Question

2) Discuss: If the economy runs most efficiently when left on its own (Adam Smith’s invisible hand), then why do we need government involvement? Do you think government should be so heavily involved in our economy?

Answer 1

The concept of the "invisible hand" was explained by Adam Smith in his 1776 classic foundational work, "An Inquiry into the Nature and Causes of the Wealth of Nations." It referred to the indirect benefits for society that result from the operations of a free market economy.

Smith's theory of the invisible hand constitutes the basis of his belief that large-scale government intervention and regulation of the economy is neither necessary nor beneficial. Smith put forth the notion of the invisible hand in arguing that free individuals operating in a free economy, making decisions that are primarily focused on their self-interest logically take actions that benefit society as a whole, even though such beneficial results were not the specific focus or intent of those actions.

But even if the economy runs most efficiently when left on its own (Adam Smith’s invisible hand), we need government involvement because of following fuctions of govt. intervention:

Impartiality:     In a free market, inequality can be created by privilege and monopoly power. Without government intervention, firms can exploit monopoly power to pay low wages to workers and charge high prices to consumers. Without government intervention, we are liable to see the growth of monopoly power. Government intervention can regulate monopolies and promote competition. Therefore government intervention can promote greater equality of income, which is perceived as fairer.

Maximizing social welfare is one of the most common and best understood reasons for government intervention.

Addresses inefficiency: Governments intervene in markets to address inefficiency. In an optimally efficient market, resources are perfectly allocated to those that need them in the amounts they need. In inefficient markets that is not the case; some may have too much of a resource while others do not have enough. Inefficiency can take many different forms. The government tries to combat these inequities through regulation, taxation, and subsidies. Most governments have any combination of four different objectives when they intervene in the market.

Rawls social contract. Rawls’ social contract stated that the ideal society is one where you would be happy to be born in any situation, not knowing where you would end up. Using this social contract, most people would not choose to be born in a free market because the rewards are concentrated in the hands of a small minority of the population. If people had no idea where they would be born, they would be more likely to choose a society with a degree of government intervention and redistribution.

Macro-Economic Factors: Governments also intervene to minimize the damage caused by naturally occurring economic events. Recessions and inflation are part of the natural business cycle but can have a devastating effect on citizens. In these cases, governments intervene through subsidies and manipulation of the money supply to minimize the harsh impact of economic forces on its constituents.

Macro Economic Intervention: In recessions, there is a sharp fall in private sector spending and investment, leading to lower economic growth. If the government also reduce spending at the same time, there is an even bigger fall in economic growth and collapse in confidence. In a deep recession, governments can borrow from the private sector and spend the money to employ unemployed resources. If there is a collapse in the money supply, there may be a role for the Central bank or Government to print money.

Similarly, the government may need to prevent an economic boom and explosion of credit.

Socio-Economic Factors: Governments may also intervene in markets to promote general economic fairness. Government often try, through taxation and welfare programs, to reallocate financial resources from the wealthy to those that are most in need. Other examples of market intervention for socio-economic reasons include employment laws to protect certain segments of the population and the regulation of the manufacture of certain products to ensure the health and well-being of consumers.

Other Objectives: Governments sometimes intervene in markets to promote other goals, such as national unity and advancement. Most people agree that governments should provide a military for the protection of its citizens, and this can be seen as a type of intervention. Growing a large and impressive military not only increases a country’s security, but may also be a source of pride. Intervening in a way that promotes national unity and pride can be an extremely valuable goal for government officials.

In spite of all such benefits of govt. intervention I don’t think that government should be so heavily involved in our economy because Governments is liable to make the wrong decisions – influenced by political pressure groups, they spend on inefficient projects which lead to an inefficient outcome. Secondly Government intervention takes away individuals decision on how to spend and act. Economic intervention takes some personal freedom away. Thirdly the market is most efficient at deciding how and when to produce.

Hence the main issue is the extent to which the government should intervene in the economy. There is no real model of a society which runs in the absence of government intervention. Even the most extreme libertarian economists would accept there needs to be some state protection of property rights and spending on national defence. The debate comes on the extent of government intervention. This needs to take place in each aspect of government intervention. So the govt. intervention should be to a limited extent keeping in view the overall factors for the smooth functioning of economy.