State intervention in the economies of developed countries

In the second article on the NRM successes
and challenges which was published in the Weekly Observer, I pointed out that
because of imperfections in the functioning of the market forces, governments
have had to step in to correct those imperfections or to provide services that
do not fall within the comparative advantage of the private sector. I gave
examples of such interventions from developing countries.

Some observant readers pointed out that I
did not draw on examples from developed countries as well. They asked me to do
so if such examples existed in order to have a balanced presentation. This article
is designed to do just that with reference to the
United States of
and the United Kingdom – the two
developed countries that I am fairly familiar with.

When Franklin D. Roosevelt (FDR) became
President of the
United States, he inherited an
economy that had been devastated by the Great Depression of the 1930s. Banks, small
businesses and factories had closed. Farm prices had plummeted, falling below
the cost of production and transport to the market, leading to the paradox of
food rotting in the fields while urban poor populations starved. Unemployment
rose from under 500,000 in October 1929 to 17 million or 25 percent of the
labor force in January 1933. At that time no tradition had existed of
government intervention in the
United States economy. The
economy corrected itself under the ‘invisible’ hand of the market forces.
However, this time, the extent of human suffering particularly of the poor and
the vulnerable: the old, the sick and single parent families demanded
government’s rapid and effective response. FDR convened a special session of Congress (parliament) that passed laws
to speed up economic recovery, provide relief to the victims of the economic
hard times and to make reforms in financial, business, agricultural and
industrial sectors. The programs under the ‘New Deal’ (a belief in national
planning as opposed to an individualistic, intensely competitive, laissez-faire
economy) reached directly into the lives of every American as millions received
relief, got jobs or aid with credit. The Public Works Administration
appropriated $3.3 billion for hiring the unemployed to build roads, sewage and
water systems, public buildings, ships, naval aircraft, and a host of other

The Tennessee Valley Authority (TVA)
provided assistance for flood control and the construction of dams to generate
cheap electricity; soil erosion control mainly through reforestation and better
farming methods such as contour plowing; produced fertilizers and introduced
education programs. These programs contributed to the economic recovery and had
a long term impact on the economy and society. They created jobs, improved the
purchasing power and in the process got business going again. As a result of
government borrowing, the deficit rose from $22.5 billion in 1933 to $40.5
billion in 1939.

From the 1960s the world economy
experienced difficulties which degenerated into stagflation (stagnant economic
growth, rising inflation and unemployment) in the 1970s that could not be
solved by the Keynesian approach of demand management through deficit financing
to achieve full employment. The right wing economists blamed the economic hard
times in the 1970s on the Keynesian economics. They proposed that a monetary
policy (monetarism) to control the quantity of money in circulation be
instituted to ensure non-inflationary sustained growth without government
interference. However, governments that followed this advice soon abandoned it
in favor of intervention.

When John F. Kennedy became President, the US economy was
experiencing difficulties and unemployment was high. Government intervention
became necessary to boost the economy through tax cuts and deficit financing.
The program was continued under his successor, Lyndon B. Johnson. The economy
responded favorably, national output surged, unemployment declined and the gap
in the federal budget narrowed as rising national income increased tax

Johnson was succeeded by Richard Nixon who
inherited inflation. Consequently, he adopted a tight monetary policy. The
result was a recession and unemployment which rose from 3.5 to 6.0 percent of
the total labor force. Nixon switched from a restrictive to an expansive fiscal
and monetary policy. He became a Keynesian as a result of his intervention in
US economy to correct
free market imperfections.

When Ronald Reagan
became President, he was determined to tame inflation, curb the role of
government in the economy and remove regulations in order to release individual
and business energies as the engine of economic growth.

The Federal Reserve
(Central Bank) implemented a restrictive monetary policy through high interest
rates. Inflation was brought down but the policy caused a steep recession in
1981-82 considered to be the worst in the postwar period. The recession pushed
unemployment to a post war peak of more than 11 percent. Alarmed by these
developments which were politically untenable, the Federal Reserve dropped its
professed monetary policy and together with the Treasury Department adopted a
stimulus monetary and fiscal or pro-growth policy characterized by tax cuts and
deficit spending to stimulate aggregate demand and economic growth.

The economy
responded favorably to Reagan’s intervention growing at an average annual rate
of 3.2 percent with low inflation. The excess capacity accumulated over the
1981-82 recession period helped to keep inflation down. For this reason, Dennis
Healey, a former British finance minister concluded that it was the Keynesian
economics of government intervention rather than the power of the free market
(supply-side economics) that led to the economic recovery and sustained growth
during Reagan’s presidency. The recovery began when the Chairman of the Federal
Reserve relaxed monetary control in 1982.

In Britain Prime Minister Margaret Thatcher
declared her determination to control inflation as her first economic priority by
reducing the quantity of money in circulation, cut public-sector investments
and reduce the role of government in the economy. The steep rise in interest
rates that followed the reduction in the money supply led to a deep economic
recession from 1979 to 1982. Unemployment rose from 5.4 to more than 12 percent
or three million people. The restrictive monetary policy was abandoned in 1983
when it became clear that the relationship between the money supply and
inflation hardly existed. Thatcher’s government borrowed 6 percent of
Britain’s GNP – one of the
highest public debt ratios in the world – to stimulate the economy, create jobs
and end the recession.

Before concluding, it is important to
remember that in the 1960s and 1970s, African governments pursued a Keynesian
approach and intervened in the economy to boost growth and create jobs.
However, since the 1980s, the donor countries have regarded the Keynesian
economic approach as an obstacle to development and imposed the neo-liberal
policy of free trade and private sector as the engine of growth. Having failed
to deliver after more than twenty years, structural adjustment or the
Washington Consensus has thus been abandoned in favor of an effective and
strategic state intervention.

When the NRM came to power in 1986, it
inherited an inflation rate in three digits. With advice from foreign advisers,
the government assigned top priority to inflation control. The quantity of
money in the economy was reduced, hiring in public institutions was restricted
and interest rates were raised. With the assistance of huge excess capacity in industry,
agriculture and labor market as well as generous donor funding and remittances,
the economy grew fast from a low base in areas where peace and security
prevailed, the supply of goods and services increased and inflation came down.
With excess capacity almost used up and donor funding declining, economic and
social strains are beginning to show as witnessed by increasing unemployment
and poverty.

To avoid further deterioration, it is high
time that the relevant authorities worked out an intervention package of
programs to create jobs and stimulate economic growth. The interest rates will
need to be managed in such a manner that they permit borrowing by small and
medium enterprises to take place. Keeping interest rates so prohibitively high
for the sake of low inflation is increasingly becoming counter-productive. The
Central Bank needs to be pragmatic especially in view of the fact that the IMF
has accepted a reasonable level of flexibility.

It is worth stressing by way that
government moderate deficit financing is not necessarily a bad idea provided
the resources are invested in productive activities that generate revenue with
which to retire the debts. Trouble occurs when the government borrows and
spends on consumption or mismanages potentially productive investments.