The government does allow what economists call natural monopolies.
However, the government then regulates those businesses to protect
consumers from high prices and poor service, and often limits the profits
these firms can earn. The classic examples of natural monopolies are
local services provided by public utilities. Economies of scale make it
inefficient to have even two companies distributing electricity, gas,
water, or local telephone service to consumers. It would be very
expensive to have even two sets of electric and telephone wires, and two
sets of water, gas, and sewer pipes going to every house. That is why
firms that provide these services are called natural monopolies.
There have been some famous antitrust cases in which large companies were
broken up into smaller firms. One such example is the breakup of American
Telephone and Telegraph (AT&T) in 1982, which led to the formation of a
number of long-distance and regional telephone companies. Other examples
include a ruling in 1911 by the Supreme Court of the United States, which
broke the Standard Oil Trust into a number of smaller oil companies and
ordered a similar breakup of the American Tobacco Company.
Some government policies intentionally reduce competition, at least for some period of time. For example, patents on new products and copyrights on books and movies give one producer the exclusive right to sell or license the distribution of a product for 17 or more years. These exclusive rights provide the incentive for firms and individuals to spend the time and money required to develop new products. They know that no one else will copy and sell their product when it is introduced into the marketplace, so it pays to devote more resources to developing these new products.
The benefits of certain other government policies that reduce competition are not always this clear, however. More controversial examples include policies that restrict the number of taxicabs in a large city or that limit the number of companies providing cable television services in a community. It is much less expensive for cable companies to install and operate a cable television system than it is for large utilities, such as the electric and telephone companies, to install the infrastructure they need to provide services. Therefore, it is often more feasible to have two or more cable companies in reasonably large cities. There are also more substitutes for cable television, such as satellite dish systems and broadcast television. But despite these differences, many cities auction off cable television rights to a single company because the city receives more revenue that way. Such a policy results in local monopolies for cable television, even in areas where more competition might well be possible and more efficient.
Establishing government policies that efficiently regulate markets is difficult to do. Policies must often balance the benefits of having more firms competing in an industry against the possible gains from allowing a smaller number of firms to compete when those firms can achieve economies of scale. The government must try to weigh the benefits of such regulations against the advantages offered by more competitive, less regulated markets.
Promoting Full Employment and Price Stability
In addition to the monetary policies of the Federal Reserve System, the
federal government can also use its taxing and spending policies, or
fiscal policies, to counteract inflation or the cyclical unemployment
that results from too much or too little total spending in the economy.
Specifically, if inflation is too high because consumers, businesses, and
the government are trying to buy more goods and services than it is
possible to produce at that time, the government can reduce total
spending in the economy by reducing its own spending. Or the government
can raise taxes on households and businesses to reduce the amount of
money the private sector spends. Either of these fiscal policies will
help reduce inflation. Conversely, if inflation is low but unemployment
rates are too high, the government can increase its spending or reduce
taxes on households and businesses. These policies increase total
spending in the economy, encouraging more production and employment.
Some government spending and tax policies work in ways that automatically stabilize the economy. For example, if the economy is moving into a recession, with falling prices and higher unemployment, income taxes paid by individuals and businesses will automatically fall, while spending for unemployment compensation and other kinds of assistance programs to low- income families will automatically rise. Just the opposite happens as the economy recovers and unemployment falls—income taxes rise and government spending for unemployment benefits falls. In both cases, tax programs and government-spending programs change automatically and help offset changes in nongovernment employment and spending.
In some cases, the federal government uses discretionary fiscal policies in addition to automatic stabilization policies. Discretionary fiscal policies encompass those changes in government spending and taxation that are made as a result of deliberations by the legislative and executive branches of government. Like the automatic stabilization policies, discretionary fiscal policy can reduce unemployment by increasing government spending or reducing taxes to encourage the creation of new jobs. Conversely, it can reduce inflation by decreasing government spending and raising taxes. .
In general, the federal government tries to consider the condition of the
national economy in its annual budgeting deliberations. However,
discretionary spending is difficult to put into practice unless the
nation is in a particularly severe episode of unemployment or inflation.
In such periods, the severity of the situation builds more consensus
about what should be done, and makes it more likely that the problem will
still be there to deal with by the time the changes in government
spending or tax programs take effect. But in general, it takes time for
discretionary fiscal policy to work effectively, because the economic
problem to be addressed must first be recognized, then agreement must be
reached about how to change spending and tax levels. After that, it takes
more time for the changes in spending or taxes to have an effect on the
economy.
When there is only moderate inflation or unemployment, it becomes harder to reach agreement about the need for the government to change spending or taxes. Part of the problem is this: In order to increase or decrease the overall level of government spending or taxes, specific expenditures or taxes have to be increased or decreased, meaning that specific programs and voters are directly affected. Choosing which programs and voters to help or hurt often becomes a highly controversial political issue.
Because discretionary fiscal policies affect the government’s annual deficit or surplus, as well as the national debt, they can often be controversial and politically sensitive. For these reasons, at the close of the 20th century, which experienced years with normal levels of unemployment and inflation, there was more reliance on monetary policies, rather than on discretionary fiscal policies to try to stabilize the national economy. There have been, however, some famous episodes of changing federal spending and tax policies to reduce unemployment and fight inflation in the U.S. economy during the past 40 years. In the early 1980s, the administration of U.S. president Ronald Reagan cut taxes. Other notable tax cuts occurred during the administrations of U.S. presidents John Kennedy and Lyndon Johnson in 1963 and 1964.
Limitations of Government Programs
Government economic programs are not always successful in correcting
market failures. Just as markets fail to produce the right amount of
certain kinds of goods and services, the government will often spend too
much on some programs and too little on others for a number of reasons.
One is simply that the government is expected to deal with some of the
most difficult problems facing the economy, taking over where markets
fail because consumers or producers are not providing clear signals about
what they want. This lack of clear signals also makes it difficult for
the government to determine a policy that will correct the problem.
Political influences, rather than purely economic factors, often play a major role in inefficient government policies. Elected officials generally try to respond to the wishes of the voting public when making decisions that affect the economy. However, many citizens choose not to vote at all, so it is not clear how good the political signals are that elected officials have to work with. In addition, most voters are not well informed on complicated matters of economic policy.
For example, the federal government’s budget director David Stockman and other officials in the administration of President Reagan proposed cuts in income tax rates. Congress adopted the cuts in 1981 and 1984 as a way to reduce unemployment and make the economy grow so much that tax revenues would actually end up rising, not falling. Most economists and many politicians did not believe that would happen, but the tax cuts were politically popular.
In fact, the tax cuts resulted in very large budget deficits because the
government did not collect enough taxes to cover its expenditures. The
government had to borrow money, and the national debt grew very rapidly
for many years. As the government borrowed large sums of money, the
increased demand caused interest rates to rise. The higher interest rates
made it more expensive for U.S. firms to invest in capital goods, and
increased the demand for dollars on foreign exchange markets as
foreigners bought U.S. bonds paying higher interest rates. That caused
the value of the dollar to rise, compared with other nations’ currencies,
and as a result U.S. exports became more expensive for foreigners to buy.
When that happened in the mid-1980s, most U.S. companies that exported
goods and services faced very difficult times.
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