15: Economic and Environmental Policy Contributing to Prosperity

Government as Regulator of the Economy Economy: a system of production and consumption of goods and services allocated through exchange The Wealth of Nations (1776), Adam Smith Advanced the doctrine of laissez-faire economics Demand guiding supply: the “invisible hand” Acknowledged that laissez-faire capitalism has limits Need for regulation of banking, currency, and contracts Today’s mixed economy

Efficiency through Government Intervention Promoting competition: Free market argument for economic efficiency Markets are not always competitive Price fixing, monopolies etc. Federal Trade Commission and other agencies provide oversight Deregulation and underregulation: Regulation is intended to increase economic efficiency Overregulation has been curbed with deregulation Deregulation carried too far: the 2008 mortgage crisis Dodd-Frank Wall Street Reform and Consumer Protection Act

The Subprime Mortgage Crisis The subprime home mortgage crisis triggered the near collapse of the financial sector in 2008. Financial regulations had been reduced to allow banks to grant mortgages to a wider range of borrowers. By 2006, a third of mortgages were being given to people with weak or unconfirmed credit records. When the economy went into a severe downturn, banks found themselves in possession of millions of empty houses.

Equity through Government Intervention Economic equity: a transaction fair to each party Equity regulation has come in waves First wave: the Progressive Era, early twentieth century Sought to stop corrupt business practices Food and Drug Administration founded, 1907 Second wave: New Deal, 1930s Sought to restrict destructive business practices Investor and organized labor protections; minimum wage Third wave: 1960s and 1970s Environmental and consumer protections; worker safety Unsafe products: cigarettes; leaded paint and gasoline

Table 15-1 The Main Objectives of Regulatory Policy Definition Representative Actions by Government Efficiency Fulfillment of society’s needs with as few of its resources as possible. The greater the output for a given input, the greater the efficiency. Preventing restraint of trade; requiring producers to pay the costs of environmental damage; regulating business only when justified on a cost–benefit basis. Equity Ensuring that the outcome of an economic transaction is fair to each party. Requiring firms to treat workers and consumers fairly.

The Politics of Regulatory Policy Progressive Era and New Deal regulatory agencies were charged with overseeing particular industries Industry opposition diminished as regulated industries began to influence agency regulators in their favor Most newer agencies were granted a broader mandate Regulate an activity across a variety of industries No single industry can easily influence their decisions President’s discretion in installing and removing agency heads has led them to be more responsive to the president than to the firms they oversee

Government as Protector of the Environment Externalities: the unpaid costs of business activity Before the 1960s, the federal government did not require firms to pay to reduce externalities Silent Spring helped launch the environmental movement and inspired new legislation 1963 Clean Air Act 1965 Water Quality Act

Environmental Protection Environmental Protection Agency (EPA), 1970 Responsible for enforcing environmental law EPA moved quickly to issue a wide range of regulations Business criticism and a sluggish economy halted support for more regulation Today’s emphasis is on enforcement of the laws put in place in the 1960s and 1970s Regulation has led to dramatic improvements in air and water quality

Global Warming and Energy Policy Global warming receives more attention today than any other environmental issue Scientific consensus: greenhouse gas emissions are to blame; and the result will be water shortages, rising sea levels, and extreme heat waves There is a lack of consensus among U.S. policymakers Most policy efforts have been stymied Some success: Energy Independence and Security Act U.S. lags behind in greenhouse gas reduction efforts No single nation can solve the problem on their own Complicated by the expansion of developing nations

Figure 15-1 Average Temperature of the Earth’s Surface The average surface temperature of the earth has risen substantially in the past century and has done so at an accelerating pace in the past three decades. Source: National Weather Service, Great Britain, 2014.

Carbon-Fuel Emissions and Global Warming Data from the European Commission indicate the five leading sources of carbon-fuel emissions account for two-thirds of the world’s total.

Government as Promoter of Economic Interests United States has a long history of promoting its economic interests Tariff on goods brought into the U.S. on foreign ships, 1789 Importers switched to a greater reliance on American ships Support continues today for a variety of interests

Promoting Business Financial support and tax policy Government-provided loans Special tax breaks Subsidies Most significant contribution is in the traditional services government provides Public education Transportation infrastructure National defense

Promoting Labor National Labor Relations Act of 1935 Protects union activities and workers Today’s additional support Minimum wage Maximum work week Unemployment benefits Nondiscriminatory hiring practices Government support of labor is much less extensive than its support of business

Promoting Agriculture Homestead Act of 1862 Today more than 20 percent of net agricultural income comes in the form of federal payments American farmers are among the most heavily subsidized Subsidies are intended to reduce market risks and stabilize farm incomes

Fiscal Policy as an Economic Tool Until the Great Depression, the prevailing economic theory held that the economy was self-regulating Economy did not recover but continued to contract FDR used government spending to stimulate the economy Today, government is expected to intervene when the economy slows Fiscal policy: the government’s taxing and spending decisions

Demand-Side Policy Keynesian economic theory: Demand-side economics: emphasis on the consumer (demand) component of the supply–demand equation Increase government spending to alleviate economic depression or recession Economic depression: an exceptionally steep and sustained decline in the economy Economic recession: less-severe downturn Generally preferred by Democratic lawmakers Can result in higher budget deficits and an increased national debt

Figure 15-2 Demand-Side Economic Stimulus When the economy is sluggish, demand-side economics holds that government should increase its spending in order to boost consumer spending (demand), which will create jobs and stimulate production (supply).

Supply-Side Policy Supply-side economics: emphasis on the production side of the supply-demand equation Tax breaks for firms and upper-income individuals, intended to encourage business investment with resulting increases in employment and income Generally preferred by Republican lawmakers Can result in higher budget deficits and an increased national debt

Figure 15-3 Supply-Side Economic Stimulus When the economy is sluggish, supply-side economics holds that government should cut taxes on business and wealthy taxpayers in order to boost investment in production (supply), which will create jobs and increase consumer spending (demand).

Fiscal Policy: Practical and Political Limits Both economic models have benefits and drawbacks Stimulate the economy, but always with a cost Annual budget deficit: the federal government spends more in a year than it receives in tax and other revenues Increased national debt: the total the federal government owes to its creditors Last balanced budget was in the late 1990s National debt exceeds $19 trillion Interest payments: 15 percent of the annual budget Each political party blames the other

Figure 15-4 Increase in National Debt under Recent Presidents The national debt, which is the total cumulative amount the federal government owes to its creditors, jumped under Presidents Bush and Obama, owing to overly steep tax cuts, wars in the Middle East, and the severe economic downturn that began in 2008. The debt burden could limit future administrations’ ability to apply a supply-side or demand-side stimulus in response to a recession. Source: Federal Reserve.

Federal Taxes and Benefits: Winners and Losers Fiscal policy varies in its effect on the states, as data from the Tax Foundation indicate. This map categorizes the tax-to-spend ratio of each state—that is, the amount of taxes paid compared to the amount taxpayers get back in federal spending in their state. Jump to long image description

Monetary Policy as an Economic Tool Monetary policy: based on adjustments to the amount of money in circulation Monetarists contend the money supply is the key to a healthy economy Supply and demand are best controlled by the money supply Federal Reserve Act of 1913 created the Federal Reserve System (“the Fed”), which controls the money supply

The Fed Tools of the Fed: Fed essentially has the power to print money Control over the money supply Raise/lower the cash reserve required of member banks Raise/lower interest rate on member banks To fight an economic downturn Decreasing the interest rate on loans to member banks Lowering the reserve rate Buying government securities (bonds, notes, etc.) Quantitative easing: buying assets from member banks Fed essentially has the power to print money

Table 15-2 Monetary Policy: A Summary of the Fed’s Policy Tools Description Reserve Rate Amount of their assets that member banks must keep on hand. The rate can be lowered to increase the money supply or raised to decrease it. Interest Rate Interest rate charged to member banks when they borrow from the Fed. The rate can be lowered to increase the money supply or raised to decrease it. Buying of Securities By buying securities, the Fed gives money to the seller, which increases the money supply. By selling securities, the Fed receives money from the buyer, which decreases the money supply.

The Fed and Control of Inflation Inflation: increases in the average level of prices of goods and services while wages stagnate Impact of inflation rate of 13 percent in 1979 was substantial To fight inflation, the Fed reduces the currency in circulation Increasing the interest rate on loans to member banks Raising the reserve rate Selling government securities (bonds, notes, etc.)

The Politics of the Fed Fed has the ability to react relatively quickly Created before monetary theory existed, the Fed’s prominent role could not have been predicted Questions have been raised about the power it wields Whose interests does the Fed actually serve? To whom is the Fed accountable? Fed is part of the new way of thinking about the federal government’s role in the economy that emerged during the Great Depression

Critical Thinking Define economic efficiency and economic equity. Provide an example of a regulatory policy aimed at achieving economic efficiency. Also provide one that has economic equity as its goal. Contrast demand-side economics and supply-side economics in terms of theory, government policy, and partisan politics. What are the tools of monetary policy? How are they applied to deal with an economic recession? How are they applied to deal with high inflation?

Long image descriptions Appendix A

Federal Taxes and Benefits: Winners and Losers Appendix The “winners” are Alabama, Alaska, Kentucky, Louisiana, Mississippi, New Mexico, North Dakota, South Dakota, Virginia, and West Virginia. These states receive $1.50 or more in federal spending for every dollar they pay in federal taxes. States that receive $1.10 to $1.49 for every dollar include Arizona, Arkansas, Hawaii, Idaho, Iowa, Kansas, Maine, Maryland, Missouri, Montana, Nebraska, Oklahoma, South Carolina, Tennessee, and Wyoming. States that receive 80 cents to $1.09 for every dollar include Colorado, Florida, Georgia, Indiana, Massachusetts, Michigan, North Carolina, Ohio, Oregon, Pennsylvania, Rhode Island, Texas, Utah, Vermont, Washington, and Wisconsin. States that receive 79 cents or less for every dollar include California, Connecticut, Delaware, Illinois, Minnesota, Nevada, New Hampshire, New Jersey, and New York. Jump back to slide containing original image