Wednesday, August 1, 2007

3 of the Worst Economic Policies

1. Response to Great Depression.

The Wall Street Crash of 1929 precipitated an unprecedented collapse in confidence and economic growth. The fall in share prices caused reverberations in nearly every economy around the world, leading to mass unemployment and falling living standards. The response of most government's was ineffectual and in some cases made the situation worse. True, we have the benefit of hindsight, but at the time time orthodox economics was wholly inadequate in offering solutions. In the face of overwhelming evidence, economic advisers stuck to outdated models which had clearly been proved to be misplaced and useless.

In 1931, the UK had seen an explosion in unemployment to over 20%, output was falling and confidence was at all time low. How did the Government respond? Under the advice of treasury officials, the government decided that the most important thing was to balance the government's budget. This stemmed from orthodox theory that a budget deficit was a bad thing. To reduce the government deficit, the government increased taxes and cut unemployment benefits. This led to the resignation of most labour MPs; but the PM, Ramsey MacDonald was joined by the Conservative party to form a National government and the controversial budget was passed.

Unsurprisingly the effect of higher taxes and lower unemployment benefits was to merely exacerbate the economic slump. Higher taxes and lower benefits merely served to reduce consumer spending further. This fall in spending led to continued deflation and lower output. As output fell, the government budget deficit continued to deteriorate, as lower incomes and lower wages meant lower taxes. Thus the decision to increase taxes and cut benefits, not only made the depression worse, it also failed to even solve the budget deficit. Yet, this belief in the benefit of saving, permeated the national consciousness. There were stories of people collecting up their life savings and sending it to the government. They thought by saving and giving it to the government, the economy would be improved. However, this collected savings, merely created less spending and lower growth. Keynes referred to it as the paradox of thrift

It was these perverse actions that led to Keynes' new economic theories. He argued that to get out of a great depression it was necessary for a government to reflate the economy. Through injecting money into the economy, borrowing if necessary. However, by and large, the interventionist policies, suggested by Keynes, were not adopted with any great enthusiasm. In America the New Deal, did see some money injected into the economy, but as a % of the national economy it was quite small and quite ineffective

2. Agricultural subsidies.

In modern industrialised economies, farmers often fail to reap the economic benefit. As incomes rise people don't want to buy more potatoes. If farmers increase supply, through better technology, it merely serves to create a glut in supply and a collapse in price. Lower prices do not help farmers - people don't want to eat more potatoes just because they are cheaper. Therefore, governments have often felt obliged to subsidise farming; however, the method that they usually choose has merely reinforced economic inefficiency.

The Common Agricultural Policy of the EU guaranteed Minimum Prices for farmers. By giving farmers a guaranteed minimum price encouraged them to supply as much as possible. This led to:
  • Increased use of chemical fertilisers, causing damage to the environment.
  • It created oversupply of food produce. Thus the government were forced to use taxpayers money to buy food nobody wanted to consume.
  • This led to huge oversupply of foods, the butter mountains, wine lakes e.t.c.
  • The EU then decided to "dump" alot of this excess supply on foreign markets. This might be good for consumers of food, however, it is very bad for foreign producers of food. Because of the extra supply from Europe, prices plummeted, putting many farmers out of business.
  • High tariffs on imports of food. To make matters worse, the EU needed to place tariffs on the import of food, to make them as expensive as the artificially high EU products. Tariffs caused economic hardship for agricultural exporters, leading to retaliation on EU exporters.

The net effect of these agricultural policies was:

  1. Higher prices for consumers
  2. Cost upto 60% of EU budget to buy surplus.
  3. Farmers in developing countries adversely effected by import tariffs and lower world prices from dumping of excess supply
  4. Environment affected by encouragement of intensive farming.
  5. High tariffs have been a stumbling block to world trade.

US agricultural policy has been little better. In the US, the added twist is that the government has often been subsidising the production of sugar and corn starch. In effect they have been subsidising unhealthy foods. Contributing to America's poor diet.

3. US Health Care.

The US spend more on health care than any other nation. Yet, despite the huge total cost, there are still huge gaps meaning those on low income, often fail to gain health insurance. The system becomes a lottery, losing your job means you can be subject to losing your health care provision. Private provision is supposed to improve efficiency. But, what happens is that it creates incentives for health insurers to maximise their profits. Getting payment, can involve a long and bureaucratic procedure, where often patients have to go through long procedures to get their health insurance. There is little benefit from maintaining a fragmented and unfair health care system. But pressure from health insurance companies means it has always proved difficult to push through a unified health care system. Universal health care in European societies is far from perfect. There are waiting lists and tax rates are higher. But, it is simpler, more efficient with greater equality in the provision of essential health care.

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