Chapter 19
Government’s Role: Past and Future
Earlier writers on economics often referred to the topic as political economy. That phrase captures the intertwined relationship of how government polices impact the performance of the economy and vice versa. Economic models do not typically have a factor in their models for politics, as it does not fit well into quantitative analysis. However, big changes in policies can have a huge impact on the economy and specific investments. Investors have to remember that policies can change valuations.
Social media is diversifying and accelerating the communication of political ideas and causes. It may change where the influence on policy comes from and may disrupt the major political parties. There is also a large demographic bubble of the millennials that are impacting the politics in many countries that are more likely to be influenced by digital media than older age groups. All of this may lead to more dramatic changes than in the past. Even in more totalitarian undemocratic regimes the access to information from the internet is forcing some of these countries to open up and liberalize some policies giving more choices to their citizens. All of this means that economic policy can take paths that diverge from the historical trends and can change more suddenly due to rapid real, or manufactured, public reaction. It is too easy to assume the policy stays status quo when planning investments and that is not prudent.
When the U.S. Government Took the Gold—Executive Order 6102
Assuming economic policies do not impact your investments is foolish. Particularly when the political environment is tough or major disruptions occur government policies have a tendency to be more extreme. Crisis is always a time for increases in governmental powers and this was certainly the case during the administration of President Franklin Roosevelt and how he came into office in the United States in the midst of the Great Depression. Some aspects of his New Deal platform may not have seemed as fair as others.
In 1933 President Franklin Roosevelt signed Executive Order 6102 shortly after gaining office. The order required all individual and corporate gold holdings to be given to the government for $20.67 per troy ounce. At that time U.S. dollars were redeemable into gold. Over the next year the president moved the official gold price to $35 per troy ounce,69 which immediately devalued the dollars that had been given to the gold holders, thus the government booked a gain and the citizens a loss. There were exceptions to the gold rules, such as, for use in manufacturing, jewelry production, or if the gold was in coins that had value as collectibles and there was carve-out for five try ounces per household.
There is no question 1933 was a scary time with an incredible crisis in the United States. However, it should not be forgotten that the government can step in and dramatically change the economy or the rules by which the economy is governed. Valuations can change rapidly, due to actions that may not seem “fair” or constitutional.70 There is a generation of voters that have different views on many social issues, have seen, and probably believe in the incredible power of innovation, have experiences and biases from the great recession, and are technologically attuned. They may be anxious to have a different set of rules in the economy and investors have to be aware that the changes can be dramatic.
There are different views of what the government’s role in the economy should be. They tend to vary around three major questions:
- How much should government control the economy?
- What methods should the government use to influence the economy?
- Can these policies work within the political system and maintain support from the citizens?
Politics and economic policies are intertwined and increasingly economic ideologies are being mixed. No one system is right for every economy. It can depend on the size, diversity, institutions, and stages of economic development. Certain systems may be better for one country than another and countries may shift between systems over time.
New blueprints for economic systems are always evolving. Both China and India have shifted more toward market-based systems over the past decades and it has coincided with much greater economic growth, however, these have been evolutions not revolutions and each have evolved their own styles. You can see dramatic changes in China over the last few decades. While not a democracy by Western standards, China has shifted their economic structure and growth has accelerated as market forces have been introduced into their system, which had previously been very centralized. Manufacturing has been a major feature of this expansion. You could argue that manufacturing and infrastructure are more easily run in a somewhat centralized system like China’s, but a transition to a more consumer-based system may be more difficult in such a structure. Meanwhile, India is a democracy, and a very different country culturally than China. India for many years had a government steeped in social democracy, protectionism, public ownership of key asset, and heavy regulation. It has rapidly shifted toward a market economy beginning in the early 1990s. Its economy has grown exceptionally fast, but unlike China its growth has been heavily driven by service industries. While markets are pretty free much of the government interference is still in the form of bureaucracy.
Below is a list of some systems of political economy. It is brief and incomplete. It also mixes some ideas from economics with the world of politics. The goal is to give a flavor of the varied approaches to “political economy.”
–Capitalism is characterized by private property, competition, and noncentralized market mechanisms to determine supply, demand, and prices. This typically is associated with a limited role of government.
–Socialism is most strongly characterized by the doctrine that ownership and control of property should be owned publicly. The view is that everything that is produced is part of the social fabric and everyone is entitled to a share in it. Pricing, supply, and demand are not set in free markets because it can lead to exploitation and only help the rich, centralized governments make most of these decisions (even though they may be made up of rich people that benefit from its decisions).
–Social democracy, while originally focused on a peaceful shift to a fully socialist society, has evolved into a system that generally allows for private ownership but in a very highly regulated environment with extensive limitations on business. As it has evolved it has generally been accompanied by a high level of social welfare programs, which has led to more public ownership of certain industries and high tax regimes.
–Laissez-faire policies espouse as little government involvement in the market place and peoples’ lives as possible. Libertarians tend to favor this approach. Believers in a laissez-faire approach to the economy usually prefer a more monetarist approach to economic intervention, but generally prefer to defer to market forces to move the economy, no matter what level of instability is introduced.
–Monetarism is based on the belief that the amount of money in an economy is the best way to manage growth. This favors influencing the economy through interest rates rather than fiscal policies, preferring to minimize government interference. Monetarism is also closely linked to the view that inflation is a key factor in economic stability.
–Keynesian economics (for the record, much of this theory evolved after Mr. Keynes’s death) favors governments having an activist approach to the economy using fiscal spending to smooth out business cycles. This approach is quite comfortable using taxation as a policy tool and with temporary deficit spending. Managing unemployment tends to be a critical factor of focus in trying to limit capitalism’s inherent instability.71
–United States liberalism tends to favor more Keynesian philosophies.72 This is often based on the belief that capitalism can lead to economic extremes and societal evils. It favors interventionist centralized policies that it believes can smooth out these inefficiencies. This often leads to favoring wealth transfers and higher taxes.
–A socialist market economy is what has evolved in China. Under this evolving model many aspects of capitalism and a fair amount of private ownership is allowed, but all of this is heavily controlled by the government. Markets operate and can drive a certain level of decisions and choices, but this occurs with significant government intervention. The government has exceptional power to claim property and still controls huge parts of the economy through direct ownership or regulation.
Broad-based market systems with a strong sense of private property and competition allow economies to run efficiently and historically have produced the most for their people. They also allow for people to have the most freedom in what they do and what they want to buy as businesses need to react to the consumer, or perish. However, these market-based economies need infrastructure including good information requirements and strong rules of law to work successfully and fairly, this is usually the responsibility of government to put in place, adjust, and enforce.
Market-based economic structures allow for a high level of innovation and change. To be successful a market structure requires competition. Any system that allows for competition, change, and innovation will cause some disruption to incumbent operators and systems. Therefore, market systems produce great good but also have periods of instability often resulting in taking some steps backward.
Sometimes a country’s leadership decides it is willing to trade off prosperity and innovation in order to offer more stability. Certainly growth at any cost is not a good goal. These trade-offs however, usually seem to work better in smaller economies that often have a reasonable amount of wealth. There are also some societies that have varied priorities, such as a religious agenda, and may decide to sacrifice freedom and/or prosperity for other goals. Much of the world is experiencing a long reaching growth trend thanks to developments in technology, this may prove historic as it could last longer than any in recent memory, even though it is likely to have some dips. There are always risks to such a scenario and government actions might be the biggest ones. Over (or under) regulation, aggressive or misguided use of interest rates, or profligate deficit spending and its consequences all could derail the potential for a historic period of growth. The lines between the different approaches to government and economics are not always clear. Shifts from one ideology toward another are not uncommon and can lead to major changes in policies such as taxation or competition. The increased use of social media combined with demographics may cause political changes and more rapid policy changes over the next few years. This can disrupt business models and change the competitive playing field so investors can not be complacent about policy.