Hey, Big Spender! The Federal Budget: Role of Government in a Capitalist Economy

Role of Government in a Capitalist Economy

In a way, the political arguments that rage on in America are relatively trivial. While there are serious situations to address—poverty, crime, drugs, and terrorism—the vast majority of Americans largely agree on the basic principles that rule the economy.

Most Americans agree on the individual's right to private property; the government's right to issue currency, levy taxes, and borrow money; and the rights of businesses and consumers to enter agreements and to resolve their differences through legal channels. (Immigrants marvel at how easy it is to start a business in America.) Few people believe that laws regarding child labor, toxic waste, food and drug purity, and the financial markets should be repealed.

For some 90 percent of the adult population, the political and economic arguments really amount to whether the federal government should account for 20, 22, or 18 percent of the economy. Legislators of both parties in both houses of Congress grab as much federal money as they can carry back to their constituents, and the constituents don't send it back to Washington in protest.

By and large there is general agreement on the role of government in the U.S. economy, which is to …

• Provide the public goods that society requires
• Issue currency, levy taxes, and borrow money
• Maintain economic order, stability, and growth

Let's examine each of these roles.

The Government Provides Public Goods

Public goods are those that society requires and that benefit everyone, but that the private sector has no economic incentive to provide. Public goods benefit everyone, whether they pay for them or want them or not. The most basic public good is defense of the populace from attack and invasion. This begins at our borders and extends inward to the formation of police forces at the federal (the Federal Bureau of Investigation), state, and local levels. Other public goods include the highway system and traffic lights, clean air and water, and public education.

There is a tradeoff—as always in economics—between public goods and private goods. Societies allocate their resources to both, in a mix that works for them. Some societies employ a mix weighted toward private goods, while others prefer a mix weighted toward public goods. In general, the more developed an economy becomes, the more resources it devotes to public goods.

The government provides public goods by administering the budget and overseeing the delivery of the goods. However, in most cases the goods are actually provided by the private sector. The personnel for the armed services are an exception, but even for defense, most of the equipment and weapons are manufactured by the private sector.

Currency, Taxes, and Borrowing

The federal government issues the nation's currency, levies taxes, and, when taxes don't cover federal spending, borrows money by issuing government securities. We will discuss the federal agencies responsible for these functions later in this section.

Each of these three functions are subject to debate, especially taxes and deficit spending, which we cover in Fiscal Policy and Economic Growth. Currency arouses little debate, although many people first hated the redesign of U.S. money a few years ago.

Order in the Economy!

The federal government in any society tries to maintain order and growth in the economy. Disorder in the economy leads to social unrest and political upheaval. Lack of economic growth leads to unemployment, which also generates unrest. If poor economic growth persists, a nation may even wind up unable to defend itself from attack or invasion. For instance, the economy of the USSR under socialism could not sustain itself, which led to the breakup of the Soviet Union.

Most modern governments take an active role in managing their economies through economic policies. These policies aim to maintain a stable currency and economic growth at a rate that balances inflation and unemployment.

In socialist and communist economies, such as China and North Korea, the government uses central planning to gauge demand and make production decisions. This stands in sharp contrast to the role of government in a market economy. In a market economy, the government usually acts as a referee, ensuring that the market works properly and achieves the goal of delivering the greatest good to the greatest number of people.

Toward that end, the U.S. government regulates certain activities in the market. For example, the Justice Department occasionally launches antitrust suits to limit monopolistic business practices, as it did against Microsoft in the late 1990s. The federal government will occasionally levy tariffs and erect other barriers to trade to protect a domestic market from foreign competition, as it did with certain steel imports in 2002. The Securities and Exchange Commission initiates suits against companies that violate securities law, as it did in 2001 and 2002.

In other words, society uses the government to limit behaviors that could distort the workings of the market for the benefit of a few unscrupulous or powerful competitors at the expense of everyone else.