It is important to understand the importance of economics in social life, particularly the role of government in the economy, as a basis for forming opinions about how economic actions affect us both domestically and internationally.
Economic decisions are difficult for three reasons:
First, a governments resources are always limited and deciding how best to use them in the face of competing interests is usually a dilemma.
Second, economic decisions are based on predictions about how the economy will respond to different government actions. The practice of economics is a science, involving the analysis of statistics and trends. But, it is also an art. Different economists, analyzing the same numbers, often produce vastly different results. This is because they can never know with certainty what humans will do. It is people, business leaders, labor organizers, government policymakers and consumers, who make the thousands of decisions that shape the world economy every day.
Third, in our system of government, economic decisions are political in the sense that policymakers must take into account the differing social and political agendas of private industry, labor and special interest or population groups who fight to protect their self-interest.
All nations try to balance three basic economic problems, unemployment, inflation and productivity, but vary in their approaches to solving them. Their governments exist to provide a stable framework for social harmony. Without government, we would have no restrictions on our personal freedom. Neither, however, would our neighbors. With unrestrained individual interests colliding, we might face the situation that philosopher Thomas Hobbes called the war of all against all. People have historically been willing to accept government rules and policies to avoid societal chaos.
The reasons why governments are involved in the economy of a nation are much the same. There are many competing interests in the marketplace and many kinds of resources to manage. No nation has all the resources it needs or wants. This situation, called scarcity, creates the need for economic choices to be made. Every nation must find ways to collect, manage and distribute its resources to meet the needs and wants of its citizens. Governments take on a leadership role because they are the only institution that has the authority to focus on the needs of society as a whole. Only governments have the power to establish the rules that ultimately will provide for the common good. Without the organized leadership that governments provide, economies would be very inefficient. In our economy, every participant in the economy is tied to every other. Consumers need industry to produce goods and services. Industries need consumers to buy their products. Government acts as a kind of coordinator for both consumers and industry, providing the basic framework in which economic activity takes place.
At the heart of every government's involvement in the economy should be a desire to ensure that all citizens have a decent standard of living. In developing nations, this means giving everyone access to food, shelter, medical care and job skills. In developed nations, governments generally try to improve the standard of living by encouraging economic growth. Economic growth promotes political stability and gives a nation the resources to pursue broader political goals. These might include maintaining a strong national defense, providing a wide variety of social services and supporting scientific research programs. Which goals a nation decides to pursue reflects its social and political values. For example, a socialist nation such a Cuba is more likely to place a higher value on economic equity over economic freedom, whereas a socialist-democratic country like Sweden will probably place a high value of economic efficiency and a lower value on economic growth. Our system tends to place a high value on economic freedom and growth tempered by a concern for economic equity.
How a nation goes about achieving its economic goals is one of the key differences among political systems. In a socialist/communist nation such a Cuba, the government owns most of the resources and makes most of the decisions about how to use and distribute them. The government decides what goods will be produced and in what quantity, sets workers wages and guarantees that everyone will have a job. In a mixed-capitalist economy such as ours, the government does not own or operate many industries. It prefers to allow individual companies to decide what products they wish to produce, in what quantities and at what price. The government allows individual citizens to decide where they want to work, in what capacity and at what level of pay. As a corollary, production in Cuba is limited to goods considered to benefit society, because basic needs for food and industrial goods are scarce. You will find no pet rocks or invisible dogs in its stores, while in our country almost anything that may make a profit is available to buy.
Contrasting these two systems suggests that a belief in competition is important to us, while cooperation has a higher value in a socialist system. In Cuba, individuals supposedly work for the good of the good of the community (the State) while in our country individuals feel they work fundamentally in pursuit of their own goals. Both systems claim to place a high value on equality, but their understanding of this concept is very different. Equality of opportunity (the idea that anyone can be economically successful if he or she is clever and industrious) is still believed as an ideal. In contrast, in Cuba equal distribution of wealth is fundamental to its philosophy.
In reality, in neither case has the true equality been achieved. Cuban workers have their very basic needs guaranteed, but there is still much inequality. In our case, everyone has an opportunity, at least in theory, to improve his or her economic status with government assistance available to help meet basic needs. Yet, there are many barriers that prevent people from achieving a more satisfactory economic situation. It is important to remember that no nation has a purely capitalist or socialist economy. Elements of free enterprise exist in today's Cuba and the Government of Puerto Rico, for example, owns and/or operates several key industries. Some nations, such as Sweden and France, have tried to combine elements from both economic systems, known as Democratic Socialism. In fact, the methods a government uses to achieve its economic goals often change over time, a phenomenon patently present in the case of Puerto Rico.
Indeed, just how does government affect our Puerto Rican economy, keeping in mind our close relationship with the United States? The quest for steady, measured growth that produces increasing prosperity without inflation or recession is beyond the complete control of the Puerto Rican Government and much depends on several tools used by the U.S. Government to influence over-all economic conditions. These tools are powerful, with the potential to affect the key elements of the economy. They can be used to treat a failing economy as well as to prevent undesirable trends from beginning. Both governments assume direct economic responsibilities because the free market alone has proven to be incapable of maintaining a desirable balance.
There are three ways in which government influences our economy: monetary policy, which establishes the amount of money available in the economy; fiscal policy, which determines government spending and taxation; and trade policy, which regulates commerce with foreign nations. Making choices in the use of these tools involves much more than economic science. Each involves political issues, competing social values and philosophical questions about the proper role of government in the economy.
Monetary Policy: Money is society's medium of exchange. It is anything generally accepted as payment for goods and services. Every nation needs a consistent flow of money in its economy to allow consumers to buy the goods that keep production levels high. Money is also used by industries to upgrade their factories and invest in future growth. The U.S. Government attempts to influence the amount of money in circulation (money supply) to promote stable economic growth. This function, known as monetary policy, is entrusted to the Federal Reserve System (also called the Fed).
Founded in 1913, the Federal Reserve System serves as the bankers bank. All commercial banks are required by law to keep a certain amount of money on deposit with the Fed, which holds that money in reserve. Commercial banks earn interest on their deposits with the Fed and can also borrow from the Fed when their funds run low. This agency is charged with carrying out the government's monetary policy by making the decisions about the money supply.
When the economy is slow, the Fed increases the money supply to make more funds available for business expansion and consumer spending. This helps to stimulate growth in the economy. When the economy is growing at too fast a pace, with prices rising in an inflationary spiral, the Fed decreases the money supply. With fewer dollars available for businesses and consumers, the economy slows down and inflation begins to fall. Later, after inflation is brought under control, the money supply can be expanded again to promote growth, and the cycle begins again.
To carry out the governments monetary policy, the Fed has three tools. It can: (1) change the reserve requirement (i.e., the amount of money commercial banks are required to keep on reserve with the Fed); (2) buy and sell government bonds; and (3) set interest rates.
The Fed has tremendous impact on the U.S. and Puerto Rican economies. When the Fed expands the money supply, it is known as a time of easy money. An easy money policy is always popular with consumers because it means they will be able to obtain low-interest loans. The Fed pursues an easy money policy when there is high unemployment or when the economy is sluggish. Easy money boosts production and creates jobs. However, it can also lead to a rise in inflation and high prices. Contracting the money supply, on the contrary, is known as a time of tight money. This policy is seldom popular with consumers because it means that loans will be harder to obtainand at a higher interest rate. It is employed during periods of high inflation to slow down the economy by lowering consumer demand for goods, which eventually leads to higher unemployment. For the most part, the Fed attempts to strike a balance between both policies in an effort to maintain economic stability.
Fiscal Policy. Fiscal policy is the government's plan for collecting income (taxes) and spending money (expenditures). This is the one tool under the direct control of the Puerto Rican Government. The governments budget determines how much revenue it must collect to fund its own pre-determined social goals. The money it decides to spend on its programs has a direct effect on jobs, individual spending and, ultimately, its security and stability.
The Puerto Rican Government needs to collect money from its citizens to pay for the salaries of government workers and programs designed to meet collective needs. The amount of taxes imposed has a profound effect on the economy, and the amount of money each person has left after paying taxes will largely determine the overall level of spending for goods and services. When the government increases taxes, consumers have less money to spend and the economy slows down. Higher taxation can be used to help reduce inflation or reduce this burden in an attempt to help fight unemployment and stimulate a sluggish economy. Similarly, when the government increases its overall spending for goods and services, more money is pumped into the economy and production and employment levels rise. When the government decreases spending, it has the opposite effect.
Trade Policy. When nations trade, their economies grow faster than they would if all goods and services were produced for just their own people. Most countries have a particular comparative advantage, such as location, climate, skilled labor, capital (money for investment) or technical superiority, that enables them to make certain products at a lower cost than other countries can. Comparative advantage allows every country to profit by trading the goods it produces most efficiently for products made more efficiently by other countries. In this way, trade increases a country's standard of living.
Businesses look to the government to further their interests in the international marketplace. Economic interdependence makes all countries vulnerable to the actions of foreign competitors. U.S. trade policy is designed to promote its industry both at home and abroad with an eye to ensuring economic growth domestically and free competition internationally. Like other nations, however, it often uses measures to hamper imports considered harmful to its self-defined national interests. Tools that restrict imports are considered trade barriers, or protectionism. They include: tariffs (taxes imposed on foreign products) and quotas (limits on the amount of foreign goods to be imported). Many economists believe that industries that cannot compete in the international market should not be given help. Protectionist policies can backfire and lead to higher prices for domestic products and/or cause other nations to erect their own tariffs and quotas in retaliation.
