Impact of governments on business and business environments –

Element 1.3
Government intervenes to achieve optimum economic performance. In doing this, governments
usually have four main economic aims.

Low Inflation

 Rate of inflation is the percentage increase in prices over a 12-month period.

 Government policy typically here would be to keep inflation low and stable.
 The main reason for this is that it gives price stability and aids economic decision-making.
This means organisations can set wages, prices and make investment decisions with much
more confidence.

Inflation and interest rates are inter connected,

 If interest rates are lowered, people are able to borrow more money. The result is that
people have more money to spend, causing the economy to grow and inflation to increase.
 Opposite is true for rising interest rates. People tend to save as interest rates are higher,
which means less disposable income to spend, and, as the economy slows as a result,
inflation decreases.

Economic growth

 The rate of economic growth is the percentage increase in national output.

 Governments try to achieve stable economic growth over the long term, so avoiding
excessive periods of non-sustainable short-term growth and the extremes of a recession. (A
recession is where national output falls for six months or more, i.e., growth becomes
negative.)
 Interest rate reduction will encourage consumers to consume more and save less influencing
increased production by businesses. This results in economic growth.
 Government spending also has a similar effect. Higher government spending on
infrastructure and other projects helps to increase money flow in the economy (job creation
and consumer spending) and increase economic growth.
 The intention is to make economic growth stable and less fluctuate.

Low unemployment

 Reducing unemployment is an objective not only for the sake of the unemployed, but also
because it represents a misuse of human resources.
 The provision of unemployment benefits can be a considerable drain on government
resources and cause a significant opportunity cost as these resources cannot be used
elsewhere.
 Lowering interest rate increased govt spending is a way of reducing unemployment as well
since higher level of production driven by economic growth will create job opportunities and
drive down unemployment.
Balance of payments stability

 Businesses may trade locally but in a national economy, it’s important to see the impact of
global factors, such as the importing of goods and services which result is a movement of
currency in and out of the country reacting the balance of trade.
 The intention is to create a balance between foreign currency inflows and outflows and
breakeven.
 Foreign currency inflows being higher than out flows is s very favourable situation but is less
practical, especially for less developed and developing countries.
 If foreign currency outflows is greater than inflows, govt has finance the gap.

In addition to these four main areas, there are other objectives that are becoming increasingly
important to governments.

For example, increasing productivity, care for the environment and equal distribution of wealth
and income. All the above objectives are important; however, different governments will vary in
how they prioritise them

Monetary and fiscal policy

These are known as demand side policies. A demand side policy is a government policy designed to
alter aggregate demand and, in turn, the level of output, employment and prices.

Monetary policy – (Source: https://www.youtube.com/watch?v=IMkLAP_aj3I)

Monetary policy involves influencing the interest rate (cost of money) and/or altering the supply of
money in the economy

Advantages:

• Can be implemented quickly and easily.

• Central banks can be independent and politically neutral.

• Predictable exchange rates with other currencies can be maintained. This means
businesses that either export and/or import can plan ahead with greater confidence.

Disadvantages:

• There may be a time lag (delay) in the effect of these policies on the economy.

• Monetary policy is general and affects an entire population. Higher or lower levels of
interest will affect different parts of a population in different ways. For example, low levels
of interest may encourage spending but discourage saving.
Fiscal policy – (Source: https://www.youtube.com/watch?v=DAF81UKWCOI)

Fiscal policy involves changing the level of government expenditure and/or the levels of taxation to
achieve govt objectives.

Advantages:

• Increased levels of government spending can be used to stimulate economic activity.

• Tax can be used to discourage negative externalities (e.g., taxing polluters).

Disadvantages:

• Can create fiscal deficits if increased levels of govt spending are not matched by increased
levels of taxation.

• Government spending or tax incentives may be spent on imports, which could be a

disadvantage to the national economy and to those businesses that export.

Trade (Source: https://www.youtube.com/watch?v=_tmPnH-JkNg)

The advantages and disadvantaged of free trade

Free trade is when a group of countries agree to have no trade barriers between each other.

Free trade is a “supply side” policy. A supply side policy is a government policy that attempts to
directly alter the level of aggregate supply (rather than through changes to aggregate demand).

Free trade should allow lower prices for consumers, increased imports, benefits from economies
of scale and increased choice.

Advantages:

• The law of comparative advantage. (A country has comparative advantage over another if it can
produce a good at a lower cost, forgoing less goods in order to produce it.) This means that trade
can benefit all countries if they specialise in the goods in which they have a comparative
advantage.

• Reducing tariff barriers leads to creation of trade between countries.

• Increased exports.

• Economies of scale. When increasing scales of production leads to lower long-run cost per unit
of output.

• Increased competition. This may stimulate greater efficiency and may prevent the emergence
of domestic monopolies, oligopolies and cartels.

• Trade as an “engine of growth”. In a growing world economy, demand for a country’s exports is
likely to grow, providing stimulus to growth in the exporting country.
Free trade involves costs as well as benefits. Hence no government provides complete free trade.

Disadvantages of Free Trade

 The infant industry argument. (An industry that has potential comparative advantage but is
too underdeveloped yet to realise it.) Without protection, infant industries will not survive
competition from abroad.
 The senile industry argument. (Industries that are declining and inefficient.) Like infant
industry, senile industry cannot survive without protection.
 The importation of harmful goods.
 Damage innovation and creativity since most products can be imported from foreigh
countries
 Dumping and other unfair trade practices. A country may engage in dumping by subsidising
exports, resulting in prices no longer reflecting comparative costs.

Barriers to free trade

Import tariffs

 Import tariffs are taxes on imports. These are usually a percentage of the price of the import
 Tariffs used to restrict imports are more effective when demand is elastic.
 Tariffs can also be used to raise revenue, but they are more effective if demand is inelastic.
They can also be used to raise the price of imported goods to prevent unfair competition for
domestic companies.
 However, when introducing tariffs, trading partners can also retaliate and introduce their
own tariffs, raising the cost for exporters. Companies may look to cut production costs to
account for tariffs and then can affect the quality of the goods.

Source: https://www.youtube.com/watch?v=OkN5yog3dvQ

Source: https://www.youtube.com/watch?v=Gr-Ld7DnBZQ

Import quotas

 Quotas are limits imposed on the quantities of goods that can be imported.
 Quotas can be imposed by governments or negotiated with other countries, which agree to
import quotas “voluntarily”.
 Import quotas are usually used to protect domestic markets and encourage local industries
and to support the introduction of infant industries.
 When one country introduces quotas, their trading partners tend to do the same, giving the
same reasons. This results in fewer exporting opportunities for all producers and higher
prices for consumers.

Generally tariffs are considered as easier to administer and manage compared to Quotas.

Embargoes

 An embargo is a complete government ban on certain imports (e.g., drugs) or exports to

certain countries (during times of war).
  Embargoes can raise awareness of a political issue and force the embargoed country to
change their approaches. Embargoes also tend to be very quick to take effect.
 However, embargoes can cause restraint of trade, limit communication and can have
unfortunate implications for the general population of the embargoed country

Non-tariff barriers

Quality restrictions

Eg: Set certain Quality standards which decides the ability to import the product to the
country

Limit on age of certain products imported to the country.

EG: Can only import cars which are 5 years old from manufacturing date.

Trade agreements

A trade agreement can be defined as a treaty between two or more countries to establish a free
trade area where trade can take place across borders without tariffs.

Trading blocs (Source: https://www.youtube.com/watch?v=L4PberOpCZ8)

A trading bloc can be defined as a set of countries that engage in international trade together and
are usually related through a free trade agreement or similar association. This makes it easier to
trade between the countries. Outsiders (countries) find it hard to enter and trade in these countries
within a trade block

Eg: NAFTA, EU

If a country is not part of a trading block, you move to WTO rules. Usually a country can only be a
part of one trading block (Eg: NAFTA: North America)
Activity to Attempt

Activity 7
How well your central/national government is achieving in meeting the
four main macro environmental objectives:
a) Low inflation
b) Low unemployment
c) Economic growth
d) Stable balance of payments.

Provide examples of techniques that your government uses to deal with

these objectives.

Activity 8

Discuss:
a) The advantages and disadvantages of monetary and fiscal policy.
b) The techniques available to governments to implement monetary
and fiscal policy.
c) Whether your central government is adopting a monetary or fiscal
economic strategy.

Activity 9

Discuss the advantages and disadvantages of:

a) Import tariffs
b) Import quotas
c) Embargoes
d) Non-tariff barriers.

For each of the above, discuss the potential impacts on businesses.