Describe
Government intervention is generally understood as interference of government in economic system to realize several political-economic objectives. In a classical capitalist system, government did not have any economic role to play. Its interference, in economy, was strongly discouraged, as classical economists believed that government interference, in economy, yielded complications. Therefore, in classical capitalist systems, government abstained from interfering. However, it all changed after 1929 Great Depression, which central monetary authority failed to curb/end by implementing expansionary monetary policy.
To adequately address Great Depression, which had drastically reduced the size of consumption, employment and investment, fiscal instrument was introduced. By the introduction of fiscal instrument, Keynesian-economic system substituted classical economic system.
Most of the economists believe that inherent contradictions of capitalist economic system justify government intervention; therefore, the transition of classical capitalist system to liberal/Keynesian economic system is natural. However, neo-classical economists are of the view that free-market economic system is self-evolutionary, which implies that it is able to produce solutions.
Analyze
The argument that capitalist economic system can produce solutions for the challenges it create is quite weak, especially in context of financial crisis and high unemployment rate. Since great depression, several economic crises have occurred, mild and severe, which the system failed to address appropriately. For instance, the capitalist economic system failed to predict and effectively address 2007 economic crisis (Aikins, 2009). As the severity of the challenge increased, central financial institution (Federal Reserve) and government had to intervene. Federal Reserve expanded money supply (expansionary monetary policy) and government introduced expansionary fiscal policy. Therefore, we can say that prevailing economic system does not have the capacity to produce solutions on its own and it relies on intervention by government and central financial institution.
Examine who may be helped and who may be hurt and externalities and/or unintended consequences
Economic growth and full employment are primary objectives of both state and economy. However, most of the times capitalist economies fail to realize these objectives, which compel government and central financial institution to intervene. For instance, whenever unemployment rate increases more than natural rate of unemployment, central bank, government or both have to intervene. Therefore, we can claim that intervention of government is inevitable, when economic system fails to realize its primary objectives, such as economic growth and high employment rate (Bjornskov, 2016). Though, it is also fact that intervention of government, to realize the objectives of full employment and economic growth, has unintended consequences, which complicates functioning of economic system. In addition, because of the intervention, some groups benefit more than the others.
Unintended Consequences and Its Cost
Governments generally use expansionary fiscal policy to realize primary objectives, such as economic growth and high employment rate. The expansionary fiscal policy includes government expenditure and changes in tax regimes. The most dangerous aspect of this policy is government expenditure, which yields range of challenges. One of the challenges is that it increases the size of government. The increase in the size of government affects its functioning adversely.
Another unintended consequence of government intervention, to realize primary objectives, is crowding-out effect, which increases prevailing interest rate and reduces the size of private investment in economy, which is a serious issue (Mishkin, 2011).
Success and Failure of Government Intervention
The fact that without government intervention, an economy cannot truly get out of economic crisis, which slows down economic growth and increases unemployment rate, justifies government intervention. However, the unintended consequences suggest that method of intervention must be more systematic and precise; it must have a minimum cost.
From the study of all previous economic crises, whether mild or severe, suggests that government intervention (in the context of financial crisis) has high success rate. However, during normal economic conditions, when government interferes, it adversely affects economic system.
Whether Program Should Continue
Expansionary Fiscal policy is not employed frequently, but rather it is reserved for abnormal economic conditions (financial/economic crisis that reduces pace of economic growth and size of employment). It is a very potent instrument, which aids economy to get out of crisis; however, the use of fiscal instrument also has a cost. One of the major backlashes, of the bold use of fiscal instrument, is increase in the size of government.
Other challenge is regarding the crowding-out effect, which reduces the size of private investment. However, as the benefits outweigh cost; therefore, the policy of government intervention, in order to increase pace of economic activity/growth and size of employment, must continue.
References
Aikins, S. K. (2009). Global financial crisis and government intervention: a case for effective regulatory governance. International Public Management Review, 10(2), 23-43.
Bjornskov, C. (2016). Economic freedom and economic crises. European Journal of Political Economy, 45(1), 11-23.
Mishkin, F. S. (2011). Over the Cliff: From the Subprime to the Global Financial Crisis. Journal of Economic Perspectives, 25(1), 49–70.
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