ANSWER : Some
commentators argue that when a financial firm is rescued by the
government in the midst of a financial crisis, the firm’s equity
holders should be wiped out, but the firm’s creditors should be
protected :
- Equity and debt are the two type of
investments done by the common people and institutions. Here,
equity investment makes shareholders, whereas debt investment makes
creditors. Hence, the interest of both the parties should be
protected as it has not to do with the moral hazard. The moral
hazard takes place when the management of the firm takes risky
decisions whose costs are paid by the investors, creditors and
employees.
- Hence, it is the management that is
responsible for the moral hazard and it should be regulated to
control the moral hazard if the government bails out the struggling
firms. Hence, only wiping the equity shareholders will not solve
the problem as these are the people who only provide funds and most
of them don’t take decisions on behalf of the company. So, it will
be an injustice to wipe the equity shareholders.
- Besides, the organization should be
regulated in terms of agency conflict, the presence of independent
directors on board and other government appointed people so that
the scope of any future moral hazard and agency conflict issue is
eliminated.
STABILITY FOR THE LONG RUN
OF THE ECONOMY :
Fiscal
prudence:
- The Code for Fiscal Stability sets
out the broad fiscal framework. Within that framework, the
Governments approach is defined by two strict fiscal rules applied
over the economic cycle: the golden rule and the sustainable
investment rule (the latter requiring the net public debt to GDP
ratio be held at a stable and prudent level).
- These rules reinforce economic
stability, which is vital for growth and employment. The fiscal
stance was tightened very considerably in 1997-98. The new
projections in this Report lock in the fiscal tightening projected
in the March Budget. Between 1996-97 and 1999-2000, public sector
net borrowing will have fallen by 3½ per cent of GDP.
- The Government has set firm plans
for overall spending over the remainder of this Parliament based on
a careful assessment of what can be afforded while still meeting
the fiscal rules and the Governments spending priorities. This sets
the framework for the conclusions of the Comprehensive Spending
Review. The Government has concluded that real growth of current
spending can average 2¼ per cent per annum over the remainder of
this Parliament.
Investment and best use of
assets:
- The Government will establish an
Investing in Britain Fund to renew and improve Britains
infrastructure and public sector. This Fund will allow public
sector net investment almost to double, stabilizing at 1½ per cent
of GDP by the end of this Parliament. Investment will remain well
within sustainable bounds: the ratio of net public debt to GDP is
projected to decline to below 40 per cent.
- This decline is prudent over this
economic cycle. The Government will also continue to improve public
sector asset management to produce a more efficient and effective
use of resources. This includes a program of disposals to release
funds for new investment and the development of new public-private
partnerships.
Stable and long-term
plans:
- The Government is establishing a
firm public expenditure envelope for the next three years. This
gets away from the short-termism, incrementalism and excessive
departmentalism of annual spending rounds. It will end the existing
piecemeal, department-by-department, approach to spending. The
Government is reforming the regime for planning and controlling
spending to improve spending control and promote longer term
planning.
Key factors in the Long run
Economic Growth :
- Accumulation of capital stock
- Increases in labor inputs, such as workers or hours worked
- Technological advancement
Growth accounting measures the
contribution of each of these three factors to the economy. Thus, a
country’s growth can be broken down by accounting for what
percentage of economic growth comes from capital, labor and
technology.
It has been shown, both
theoretically and empirically, that technological progress is the
main driver of long-run growth. The explanation is actually quite
straightforward. Holding other input factors constant, the
additional output obtained when adding one extra unit input of
capital or labor will eventually decline, according to the law of
diminishing returns. As a result, a country cannot maintain its
long-run growth by simply accumulating more capital or labor.
Therefore, the driver of long-run growth has to be technological
progress.