Role of Government in Mixed Economy: Public & Private Sector

6 months ago

Atiqur Rahman

18 minutes

Introduction

Classical economists were proponents of Laissez-faire – a government free market system. They advocated limited government intervention and believed in the existence of ‘an invisible hand’ that would restore full employment in the economy. However, the Great Depression of the 1930s exposed the loopholes and vulnerabilities associated with the price mechanism and the market system.

The period of 1920-1930s saw the rise of Keynesian economic theory that forcefully argued in favour of government intervention in economic activities. It argued that fiscal policy can generate employment and can maintain it at high levels too.

There was a growing concern for greater equity via income distribution. The subsequent periods saw the expansion of the government’s role in social and economic activities across countries.

Moreover, the rise of command economies of the Soviet Union and the Eastern European economies created pressure for a larger government role in social-economic affairs.

Various intellectuals saw virtues in these upcoming economic systems, and market-oriented economies such as the US gradually moved towards a ‘mixed economy system’ with increasing government expenditures.

The term “mixed economy” was introduced to describe an economic system that matches the characteristics of the pure market and the planned economy, forming a mix of competitive and non-competitive mechanisms of creation, distribution and application of national resources.

The whole theory of mixed economy has been established as the growth of the role of the government and the creation of the public sector in a capitalist economy.

Concept of Mixed Economy

The Great Depression sowed the seeds of government participation in economic activities. It exposed the problems associated with the market system and called for active government participation, as, in Keynes’s view, the public was not satisfied with the private sector.

Keynes called for fiscal measures to spur up investment and demand in the economy. He argued that public spending on social and economic infrastructure can provide the necessary boost to the economy and raise effective demand and thus can be instrumental in economic growth.

In preceding years, there was a growing consensus among the policymakers that markets can fail and the government has all the required expertise, knowledge and resources that can correct market failure. Apart from protecting the nation, it can arrest growing inequalities, can curb poverty, generate employment, raise investment and stabilize the economy.

Economists came to believe that a higher level of public spending could compensate for the lack of private investment and could make the economy recession-proof.

Apart from economic developments, political developments also played a part in the growing government presence. Both Socialist and fascist ideologies arising from the Soviet Union and Eastern European nations pushed for an overwhelming role of government in the allocation of resources and income distribution.

The increasing popularity of the government’s action contributed to the rise of public spending in market-oriented economies such as the US, Canada, the United Kingdom and Australia.

Thus, the period of the 1950s and 60s saw a rise of market economies or ‘welfare states’ in some countries and marked the end of Laissez-faire. In the US, public expenditure as a percentage of GDP rose from 9.9% in 1929 to 28.4% in 1958.

Thus, a mixed economic system is one in which both public and private sectors play an important role. The two sectors coordinate with each other in the decision-making process covering economic activities in general and resource allocation in particular.

Shonfield (1984) describes a mixed economy as “A mixed economy is one in which prices and supplies of goods and services are largely determined by market processes. At the same time, the state and its agencies have a large capacity for economic intervention, which is used in an endeavour to secure objectives that the market would, it is believed, not achieve automatically or not fast enough to meet the requirements of public policy.”

In simple terms, it is a system where market forces and government regulations simultaneously operate in the spheres of production, consumption, and distribution.

Before discussing this further, it is essential to distinguish between institutions classified as the government from the private ones. The individuals running the government institutions are elected through a voting process or are appointed by the ones elected.

Whereas the individuals running a private institution are chosen by the shareholders or are self-nominated. They lack the right of compulsion, which a government is endowed with. The government can force its citizens to pay taxes, can seize properties, restrict production and so on, whereas all private exchanges are voluntary.

As we know, the public and the private sector are vital elements of a mixed economy. Coordination between the two determines the success of an economy.

The public sector is composed of enterprises which are owned and controlled by the government. Such an entity includes institutions such as hospitals, government-run schools, state offices, defence, local and state government management and their departments etc. They engage in the production, delivery and allocation of goods and services by and for the government or its citizens, whether national, regional or local/municipal, with the aim of maximizing social welfare.

On the other hand, the private sector is composed of private organizations that are not owned and controlled by the government and are run for private profits. All small businesses, corporations, profit and non-profit organizations etc., constitute the private sector.

Role of Government in Mixed Economy: Public & Private Sector

Markets are not able to achieve economic efficiency in all economic activities all the time. There is some dissatisfaction with the way markets operate. Such problems are classified as market failures – the inability of markets to achieve Pareto optimal outcomes.

Weaknesses associated with the market system:

Failure of competition where a single or few firms dominate markets can result in undesirable consequences such as higher prices, less than socially optimal output, fewer choices and compromise on quality etc.
Another weakness associated with a market economy is that it cannot protect individuals such as the elderly, disabled who lack adequate ability, knowledge and are less informed to make informed rational decisions. Information required to assess the products can be costly, technical and time-consuming to acquire and evaluate. For example, there is a lack of an organized system to ensure that products offered for sale are genuine and safe such as chemicals.
The externalities associated with the production and consumption activities of individuals can result in significant costs for third parties. The profit-driven and cost-minimizing efforts of businesses can lead to significant external costs for society, for example, environmental degradation caused due to a power plant in a locality.
Market failures are also an outcome of age, gender and race discrimination of workers resulting in unequal treatment and inefficient use of labour resources.

A market economy left to operate itself can lead to inequality in income distribution on the one hand and promote monopolistic tendencies on the other hand.

Moreover, such economies are prone to widespread economic fluctuations unless regulated. Growing industrialization and urbanization, with large benefits, brings with them a host of economic and social problems and builds pressure on scarce economic resources.

The problems associated with the provision of health, education, housing, social security and other social-economic infrastructure are counterparts of rapid industrialization. Economic development also calls for the development of other sectors, such as agriculture.

Very often, a market economy system, especially in an underdeveloped country, neglects the growth of its agriculture and other indigenous sectors. Such problems can be effectively tackled only through the intervention of local and state government agencies.

Another factor, which distinguishes a mixed economy from a market economy, is the incorporation of planning in the development process. Planning is important in the case of underdeveloped and developing economies suffering from a lack of productive investment and infrastructure.

Most part of the savings is channelized into unproductive activities such as jewellery and real estate. Hence, the public sector can act as a catalyst in mobilizing such savings into productive uses.

Thus, government intervention is required to address an economy’s market failure and to compensate for the lack of private sector initiatives. With government intervention, an economy moves from the status of a pure market economy to a ‘mixed economy’.

Government alters the private sector behaviour through the legal system and regulations, taxes and subsidies, through lending activity and through publicly provided services.

The government influences the decision-making process through some general ways, such as-

The Establishment of a legal framework- property rights, contracts, court procedures, and other matters that guide how businesses and households operate.
Government regulation- the government intervenes in business decisions through regulations on pricing, profit and other managerial decisions to address problems such as pollution, availability, product safety etc.
The government intervenes in the labour market to ensure workers’ rights and protect their interests.
The revenue and expenditure policies of the government impact the economic activities of a country. These policies exert significant influence on employment and inflation conditions. For example, an expansionary fiscal policy during periods of an economic downturn can help boost the aggregate demand and employment in an economy. The expenditure policies also have a direct impact on certain industries and markets, such as defence.
The government also engages in social security programs such as income and employment support programs. Such programs help to improve the employment and earning potential of individuals and boost the supply of a skilled labour force.

Overall, as pointed out by Shonfield (1965), there are five aspects of government’s role in a mixed economy-

First, the government’s influence on the management of economic systems has vastly increased. This operates differently among countries; in some countries, the banking system plays a decisive role, whereas, in some other countries, public enterprises exert a significant influence on economic activities.
Second, increasing public expenditure is incurred on public welfare or in Keynesian demand management.
Third, the government’s regulatory measures, such as property rights, quotas, contracts etc., regulate the market functioning and encouragement of long-range collaboration between firms.
Fourth, government economic policy includes an active industrial policy to promote small-scale industries, promote research and development, boost exports and the training of workers.
Fifth, and finally, governments are open to long-range national planning, both in the public and in the private sector.

Shonfield (1984) highlights the objective of government intervention, “The ‘degree of mixedness’ is not determined by the size of the public sector or the proportion of public expenditure to the national income. It is the function adopted by the state rather than its mass, which counts. Governments and their agencies intervene either to accelerate a market process, or to delay it, or to bias the market in a certain direction by means of subsidies or taxes or by direct regulation. States attempt to reduce the losses of output and welfare which are caused by fluctuations in private business sentiment and activity.”

Government intervention in a mixed economy can be illustrated through the following examples-

In the input market- through anti-discrimination laws, wage legislations, and laws related to bargaining.
In the output market- through direct provision of certain goods and services, that is, public and merit goods, purchase of goods and services, consumer protection laws, tariffs, subsidies and quotas on domestic and international trade etc.
In the Business sector- through public utility regulations, monopolistic restrictions, corporate income taxes etc.
In the household sector- through inheritance laws, personal income taxes, transfer payments, welfare schemes etc.

There is no doubt that price mechanism cannot assure microeconomic efficiency and has often led to high unemployment and economic instability. Hence, government intervention has become an important component for correcting market failure and for ensuring economic stability.

It can supplement the private sector and act as an agent of economic development. The public sector assumes even more importance in underdeveloped and developing economies that lack adequate resources, and suffer from widespread poverty and unemployment.

And following are some important features that highlight the role of government in a mixed economy-

The simultaneous existence of and Coordination between the Public and the Private Sectors.
Allocation of Resources through the price mechanism and government directives.
Protection of Consumer’s choice and their sovereignty.
The arrangement of definite economic planning for the Public Sector enterprises.
Government intervenes and regulates the profits of the private sector.
Promotion and ensuring the Social Welfare of the citizens.
Implementing effective fiscal policy and monetary policy conducive to economic development.
Encouraging technological progress to promote efficiency in the economy.

The government participates in a mixed economy through various measures such as:

Direct participation
Regulatory or Indirect measures
Direct physical controls

Direct Participation

The government directly participates in many economic and social sectors. For example, in India, the industrial policy of 1956 gave the government monopoly over major industries. The Indian government still continues to enjoy exclusive control over sectors such as railways, defence, atomic energy etc. The government exclusively performs economic activities such as those targeted towards poverty reduction.

Regulatory or Indirect Measures

The government can resort to indirect measures such as taxes, subsidies, tariffs etc., to achieve the planned targets. For example, the government can resort to higher import duties to curb imports, restrict money supply during periods of inflation through the central bank’s intervention etc. It can also resort to regulatory measures to control the private sector so as to achieve desired social-economic objectives.

Direct Physical Control

The government can resort to direct physical control measures such as quotas, licensing and other rationing system to direct allocation of resources. Such measures are adopted in situations where government does not want to directly enter or when regulatory measures fail. For example, export restrictions in event of the scarcity falls under the category of direct physical controls.

Role of Government in Under-developed Economies

Government intervention in the form of public sector activities is inevitable in the case of underdeveloped countries that suffer from economic rigidities and a vicious circle of poverty and underdevelopment and where market failure may be even more severe. This vicious circle can be broken through comprehensive government planning.

The process of economic development is held up in the early stages due to lack of economic and social infrastructure such as health facilities, education, highways, telecom etc. in under-developed countries. Provision of such social overheads will create external economies for expansion of the private sector.

However, there is a lack of private initiative in the provision of such overheads because it requires huge capital outlays, long gestation period and low and uncertain returns.

Moreover, return accrues in the form of say high standards of education, an organized transportation network etc. which accrue to the society as a whole rather than to individually to a private investor who undertook investment in the creation of such infrastructure.

Hence, private investors find such expenditures not highly profitable and as a result, there is a lack of private investment in such areas. The private sector lacks the capacity and necessary approach for undertaking such development initiatives.

This necessitates direct government intervention. The government can raise the necessary resources for building such infrastructure through modes of taxation, public debt and deficit financing.

Another area where undeveloped countries suffer is the lack of resources and adequate skills. The markets, as we know, cannot allocate all resources efficiently all the time. They suffer from both incentive and information constraints. Thus, the government through planning and scheme of priorities can lead to efficient allocation of scarce resources.

Besides, the private sector in these countries lack attention to the long run problems and objectives of the economy and rather concentrates on short term profit objectives, are unprepared and reluctant to invest in social projects, suffer from uncoordinated economic decisions among various sectors of the economy.

Importance of the Public Sector in the Economy

The problems associated with the functioning of the price mechanism are a strong rationale for the growth of the public sector. An efficient and effective coordination between the public and the private sector is an imperative requirement for the development process.

The public sector has three important roles to play-

Compensatory or Substitutive Role:

The need for public sector arises when there is a need to compensate for the deficiency of the market system. It can substitute for the private sector and perform corrective productive and distributive activities and at the same time ensure efficient utilization of scarce resources.

For example, the power sector, exclusively, in the hands of the private sector is prone to monopolistic tendencies or externalities. The control of government, through regulations, over the power sector is the remedy for such situation.

The public sector also makes up for the deficiencies of the market system in the achievement of socially desirable objectives such as those concerning health and education. The private provision of such services has been often inadequate and inequitably distributed.

The Adjunctive Role:

The public sector plays an adjunctive role in the provision of public and merit goods. The market fails in the assessment of true preferences of the individuals for goods satisfying social wants and thus does not provide such goods.

The Competitive Role:

The public sector plays a competitive role in provision of merit goods in order to keep the private sector’s monopolistic tendencies in check. The government either directly provides these goods or subsidizes the private sector provision of these goods.

Overall, the success of all these governmental efforts depends upon the administrative competence of the government. It should aim for an environment conducive to the efficient functioning and coordination between various players of the market system.

Creation of a right incentive and information structure for the private sector will attract the right amount and quality of private investments.

In poor economies, it should take care of crucial activities such as health, education, and infrastructure and ought to be active in the fields of social security and at the same time should refrain from activities where the market system is already efficient.

Role of Government in Mixed Economy: Public & Private Sector

Introduction

Concept of Mixed Economy

Role of Government in Mixed Economy: Public & Private Sector

Direct Participation

Regulatory or Indirect Measures

Direct Physical Control

Role of Government in Under-developed Economies

Importance of the Public Sector in the Economy

Compensatory or Substitutive Role:

The Adjunctive Role:

The Competitive Role:

Read More in: Theory of Public Finance

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Introduction

Concept of Mixed Economy

Role of Government in Mixed Economy: Public & Private Sector

Direct Participation

Regulatory or Indirect Measures

Direct Physical Control

Role of Government in Under-developed Economies

Importance of the Public Sector in the Economy

Compensatory or Substitutive Role:

The Adjunctive Role:

The Competitive Role:

Read More in: Theory of Public Finance

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