In the previous tutorial we talked about how governments attempt to grow economies by doing
things to increase productivity, often with great success. However, sometimes things don’t work out
as intended, as governments can do things that actually harm economic growth. Let’s look at five
specific ways governments can mess up economies. #1: Overtaxation.
Taxation is a powerful tool that the government uses to pay for public goods and services.
Taxes give the government the money it needs to operate. However, it is important to think about
who actually bears the burden of a tax. Taxes can create disincentives and other behavior that
discourages investment. So while governments absolutely need taxes to pay for obligations,
since it’s the primary way they collect money, they also need to be careful not to tax too much.
Let’s look at two distinct ways taxes can end up harming economic growth.
The first is increasing prices for ordinary consumers. For example, suppose the government
collects a gasoline tax of 50 cents per gallon from gas stations. At first, you might assume
that the tax burden is only on the gas stations. However, in response to the tax, gas stations may
increase the price of gas. Therefore, consumers will also carry the burden of the tax.
When policymakers consider creating a new tax, they must consider the incidence of a tax, or the
final burden of a tax. This is because producers often pass on the burden of a tax to consumers.
The second is discouraging domestic investment. Simply put, if taxes make the
cost of doing business too high in one country, companies will take their business elsewhere.
For example, suppose the government increases the corporate income tax rate, which is a tax
on business profits. In response, a company might move its headquarters to another country to avoid
paying the higher corporate tax rate. In fact, the company will likely move to a country with
no corporate tax. Back in 2017, Google shifted 23 billion dollars to Bermuda. At the time,
the United States had a 21% corporate income tax rate, while Bermuda had no corporate income tax.
So whenever a policymaker proposes either a new tax or a higher tax rate,
they must consider the degree to which that change might scare off producers or consumers.
#2: Too much or too little regulation. Whenever governments regulate an economy,
they are manipulating a free market. This can have both positive and negative effects on an economy.
It’s probably easier to understand the negative effects of regulation.
First, highly regulated industries can make it difficult for competitive markets to form.
If a company has to spend lots of money keeping up with regulations, it may hurt their profits. More
importantly, a large company or corporation may be able to handle spending extra money
to keep up with regulations, but a brand new company starting out won’t be able to.
This results in fewer companies in a market, which often results in higher prices for consumers.
More government regulation also means more bureaucracy, and therefore more
government spending. This can lead to government inefficiency, corruption, and increased taxes.
Too little regulation can also hurt economic growth. To understand why that is,
let’s look at why regulations can be a good thing. First, regulations can raise industry standards,
resulting in higher quality goods and services. For example, because governments often put in
place strict requirements for food processing and preparation, consumers are more confident
in buying packaged food than they would be otherwise. Second, if implemented correctly,
regulations can actually increase competition in a marketplace. While this seems counter-intuitive,
regulation can limit the power of corporations that are dominating a market. Third, regulations
protect consumers. Certain goods and services can be harmful to consumers, or even deadly. However,
that has not stopped producers from providing them and profiting from them over the years.
In the early 1900s, radium was a popular “cure” for many ailments and was sold around the world.
However, it soon became known that it caused cancer, and only after governments stepped in to
ban it were companies forced to stop selling it. #3: Lack of investment in infrastructure,
education, and technology. As we saw in the previous tutorial, governments
support economic growth simply by helping create capital. Often this is by redirecting public funds
to invest in major public projects, or providing public schools and supplementary public school
programs. Economists have found that if governments don’t invest in infrastructure,
education, and technology, wealth inequality worsens and economic growth decreases.
#4: Lack of enforcement of contracts. As we also learned in the previous tutorial,
private property is usually protected through contracts. Governments ensure that if someone
breaks a contract with you, you can take them to court to resolve the issue. Historically we
have seen that, as long as governments step in to enforce contracts, economic growth naturally
occurs. However, let’s look at a scenario assuming that contracts don’t exist. Say you
rent an apartment. You don’t sign a lease with a landlord, but have a verbal agreement that you
will live there for one year, and that if there are any maintenance issues, the landlord will
take care of it. But let’s say two months later, your apartment is overrun with roaches and mice.
You tell your landlord, but he refuses to do anything about it, telling you that it’s your
problem. Without contract laws, there is nothing you can do but try to solve the problem yourself.
Even if you had a signed lease with your landlord, if governments don’t enforce the contract, it is
worthless. Think of the government as insurance for when things go wrong. Without knowing that
the government is there to step in, consumers are less likely to take risks or make big purchases.
#5: Providing a weak general welfare system. Without a strong safety net for those struggling
to meet basic needs, it is difficult for an economy to grow. A general welfare system
creates a risk-sharing economy, in which the threat of potential economic difficulties
affecting any one person is protected by the majority. Think of it as insurance. Instead of
having one person face a huge loss, a large number of people share the costs and barely notice.
Let’s say a government did not provide unemployment compensation, which is a benefit paid
to people who have recently lost their job through no fault of their own. This can happen suddenly
and unexpectedly. If this person didn’t have any money saved up, they could quickly face eviction
from their home, or become unable to afford basic necessities such as food, clothing, or healthcare.
This would quickly create a scarcity mindset, as now not only would the newly unemployed person
have to worry about finding another job, they would also have to worry about basic survival.
In conclusion, governments sometimes hurt economic growth through overtaxation,
overregulation or too little regulation,
lack of investment in infrastructure, education, and technology, a lack of enforcement of
contracts, or having a weak general welfare system. With a broad overview of government
involvement covered, let’s now look at specific government action, for better or for worse.