Study Notes

The balance between markets and intervention

IB Learning Outcomes for this module:

Strengths and weaknesses of market-oriented policies

Strengths

❏ Discuss the positive outcomes of market-oriented policies (such as liberalized

trade and capital flows, privatization and deregulation), including a more efficient
allocation of resources and economic growth.

Weaknesses

❏ Discuss the negative outcomes of market-oriented strategies, including market

failure, the development of a dual economy and income inequalities.

Strengths and weaknesses of interventionist policies

Strengths

❏ Discuss the strengths of interventionist policies, including the provision of infra-

structure, investment in human capital, the provision of a stable macroeconomic
economy and the provision of a social safety net.

Weaknesses

❏ Discuss the limitations of interventionist policies, including excessive bureau-

cracy, poor planning and corruption.

Market with government intervention

❏ Explain the importance of good governance in the development process.

❏ Discuss the view that economic development may best be achieved through a
complementary approach, involving a balance of market oriented policies and
government intervention.
L01) Discuss the positive outcomes of market-oriented policies (such as liberalized trade
and capital flows, privatization and deregulation), including a more efficient allocation of
resources and economic growth.

Market-based supply-side policies - What are they?:

1. Deregulation
2. Anti-monopoly regulation
3. Labour market reforms
4. Trade Liberalization
5. Privatization
6. Freely floating exchange rates
7. Liberalized capital flows, or absence of exchange controls which limit the amount of for-
eign exchange that can be purchased with the domestic currency

Deregulation - The reduction or elimination of government power in a particular industry, usu-

ally enacted to create more competition within the industry and to decrease the cost to all busi-
nesses.

Article example - http://www.reuters.com/article/2014/11/19/us-japan-robots- idUSKC-

N0J32DS20141119

1 sentence summary - The robotics industry has always been one of Japan’s last areas of
technological prominence, but recently it has been under threat by the US, Germany, South Ko-
rea and China. Therefore, Abe promised deregulation to foster industrial growth by making it
easier for the robotics business to operate by reducing costs and investing more in new technol-
ogy.

Privatization -

Article example -

1 sentence summary -

Anti-monopoly regulation -

Article example -

1 sentence summary -
Labour market reforms -

Article example -
1 sentence summary -

Incentive-related tax policies -

Article example -

1 sentence summary -

Trade liberalization -

Article example -

1 sentence summary -

Freely floating exchange rates -

Article example -

1 sentence summary -

Liberalized capital flows, or absence of exchange controls -

Article example -

1 sentence summary -

Strengths of market-oriented policies

● Market-oriented policies are based on the idea that free markets, working under compet-
itive conditions, offer a method to answer the what to produce, how to produce
questions of resource allocation in the best way. This allows community surplus to
be maximized and thus achieving allocative efficiency.

● The pursuit of self interest by all economic decision makers gives rise to incentives for
hard work, risk-taking, innovation and investment, which lead to higher levels of
output (and possibly a higher standard of living)

● It encourages competition (deregulation, privatisation and anti-monopoly regulation)

which work to create greater efficiency/output, lower prices and improved quality

● Labour market reforms allow for free market forces to regulate the labour market.
Incentive- related policies (lower taxes) will encourage more incentive to work, in-
novate and invest, which in turn will improve the allocation of resources.
 ● Trade liberalization leads to increased competition, increase efficiency in markets,
lower prices and improve quality, increase in consumer choice, improve allocation of
resources, and allow for greater economic growth.

● Freely floating exchange rates help bring balance to the balance of payments and al-
low greater flexibility to policy-makers to pursue policies needed domestically.

● Liberalized capital flows allow domestic residents to purchase any amount of for-
eign exchange without restriction. This is important for attracting MNCs and more effi-
cient global allocation of savings (they can make financial investments anywhere in the
world

L02) Discuss the negative outcomes of market-oriented strategies, including market fail-
ure, the development of a dual economy and income inequalities.

Weaknesses

1) Market failure

● negative environmental externalities of production and consumption and the problems

with common access resources

● insufficient provision of merit goods

● failure to provide public goods

● abuse of monopoly power and information asymmetries

2) Coordination failures

● coordination failure occurs when a group of firms could achieve a more desirable equilib-
rium but fail to because they do not coordinate their decision making

● for example, one might find mineral resources which are not mined because there is no
transport to export them, and a railway which is not built because there is no freight for it
to carry. If both projects went forward, both would be profitable, but neither is started, be-
cause the firms concerned do not know about, or do not trust, each other.

● The same problem can affect governments: a number of countries may refrain from lib-
eralization of their trade because of worries about the effects on their balance of pay-
ments, whereas if they could all agree to liberalize at once, all could benefit.

3) Weak or missing market institutions

 ● to be able to function effectively, markets need an institutional and legal environment
that is often missing in less developed countries.

This includes:

● enforcement of property rights and legal contracts

● effective legal recourse
● a stable currency
● a well-developed banking and insurance system
● readily available information on prices, quantities and quality of goods, services and re-
sources to consumers, firms and resource owners

In absence of these conditions, markets are highly imperfect in their functions and fail to func-
tion effectively such as:

4) Development of dual economies

● an economy where both technically advanced and technically primitive sectors

exist, as in developing countries where advanced technology is applied to ex-
tracting minerals or manufacturing while at the same time large parts of the
country exist at subsistence level

● Dual economies require government policies that attempt to eliminate the dualism.

5) Income inequalities
● the loss of protection of workers resulting from labour-market reforms can result in in-
come inequalities

6) Insufficient credit for poor people

● Poor people do not have access to credit and therefore will result in lower investment
possibilities, greater poverty and poorer income distribution, as well as the inability to es-
cape the poverty cycle

Questionable effects on economic growth and development

● Trade and market liberalization may not lead to improved export performance.
○ Evidence has shown that countries that are better able to take advantage of op-
portunities presented by trade and market liberalization are those that have al-
ready developed an industrial base
○ Low-incomes countries tend to perform the worse because they can least with-
stand the competition with larger, more “mature,” foreign firms
○ Withdrawal from the government provision of merit goods has negative effects on
human development
L03) Discuss the strengths of interventionist policies, including the provision of infra-
structure, investment in human capital, the provision of a stable macroeconomic econ-
omy and the provision of a social safety net.

Interventionist Policies Defined - Interventionist policies are based on government interven-

tion in markets intended to correct market deficiencies and create an environment in which mar-
kets can work more effectively.

Strengths of Interventionist policies:

1) Correcting market failures

● correct negative externalities of production and consumption and overuse of common

access resources
● provide public goods as well as merit goods that are under-provided by the market due
to positive consumption externalities
○ investment in human capital and infrastructure
● Assist in the correction of coordination failures
● Contribute to the development of market institutions that enable markets to operate more
effectively

2) Investment in human capital

3) Provision of infrastructure

4) Provision of a stable macroeconomic environment

● price stability
● full employment
● reasonable budget deficit
● reasonable balance of trade

5) Provision of a social safety net

● A social safety net is a system of government transfers of cash or goods to vulnerable

groups, to ensure that these groups don’t fall under the minimum standard of living
● government needs to set up a social safety net to ensure people falling below minimum
income level will be able to secure their basic needs

6) Redistribution of income

7) Industrial policies
 ● These are interventionist supply-side policies that include support for small and medium
sized businesses as well as protection of infant industries. These policies will help with
the early stages of their industrialization.
● Government support of appropriate technology transfer from developed countries and
establishment of a R&D capability as well as investments in human capital

L04) Discuss the limitations of interventionist policies, including excessive bureaucracy,

poor planning and corruption.

1) Excessive bureaucracy

● too many rules governing procedures, red-tape, unproductive workers, high administra-
tive costs and inefficiency

2) Poor planning

● Planning may run into difficulties because it requires technical knowledge and expertise
on the part of planners, which they may not possess, as well as a tremendous amount of
detailed information, much of which is often not available. The result is that planning can
become highly bureaucratic and inefficient, resulting in a waste of resources

3) Corruption

● corruption is the abuse of public office for private gain

○ bribery, construction of kickbacks, procurement fraud, extortion, false certifica-
tion, nepotism, embezzlement, etc.
● Corruption becomes more of a concern where the legal system, mass media and the
system of public administration is weak
● Corruption can lead to:
○ lower growth
○ increase costs
○ reduction in government revenues
○ misallocation of resources
○ weaken sustainable development
○ damage peoples’ trust
○ encourages contempt for the rule of law

L05) Explain the importance of good governance in the development process AND Dis-
cuss the view that economic development may best be achieved through a complemen-
tary approach, involving a balance of market oriented policies and government interven-
tion.

Good governance is not about what is done for economic growth and development but rather
how it is done.
The six principles of good governance:

Participation

● The extent to which the stakeholders affected by policies are involved in making
decisions and in the implementation of decisions.

Fairness

● The extent to which rules apply to everyone in society equally.

Decency

● The extent to which the formation and implementation of rules does not do harm.

Accountability

● The extent to which political figures and decision-makers are responsible to soci-
ety for the actions and their statements.

Transparency

● the extent to which decisions made by government are clear and open.

Efficiency

● the extent to which scarce resources are used with waste, delays or corruption.