy-five percent of young people in the UK voted to remain in the EU*, and yet, as a result of the voices of older people, the country is to leave the Union.

Nobel Laureate Eric S. Maskin suggests that our voting systems may need to be reformed to make them more democratic. Citing the US presidential election in 2000, he says that if the third candidate had not been on the ballot in Florida, a different president could have been sworn in. This he says, is the problem with plurality rule.

Maskin believes that we all have a duty to hold our governments to account:

"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."

Even democracy comes with problems: politicians are 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.

“[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 (and politicians) 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."

Should the state be hands on or hands off?

One of the key political debates across the world is how involved the state should be in the lives of its citizens. What should it provide? What should be the individual’s responsibility? And of the things it should provide, how much should be outsourced to the market? Nobel Laureate Oliver S. Hart’s work has influenced the US Government’s policy, and his framework for incomplete contracting shows us that there’s a world of difference between outsourcing garbage collection and something more serious:

“Could you imagine governments outsourcing foreign policy, contracting to carry out diplomacy?”

How can governments create a better future?

Nobel Laureate Robert F. Engle III believes that 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 be worried about levels of government debt?

Edward C. Prescott is another Nobel Laureate who doesn’t believe that governments should be solely focusing on debt-clearance. While he doesn’t say what an ideal level of public debt is, he’s certain of the number it shouldn’t be – zero. Talking about the USA, he says:

“Now we have a lot of old people, we need a lot of government debt. People live longer, and have longer retirements. There should be a huge amount of government debt. Something like six times annual GNP.”

As populations age, government spending on things like social security and pensions increase. This means societies should have debt, as they’re paying for their elderly citizens rather than clearing debt – something that Prescott has no problem with.

Is austerity ever the answer?

Southern Europe has experienced complete market failure, accompanied by a spike in unemployment. Nobel Laureate Sir Christopher A. Pissarides believes that austerity policies have tipped the region into a crisis 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.”

As Sir Christopher explained, the shock of austerity lead to a collapse in job creation in the country. Austerity may not be the answer to a country’s woes.

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Will the world always be this unpredictable?

The only certainty in our world is uncertainty. In our Life’s Questions series, we look at how to prepare for the future in a time when everything from global politics to technology is undergoing enormous transformation.

"Artificial Intelligence will change the way we do things in a big way. And we have to prepare our next generation with the right skills."

Janneke Niessen
Chief Innovation Officer and Co-founder of Improve Digital

More questions shaping our world

Equality

Why is it that equality is still so elusive, while inequality is seen as normal and almost inevitable?

Technology

We’re living in a time of rapid technological development. What impact will this have on our lives?

Employment

The nature of employment is changing, how do we prepare for jobs that don’t exist yet?

Society

How can we make sure that all aspects of our society work for everyone?

Investing

Why should we save, is it possible to invest without risk, and how can we all make the most of our finances?