In his book “The Wealth of Nations” (1776), Adam Smith reasoned that the state had three duties – defense of the country against invaders; maintenance of justice to prevent inhabitants from oppressing one another; and maintenance of certain public works like roads and support to elementary education. The state should not interfere in the workings of the economy. Adam Smith rejected economic regulation which should be left to the market forces.
The economic difficulties of the 1920s and 1930s especially high levels of unemployment brought into question the ability of the market to regulate itself to achieve full employment.
In his book “The General Theory of Employment, Interest and Money” (1936), John Keynes developed a basic idea – in order to keep people fully employed, governments have to run deficits to keep the economy from slowing. When markets become saturated, businesses reduce investments setting in motion a cycle of less investment, fewer jobs and less consumption that lead to further reduction in investment.
The economy may reach balance but at a cost of high unemployment and social misery. Under these circumstances, it is better for the government to step into the economy through a fiscal stimulus (public spending and tax cuts).
The Keynesian economics of demand management became fashionable between 1945 and 1973 – creating the golden age of economic growth and prosperity. Unemployment was eliminated and inflation was kept low.
From Alexander Hamilton to Friedrich List, supporters of the developmental state have argued for an active role in the economy through building infrastructure and providing financing to the private sector.
From the 1970s the world experienced high inflation, rising unemployment and stagnant economies – stagflation – that created special challenges for the Keynesian economic model which came under attack from the monetarists led by Friedrich Hayek and Milton Friedman. They argued that Keynes had misled governments into believing they could spend their way out of recessions. They stressed the importance of money and individual freedom instead which had been trampled since the end of WW II. Friedman argued that only changes in money supply can affect economic activity and inflation results from too much money in the economy, adding that economies perform better without government interference.
Friedman also reasoned that unemployment would always exist because of people between jobs and new entrants that would not find jobs immediately.
At the start of the 1980s, Conservative governments in
Margaret Thatcher, former British Prime Minister, endorsed capitalism and the market as indispensable to prosperity. She set about dismantling trade unions, privatizing state owned enterprises and downsizing the state and its role in the economy.
Ronald Reagan reversed Keynesian economics in the
Under pressure from the IMF and the World Bank governments began to implement stabilization and structural adjustment programs. The
Globally, laissez-faire has led to economic and social problems including high unemployment, skewed income distribution, environmental degradation and economic decline.
The current recession has demonstrated that state intervention is inevitable through deficit financing to create jobs, increase production of goods and services and raise purchasing power.
The new Keynesian consensus was agreed upon in the communiqué issued by the Group of 20 leading industrialized and emerging economies in November, 2008 in which they agreed to use fiscal measures to stimulate domestic demand within a policy framework conducive to fiscal sustainability.
With high and rising unemployment – 50 percent of university graduates cannot find work – declining purchasing power and slowing economic growth,