In the 18th and 19th centuries, famous economists such as David Ricardo and Adam Smith agreed to the existence of an invisible force within the market. Markets only relied on deciding prices for resource allocations and meeting the demands for rations. Their decisions were usually based on self-interest only. They did not require any active government interventions beyond the provision of law and order.
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Gradually with the passage of time, many complications started forming while handling smooth functioning of markets. The major problem was of scarcity of resources which were in high demand. To eliminate this issue, the economists and other professionals emphasized on the unregulated interactions between the financial institutions and government (Pettinger, 2012).
Economists believe that there is a very limited role of government in economic affairs. In any market economy, most of the economic decisions are made by the individual buyers and sellers, but not by the state. Residents of the country and political leaders do not agree to this statement. According to their view, the government interventions increase when the market functions have expanded. In such situations, the government is expected to perform a large variety of activities.
There are many advantages of government intervention such as even income distribution, no social injustice, secured public goods and services, property rights and welfare opportunities for those who cannot afford. Whereas, according to some economists the government intervention may also result in few disadvantages. Unnecessary goods may be produced as the government may not be much well aware about the needs and wants of their people. There may be social gap between the rich and poor because of uneven income distributions (Low, Nend, 2011).
HOW GOVERNMENT CAN MAKE MARKETS TO FUNCTION BETTER
Most markets function smoothly because of the effectiveness of unregulated markets and Adam Smith’s unseen force. There are numerous highly differentiated goods and services which are available for the consumers. Financial institutions such as firms and banks are linked together with a highly sophisticated and complicated system of investments, distribution and production chains.
There are four different types of government institutions which are operating in almost every country to facilitate their people. Firstly, there are market-enabling institutions which help economic agents to manage conflicts, to secure property rights and to help in recognizing their own rights and duties towards customers. They help in sticking to long term contracts and avoid any kind of disputes. Secondly, the market-regulating institutions keep an eye over market players who are misusing their market power and ensure a healthy competition among firms to control any firm from being the monopolist. They also improve the market prices and make sure that they reflect the correct costs and benefits for both the buyer and seller. Thirdly, the market-stabilizing institutions are the independent banks working in the economy. The governments’ central bank will serves as the lender of last resort so it may avoid banking crisis in difficult situations. Another role for these institutions is to stabilize the state’s contribution towards the macroeconomic activities (Pettinger, 2012). Lastly, the market legitimizing institutions boost up and sustain the public support for market economies. They sort out and reorganize income and provide social insurances. They are also a vital source of social stability in the economy. They encourage firms for long-term developments as they want to facilitate economic development for their residents.
ECONOMIC FUNCTIONS OF THE GOVERNMENT
What would happen if there were no regulations regarding enforcement of business contracts? And what if there were no social welfare programs to facilitate low income people with free medicines and food? There should be a control over the prices which everybody pays for goods and services. For smooth functioning of the society and economy, it is necessary that the government steps in (Robert, Kelly, 2012).
REGULATE LEGAL AND SOCIAL FRAMEWORK
The government helps ensuring the legal contracts which are implemented through a proper law regulatory body. This will help in the accountability purpose for all business persons involved in a firm. It also ensures that when a customer purchases something, there are some rights involved in it.
There are a number of competitors working together in a market. Such a market economy is known as ‘perfect competition’ where everybody sells almost similar products with a little variation in prices. The government’s role is to ensure that all competitors are able to compete and offer similar products and services to its customers (Aaron, 2010).
There are often gaps amongst social classes in the capitalistic economies. It results due to the uneven distribution of incomes. To overcome this problem, the government uses the progressive tax techniques where the consumers are required to pay taxes according to their income levels. Besides this, it is the government’s duty to provide housing, medical services, employment and food programs to help those who are in need.
PROVIDE PUBLIC GOODS AND SERVICES
Another duty of the government is to provide national parks, prisons, transportations and public schools. All these are under the government’s control rather than private businessmen.
Externalities refer to the consequences of business decisions which may affect other people, even though they had no control over the business decisions. The government sets regulations regarding ensuring the regulations to control pollution and waste materials.
PRINCIPLES OF EFFECTIVE GOVERNMENT INTERVENTION
Few basic principles need to be followed by the government institutions while designing policies and making decisions regarding market operations. These shall help in economic development. They are discussed below briefly (Aaron, 2010).
Sometimes, the government makes wrong decisions. It is necessary that the state takes under consideration that they are expected to improve market outcomes rather than destroying it.
PRAGMATIC AND LEARNING-BY-DOING APPROACH
With the passage of time there may be changes in the technologies, socio-economic and political conditions. Due to these changes, the requirements for government interventions will also change. Any problem area in the past which required special attention will no longer need it now due to the environmental changes (Robert, Kelly, 2012).
The government in control should support the proper functioning of markets and prefer to use the price-based interventions. They give incentives for people to spend less on resources which may be depleted soon. They can also consider some externalities for creating them.
SHOULD GOVERNMENT INTERVENE IN THE MARKET FUNCTIONS?
One of the major concerns to the economists is the limitations involved in government interventions in the market economy. According to the economists in a free market economy, there should a highly strict government intervention because otherwise it may lead to inefficient allocation of resources. But according to some other economists, they forcefully emphasize on the importance and need of government interventions in different economies (Pettinger, 2012)
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The economists who are in the favor of government interventions in a market give various reasons like there may be a greater equality among various social classes due to income re-distribution and improved opportunities for everyone. The government may provide incentives or subsidies to firms that meet their standards. Otherwise they may take their flaws into consideration which may result in market failures. It is necessary that governmental agencies are well aware of market situations such as inflations, excessive periods of recessions or unemployment.
Whereas on the contrary, the economists who do not favor the government interventions, they support their arguments by saying that it is not true to say that the government will always make the right decisions. It is also expected to make mistakes and wrong decisions if there is some kind of pressure by political parties. They may spend on unnecessary and ineffective projects. There is no personal freedom involved in making decisions regarding how to invest and how to save. Economic interventions by the government may take this liberty away from business entities. The key players within the industry will be well aware regarding the needs and wants of their customers so they can decide it better about how, what and when to produce.
CAN MARKETS FUNCTION EFFECTIVELY WITHOUT GOVERNMENT INTERVENTIONS?
Although it is a very rare situation that a market economy may have little or no governmental control, but such an economy is then based on supply and demand forces. It is known as a ‘free market economy’. All business entities are operating solely for their own self-interest and profit gains. There may be a unfair income distribution among residents, social injustice among social classes, no concern regarding public institutions and lack of welfare facilities. For this purpose, it is necessary to have some governmental interventions in the market economy (Low, Nend, 2011).
There has been no such society in the history of mankind where there was complete absence of state interventions. Even in the cases of most extreme open-minded and liberal economists, they have accepted at some points that there needs to be government’s protection of property rights; public goods and services, national defense system and price controls. Then, later on the debate begins about the extent up to which the government’s intervention may be permissible. This concludes that intervention is necessary and may be in any form. But it may differ from one market economy to another.