January 10th, 2018
Trends in Economic Norm Defining Policy
Economic ideologies have shaped governance policies for a long time in history. Such perhaps may be due to the economic advancement that everything has a cost that should be considered before a decision is made. The economic contention is that only when the marginal benefits of an action exceeds the marginal costs, is the performance of such an action prudent (Colander 7). Determining such marginal effects has however been subject to various schools of thought. The earliest of the schools of thought considered here is the classical economics.
Classical economics emphasized the role of market driven economies placing emphasis on long-run growth of the economy (Colander 176). This school of thought is attributed to Adam Smith whose publication “The Wealth of Nations” in 1776 inspired development of a stream of theories that agreed growth was better achieved where the market forces were allowed to act unperturbed (Krugman, “How Did Economists” 2) Long-run growth takes place “when the economy produces more goods and services from existing production processes and resources” (Colander 177). Classical economics thus discouraged interference of the market conditions from external forces such as the government. If left unperturbed; the classical perspective was that market forces could allow the growth of the economy to its potential output which is the maximal economic output from existing processes and resources (Colander 177). At times of adversity the argument was that the market forces – the invisible hand of the economy – would help it go back to its optimal level of activity (Colander 202).
The classical economics school of thought was advised by its overemphasis of the supply side of the economy. Out of such a focus, the ideology was that existing demand was sufficient to purchase whatever is supplied as advised in Say’s Law that supply creates own demand (Colander 177). To change the potential output hence lead to growth; the market was, in accordance to this school, better left to solve its own challenges (Colander 177). Such classical perspectives defined the economic policy that was employed in the US and Britain before the great depression (Shah 1).
In the 1930s, the great depression however changed the widespread disregard of short term effects among the economists. The output of the economy was at an all time low with unemployment levels being very high (Colander 202). As the depression went on over a long period of time (estimated at 10 years) the classical contention of an invisible hand of the market helping to bring a recovery to the economy proved untenable (Colander 202). Its explanation of the prolonged depression was that “labour unions and government policies kept prices and wages from falling” (Colander 202). That by abolishing labour unions and changing policies that maintained wages at high levels, the wages would decline and more people would be employed alleviating the unemployment catastrophe (Colander 202). To the unemployed however, the issue was not the wage levels – since they could take up a job at half the wage – but the inability of the economy to create these jobs (Colander 202; Keynes 23). A section of economists conceding to such aspects started turning attention to short run efforts aimed at helping bring about the long run recovery back in line. Among these was John Maynard Keynes after whom the school of thought contending that at times government interventions were required is named.
In 1936 John Maynard Keynes, authored one of the books that changed the perspective of macroeconomics. In The General Theory of Employment, Interest and Money, Keynes focused on the demand side of the economy proposing measures that the government could undertake to control for various economic outcomes such as expediting recovery in times of depression. For instance the book advanced that the interest rates is not “self-adjusting at a level best suited to the social advantage but constantly tends to rise too high” (Keynes 215). As such a prudent government policy would be to curb unabated increase of such rates through statutes, custom and when necessary, invoke the sanctions of moral law (Keynes 215). Similarly in times of depression Keynes argument was that if the government found a way to hire more people, the newly hired would spend more, the increased demand would spur more production and help in creating new jobs and in so doing eventually lead the economy out of the depression (Keynes 88-90). Classical economists however argued against such a move contending that the money to create such employment would have to be borrowed depleting resources that could have financed private economic activity necessary for growth and creation of additional jobs (Colander 203). The net effect of such an intervention policy was argued to be zero and would not achieve growth in the long run (Colander 203).
Increased gravity of the 1930s depression changed the policy through which economic effects were controlled. Short run efforts that the government needed to implement to get the economy back on track became a core focus of the Keynesian group of economists. The focus of policy thus changed from whether economic recovery could be achieved from the great depression to the short tem efforts that the society could use to counteract the effects of depression (Colander 203). In such contentions the potential output was not contended as variable component bust a constant component towards which growth proceeds (Colander 203). The outcome of this school of thought was the fiscal and monetary policies that could be used to control for various effects of the economy. In times of recession it was advanced that an expansionary fiscal policy (such as increased public spending and modifying taxation rates) could help create effective demand that would spur the economy back to optimal activity (Colander 218). A contractionary fiscal policy (e.g. increasing taxes or reducing government spending) could conversely be used to curtail unabated increase in prices where the aggregate demand is too thus preventing an entry into inflationary trend (Colander 219). Monetary policy tools could also be used for such modifying effects according to the economic condition prevailing. By controlling the supply of money through tools such as open market operations, altering the bank lending rate, and modifying reserve requirements; it was advanced that the government could alter aggregate demand in accordance with the prevailing economic environment (Colander 302).
The period after great depression was thus advised on Keynesian school of thought, leading to Bretton wood arrangement institutions. Though this system appreciated market allocation of resources in the economy, it contended that such allocation needed to be within thresholds determined by a political process (Wade 5). The expectations that players in the market would always act rationally to bring about the appropriate response was one that the Keynesian school of thought demystified (Keynes 214). To control against such irrationality, at times government intervention was advanced necessary to stimulate or curtail demand in line with the existing market conditions (Krugman, “How Did Economists” 2). During this regime, a more equitable development was proposed with tools such as spending on social areas such as health and education being advanced to be an important way to achieve this (Shah 1). Similarly the institutions such as the IMF- and World Bank created at Bretton Woods in 1944 were initially aimed to impact some control and regulation over capital with a mandate to “help prevent future conflicts by lending for reconstruction and development and by smoothing out temporary balance of payments problems” (Shah 1). As such the economical policy vouched for by such Keynesian-view considered the social aspects to be a core component of economic growth. Go to part 3 here.