ECONOMIC POLICYMAKING CHAPTER 17, Government in America

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1 ECONOMIC POLICYMAKING CHAPTER 17, Government in America Page 1 of 6 I. GOVERNMENT, POLITICS, AND THE ECONOMY A. In the United States, the political and economic sectors are closely intermingled in a mixed economy, where the government, while not commanding the economy, is still deeply involved in economic decisions. 1. The United States operates under capitalism an economic system in which individuals and corporations own the principal means of production, through which they seek to reap profits. 2. Yet the American system is not one of pure capitalism; it actually has a mixed economy a system in which the government, while not commanding the economy, is still deeply involved in economic decisions. 3. Americans also draw sharp distinctions between our economy and the world economy. Our new economy is also an international and global economy. Government and the economy in the United States have always been closely linked. 4. Multinational corporations businesses with vast holdings in many countries such as Disney, Coca-Cola, and Microsoft dominate the world s economy. B. A look at Wal-Mart illustrates two key points. 1. The government s long arm of regulation affects Wal-Mart, as it does the hundreds and thousands of other U.S. companies. 2. Wal-Mart epitomizes the imbedding of the U.S. economy in the global economy, a trend that will continue to have an enormous impact upon the domestic economy and the politics of economic policy. 3. Labor issues, including the right to a minimum wage, the right to join a labor union, and the right to engage in collective bargaining are all central issues to Wal-Mart employees. C. Studies by political scientists have reaffirmed Harry S. Truman s observations about voters and their pocketbooks. 1. Policymakers worry constantly about the state of the economy, and voters often judge officeholders by how well the economy performs. 2. Traditionally in American politics, Democrats stress the importance of employment, while Republicans are worried about inflation. This reflects their constituencies. D. Measuring how many and what types of workers are unemployed is one of the major jobs of the Bureau of Labor Statistics (BLS) in the Department of Labor. 1. No one questions using a survey to determine the unemployment rate, but some economists do challenge the BLS s definition of this rate (the proportion of the labor force actively seeking work but unable to find a job). E. The problem of inflation is the other half of policymakers regular economic concern. 1. The Consumer Price Index (CPI) is the key measure of inflation. 2. The dawning of 2008 brought a worldwide surge of inflation, which directly affected the United States. II. POLICIES FOR CONTROLLING THE ECONOMY A. The impact of government on the economic system is substantial, but it is also sharply limited by a basic commitment to a free enterprise system. 1. When the stock market crash of 1929 sent unemployment soaring, President Herbert Hoover clung to the laissez-faire principle that government should not meddle with the economy.

2 III. Page 2 of 6 2. In the next presidential election, Hoover was handily defeated by Franklin D. Roosevelt, whose New Deal experimented with dozens of new federal policies to put the economy back on track. 3. Government has been actively involved in steering the economy since the Great Depression and the New Deal. 4. The American political economy uses two important tools to guide the economy: monetary policy and fiscal policy. B. Monetary policy and the Fed 1. Monetary policy involves the manipulation of the supply of money and credit in private hands. a. An economic theory called monetarism holds that the supply of money is the key to the nation s economic health. b. Monetarists believe that having too much cash and credit in circulation generates inflation. 2. The main agency for making monetary policy is the Board of Governors of the Federal Reserve System (otherwise known as the Fed ). a. Created by Congress in 1913 to regulate the lending practices of banks and thus the money supply, the Federal Reserve System is intended to be formally beyond the control of either the president or Congress. b. The president appoints its seven-member Board of Governors (subject to Senate confirmation) for 14-year terms a length of time designed to insulate them from political pressures. The general finding is that the Fed actually is responsive to the White House, but at times the chief executive can be left frustrated by the politically insulated decisions of the Fed. 3. The Fed sets discount rates for the money that banks borrow from the Federal Reserve banks; by raising or lowering the rate that banks pay, these increased (or decreased) costs will be passed on to people who take our loans and thus will affect the amount of money in circulation. a. The Fed can also exercise control over the money supply by buying and selling government securities in the market (open market operations), thereby either expanding or contracting the money supply. C. Fiscal policy: Keynesian versus supply-side economics 1. Fiscal policy describes the impact of the federal budget taxing, spending, and borrowing on the economy. 2. Fiscal policy is shaped mostly by Congress and the president. 3. Whether bigger government or smaller government best ensures a strong economy has become the central issue in economic policymaking. 4. On the side of big government, Democrats lean more toward Keynesian economic theory, which holds that government must stimulate greater demand, when necessary, with bigger government (such as federal job programs). 5. Many Republicans advocate supply-side economics, which calls for smaller government (such as tax cuts) to increase the incentive to produce more goods. a. Rather than public works programs to stimulate demand, Americans received tax cuts under President Reagan and President George W. Bush to stimulate supply. WHY IS IT HARD TO CONTROL THE ECONOMY? A. Some scholars argue that politicians manipulate the economy for short-run advantage to win elections, but no one has shown that decisions to influence the economy at election time have been made on a regular basis. B. Managing the economy is more difficult than many politicians (and citizens) believe.

3 IV. Page 3 of 6 1. Politicians and even economists do not understand the workings of the economy sufficiently well to always choose the correct adjustment to ensure prosperity. 2. Most policies must be decided upon a year or more before their full impact will be felt on the economy. 3. The American capitalist system presents a restraint on controlling the economy: because the private sector is much larger than the public sector, it dominates the economy. 4. The increasingly interdependent world activities of other nations can interfere with the American government s economic plans. 5. Fiscal policy is hindered by the budgetary process: most of the budget expenditures for any given year are uncontrollable. 6. Economic policy in the United States is decentralized: the president and Congress may not agree upon taxes or spending, and neither may agree with the Fed. POLITICS, POLICY, AND THE INTERNATIONAL ECONOMY A. Americans live in a global economy. 1. The United States imports more than it exports, leading to a gap in the balance of payments. 2. It is even more difficult for policymakers to control the global economy than it is for them to control the U.S. economy. 3. The U.S. economy depends upon international trade for its survival. 4. Globalization has become an issue dividing international institutions and governments on the one hand and protesters on the other. B. Most emerging economies want to follow an economic policy of protectionism, letting their own fragile economies grow, while keeping out products from other countries. 1. In the late 18 th century, Alexander Hamilton favored protectionism and supported tariffs, or taxes upon foreign products imported into the United States. 2. For most of the nineteenth century, the tariff was a major source of federal revenues. 3. For two centuries, economists have been virtually united against tariffs and protectionism. 4. Politicians, however, are fearful that free trade will results in job loss among their constituents. C. After World War II, the world s governments moved slowly but steadily toward free trade and the reduction of tariffs. 1. Democrats, who depended upon union votes, found it harder to support free trade than did Republicans, whose business supporters wanted new markets. 2. President Bill Clinton overcame the resistance of unions and some other Democrats to pass the World Trade Agreement Treaty, creating the World Trade Organization, which promotes free trade and punishes protectionist restrictions. 3. Unions feared that free trade would lead to a loss of jobs, as more jobs would move overseas. 4. Jobs are also gained from foreign trade. A new surge of technology employment in the United States may result from the explosion of international trade. 5. International trade almost certainly creates long-term gain. It may also create short-term pain. Politics is often about the short run. V. ARENAS OF ECONOMIC POLICYMAKING A. Economic interests far outnumber any other kind of interest groups.

4 Page 4 of 6 1. Liberal or conservative, most interest groups seek benefits, protection from unemployment, tax breaks, or safeguards against some other economic evil. 2. Business, consumers, and labor are three of the major actors in, and objects of, government economic policy. B. Americans have always been suspicious of concentrated power, whether in the hands of government or business. In both the old economy and the new, government policy has tried to control excess power in the corporate world. 1. Corruption and concentration of economic power are two major concerns of government regulation. a. The corruption scandals of the 21 st century followed a binge of corporate concentration in the last century. b. Corporate giants have also internationalized in the postwar period. Some multinational corporations (businesses with vast holdings in many countries) have annual budgets exceeding that of many foreign governments. c. Since the early 1980s, a new form of entrepreneurship has flourished: merger mania. 2. The purpose of antitrust policy is to ensure competition and prevent monopoly (control of a market by one company). a. Government regulation of business is at least as old as the Sherman Antitrust Act of Although business owners and managers complain about regulation, the government also sometimes comes to the aid of struggling businesses. 4. The main regulatory agency responsible for regulation of business practices is the Securities and Exchange Commission (SEC). C. Consumer policy 1. The first major consumer protection policy in the United States was the Food and Drug Act of 1906, which prohibited the interstate transportation of dangerous or impure food and drugs. 2. Today, the Food and Drug Administration (FDA) has broad regulatory powers over the manufacturing, contents, marketing, and labeling of food and drugs. a. It is the FDA s responsibility to ascertain the safety and effectiveness of new drugs before approving them for marketing in the U.S. 3. Consumerism was awakened in the 1960s by consumer activists, such as Ralph Nader, who argued that it was the government s responsibility to be a watchdog on behalf of the consumer. a. The Consumer Product Safety Commission (CPSC) has broad powers to ban hazardous products from the market. 4. The Federal Trade Commission (FTC) which has traditionally been responsible for regulating trade practices also jumped into the business of consumer protection in the 1960s and 1970s; Congress also made the FTC the administrator of the new Consumer Credit Protection Act (which enforces truth in lending ). D. Labor and government 1. Until the Clayton Antitrust Act of 1914 exempted unions from antitrust laws, the federal government spent more time busting unions than trusts. 2. The major turning point in government policy toward labor took place during the New Deal. a. In 1935, Congress passed the National Labor Relations Act (often called the Wagner Act), which guaranteed workers the right of collective

5 VI. Page 5 of 6 bargaining the right to have labor union representatives negotiate with management to determine working conditions and set rules to protect unions and organizers. b. The Taft-Hartley Act of 1947 continued to guarantee unions the right of collective bargaining but also prohibited various unfair practices by unions. 1) The law permitted states to adopt what union opponents call rightto-work laws laws that forbid labor contracts from requiring workers to join unions in order to hold their jobs. 3. Unions have had two notable successes. a. Partly as the result of successful union lobbying, the government provides unemployment compensation. b. Since the era of the New Deal, government has guaranteed a minimum wage for hourly employees. UNDERSTANDING ECONOMIC POLICYMAKING A. In the U.S., solutions to many of the problems of a free enterprise economy were achieved through the democratic process. B. In the economic arena, voters often expect more of politicians than they can realistically control. 1. People often expect government to solve their economic problems, and politicians are often only too happy to oblige with campaign promises. 2. In 2008, Democrats railed against free trade. C. Economic policy brings out special interests. 1. Groups that may be adversely affected by an economic policy have many avenues through which they may work to block it. D. Economic policymaking and the scope of government. 1. Liberals and conservatives disagree about the scope of government involvement in the economy. 2. Liberals focus on the imperfections of the market and on what government can do about them; conservatives focus on the imperfections of government. 3. The two parties have different economic policies, particularly with respect to unemployment and inflation: Democrats try to curb unemployment more than Republicans, though they risk inflation in so doing, while Republicans are generally more concerned with controlling inflation. KEY TERMS AND CONCEPTS: Antitrust policy: government regulation of business to ensure competition and to prevent monopoly (control of a market by one company) Capitalism: an economic system in which individuals and corporations own the principal means of production, through which they seek to reap profits Collective bargaining: the right of workers to have labor union representatives negotiate with management to determine working conditions Consumer Price Index (CPI): a government statistic that measure the change in the cost of buying a fixed basket of goods and services Federal Reserve System: created by Congress in 1913 in order to regulate the lending practices of banks and thus the money supply Fiscal policy: the government s decisions to tax, spend, and borrow, as reflected in the federal budget Food and Drug Administration (FDA): government agency with broad regulatory powers over the manufacturing, contents, marketing and labeling food and drugs Inflation: a government statistic that measures increases in the price of goods

6 Page 6 of 6 Keynesian economic theory: the theory emphasizing that government spending and deficits can help the economy weather its normal ups and downs. Proponents of this theory advocate using the power of the government to stimulate the economy when it is lagging Labor union: an organization of workers intended to engage in collective bargaining Laissez-faire: a belief that government should not intervene in the economy Minimum wage: the legal minimum hourly wage required to be paid to (most) hourly workers Mixed economy: a system in which the government, while not commanding the economy, is still deeply involved in economic decisions Monetarism: economic theory that suggests that the supply of money is key to the nation s economic health Monetary policy: government decisions regarding the money supply, including the discount rates for bank borrowing, reserve requirements for banks, and trading of government securities Multinational Corporation: business with vast holdings in many countries National Labor Relations Act: passed by Congress in 1935, guarantees some workers the right of collective bargaining; also known as the Wagner Act Protectionism: the economic policy of shielding an economy from exports Securities and Exchange Commission: the federal agency created during the New Deal that regulates stock fraud Supply-side economics: economic philosophy that holds that the key task for government economic policy is to stimulate the supply of goods Unemployment rate: a government statistic that measures how many workers are actively seeking work but are unable to find jobs World Trade Organization: international organization that regulates international trade