Definition: Governmental intervention is the intentional interference of a government in a country’s economic system through regulatory actions. It refers to a situation when a government is actively affecting decisions taken by individuals or organizations.
What Does Government Intervention Mean?
Government intervention is needed because of the so-called market inefficiencies and failures. With the purpose of increasing welfare or pursuing certain economic and social goals, a government designs and enforces rules that aim to obtain results that could not be obtained under a market that is entirely free.
The means employed for an intervention are various but they can be grouped in three broad categories. These are subsidies, taxes and regulations. Subsidies try to increase the consumption of certain goods or services above others. For example, a subsidy to milk could intend to raise milk intake in less privileged society sections.
In contrast, taxes try to diminish the use or consumption of something by increasing its relative price. An example could be a tax on alcoholic beverages. Regulations limit certain activities or behaviors considered as not desirable but also might have the purpose of offering goods and services that are not properly provided by the market. A case can be public schools in poor neighborhoods to increase enrollment among less-affluent children.
Example
Since a perfectly free market is the most efficient way to allocate resources, excessive or inappropriate government intervention tends to distort efficiency in a significant extent. Governments might have political instead of public interests when making regulatory decisions. The government could also be inadequately informed or technically incapable to solve complex problems.
For example, a regulation to lower consumer prices of canned food sound like a good thing for poor people but if prices are insufficiently attractive to food suppliers whose main reason to exist is profit those products will not be offered at all. At the end, the desired solution would not be possible and instead, the population would face scarcity.
Government intervention is any action carried out by the government or public entity that affects the market economy with the direct objective of having an impact in the economy, beyond the mere regulation of contracts and provision of public goods.
Government intervention advocates defend the use of different economic policies in order to compensate the flaws of the economic system that give way to large economic imbalances. They believe the Law of Demand and Supply is not sufficient in order to ensure economic equilibriums and government intervention should be used to assure a correct functioning of the economy. Examples of these economic doctrines include Keynesianism and its branches such as New Keynesian Economics, which relay heavily in fiscal and monetary policies, and Monetarism which have more confidence in monetary policies as they believe fiscal policies will have a negative effect in the long run. On the other hand, there are other economic schools that believe that governments should not have an active role in the economy, and therefore should limit its intervention, as they believe it will have a negative impact in the economy. They believe that the economy should be left to run in a laissez-faire way and it will find its optimal equilibrium. Advocates of none or limited intervention include liberalism, the Austrian school and New Classical Macroeconomics.
As in most imperfect competition markets and especially in monopolistic ones, a firm may practice an abusive behaviour, which will translate into a loss of welfare. In such cases, government intervention will be praised both by consumers and those firms that seek for lower prices and a profitable share of the market. Regulations such as price setting, taxation or subsidies may be used in order to restore and maximise the initial efficiency of natural monopolies.
Nevertheless, the government must be cautious when setting and applying regulations, as an incorrect comprehension of the market structure may bring a higher cost to social welfare instead of the expected benefits. In order to achieve an optimal regulation level, governments should analyse and determine if natural monopolies can be sustained whenever they ensure a lower total cost. If this is the case, the government will have to guarantee that the firm does not make excessive revenues, and that fair prices are maintained. If, on the contrary, the total costs of the industry would diminish if new firms entered the market, the government should regulate their entrance. Essentially, what governments should do is to correctly balance the conflict between the industry’s efficiency and its profitability.
Laissez-faire is an economic theory from the 18th century that opposed any government intervention in business affairs. The driving principle behind laissez-faire, a French term that translates to "leave alone" (literally, "let you do"), is that the less the government is involved in the economy, the better off business will be, and by extension, society as a whole.
Laissez-faire economics is a key part of free-market capitalism.
- Laissez-faire is an economic philosophy of free-market capitalism that opposes government intervention.
- The theory of laissez-faire was developed by the French Physiocrats during the 18th century.
- Laissez-faire advocates that economic success is inhibited when governments are involved in business and markets.
- Later free-market economists built on the ideas of laissez-faire as a path to economic prosperity, though detractors have criticized it for promoting inequality.
- Critics argue that markets do need a certain degree of government regulation and involvement.
The underlying beliefs that make up the fundamentals of laissez-faire economics include the idea that economic competition constitutes a "natural order" that rules the world. Because this natural self-regulation is the best type of regulation, laissez-faire economists argue that there is no need for business and industrial affairs to be complicated by government intervention.
As a result, they oppose any sort of federal involvement in the economy, which includes any type of legislation or oversight; they are against minimum wages, duties, trade restrictions, and corporate taxes. In fact, laissez-faire economists see such taxes as a penalty for production.
Laissez-Faire is often associated with Libertarian views on the economy, where government plays an extremely limited role in the economy. In fact, one of the key characteristics of Laissez-Faire is that the government should only be involved with the following three functions:
- Protecting the national borders via a standing army
- Protecting private property rights and personal freedom via a police force and judiciary
- Producing public goods that serve society (e.g., parks, libraries, etc.) that the market would not be incentivized to produce on its own
Popularized in the mid-1700s, the doctrine of laissez-faire is one of the first articulated economic theories. It originated with a group known as the Physiocrats, who flourished in France from about 1756 to 1778. These thinkers tried to apply scientific principles and methodology to the study of wealth and economic production. These "économistes" (as they dubbed themselves) argued that a free market and free economic competition were extremely important to the health of a free society. The government should only intervene in the economy to preserve property, life, and individual freedom; otherwise, the natural, unchanging laws that govern market forces and economic processes—what later British economist Adam Smith, dubbed the "invisible hand"—should be allowed to proceed unhindered.
Unfortunately, an early effort to test laissez-faire theories did not go well. As an experiment in 1774, Turgot, Louis XVI's Controller-General of Finances, abolished all restraints on the heavily controlled grain industry, allowing imports and exports between provinces to operate as a free trade system. But when poor harvests caused scarcities, prices shot through the roof; merchants ended up hoarding supplies or selling grain in strategic areas, even outside the country for better profit, while thousands of French citizens starved. Riots ensued for several months. In the middle of 1775, the order was restored, and with it, government controls over the grain market.
Despite this inauspicious start, laissez-faire practices, developed further by such British economists as Smith and David Ricardo, ruled during the Industrial Revolution of the late 18th and early 19th century. And, as its detractors noted, it did result in unsafe working conditions and large wealth gaps.
Only at the beginning of the 20th century did developed industrialized nations like the U.S. begin to implement significant government controls and regulations to protect workers from hazardous conditions and consumers from unfair business practices; though it’s important to note that these policies were not intended to restrict business practices and competition.
One of the chief criticisms of laissez-faire is that capitalism as a system has moral ambiguities built into it: It does not inherently protect the weakest in society. While laissez-faire advocates argue that if individuals serve their own interests first, societal benefits will follow.
Detractors feel laissez-faire actually leads to poverty and economic imbalances. The idea of letting an economic system run without regulation or correction in effect dismisses or further victimizes those most in need of assistance, they say.
The 20th-century British economist John Maynard Keynes was a prominent critic of laissez-faire economics, and he argued that the question of market solution versus government intervention needed to be decided on a case-by-case basis.
Pros
Government involvement in business thought to be inefficient and stifling
Encourages self-responsibility and innovation
Promotes free markets and competition
Cons
Lack of regulations can harm consumers and the environment
Can generate negative externalities
Competition naturally leads to wealth inequality
May incentivize bad actors
Laissez-Faire, in French, literally means "let it be." Legend has it that the origins of the phrase "laissez-faire" in an economic context came from a 1681 meeting between the French finance minister Jean-Baptise Colbert and a businessman named Le Gendre. As the story goes, Colbert asked Le Gendre how best the government could help commerce, to which Le Gendre replied "Laissez-nous faire;" basically, "Let it be." The Physiocrats popularized the phrase, using it to name their core economic doctrine.
An economy would follow the principles of Laissez-Faire if it followed an approach where the government was not at all involved in the workings of the economy, business, or markets. Instead, the free market would regulate not only prices but also discipline producers to remain good actors. In reality, such an economy does not exist. All economies, even in countries with highly Libertarian values, have some degree of government regulation and intervention.
In Laissez-Faire capitalism, companies could operate with a pure profit motive and not have to worry about government regulation or taxation. This, of course, could create negative externalities and information asymmetries that can allow producers to behave as bad actors and get away with it. Proponents of Laissez-Faire say that costly and exhaustive regulation is not needed since the market would weed out such bad actors. In reality, however, bad actors may continue operating for a long while. For instance, if a vitamin company is filling their capsules with sawdust instead of herb powder, it may remain unknown without government testing and regulatory oversight to protect consumers.