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A regulated market or controlled market, is a market where the government controls the

forces of supply and demand, such as who is allowed to enter the market or what prices may be
charged.[1] It is common for some markets to be regulated under the claim that they are natural
monopolies. For example, telecommunications, water, gas or electricity supply. Often, regulated
markets are established during the partial privatisation of government controlled utility assets.
A variety of forms of regulations exist in a regulated market. These include controls, oversights,
anti-discrimination, environmental protection, taxation and labor laws.
In a regulated market, the government regulatory agency may legislate regulations that privilege
special interests, known as regulatory capture.
5.7 The role of government interventions in markets

Despite recent free market trends in the world and in Africa, markets in general remain a
subordinate instrument of national political systems and their policies. Government interventions
must work to facilitate market competition and to help the market achieve national policy
objectives.
Government policies and interventions must address more than the objective of "rationalising"
trade, which often results in efforts to make marketing practices conform mechanically to a
modern model. Marketing interventions should take into account the proven capability of the
marketing network. Policies should be aimed at working with the existing system, not at
replacing it. Government attempts to replace free market systems have often raised the costs of
marketing, thereby hurting consumers, distorting resource allocations and damaging the
economy. It is important that policy makers view trading as a necessary and socially desirable
activity carried out in an environment of risk.
The questions to be asked in considering any intervention are: is it really necessary or is it simply
for the sake of government control? What would happen if the intervention wag removed?
Studies of cattle marketing systems in Africa have, in fact, shown that markets often perform
well when left to private entrepreneurs.
It is generally recommended that governments play a facilitating rather than a direct role in
markets. Regulatory interventions should be limited. Appropriate interventions are thus indirect
in nature and have three general aims:
to improve market infrastructure
to improve information
to improve institutional infrastructure.

5.7.1 Improve market infrastructure


Interventions to improve market infrastructure would target roads, rail, market facilities, water
points and health-control infrastructures (i.e. quarantine facilities). Projects for market-sale
points, such as auction yards, need to be better designed and located. In Abidjan, for example, a
new concrete livestock market remained unused next to the traditional open-air market (ArizaNino et al, 1980). In this case, the informal market was already serving an existing need. If

market facilities are provided, they need to be built on existing traditional sites and should not be
so heavily regulated that agents avoid them.
Investment in water points along trekking systems may prove wasteful. Water points can cause
crop damage to neighbouring fields. Often, traders are taxed at these points, which makes them
use traditional routes. Market trails could be created if well located in terms of supply and
demand areas and grazing areas, along the route and water points. Providing grazing reserves
near major livestock markets helps to stabilise the flow of cattle, but fees for such use must be
reasonable if traders are to use them. Such reserves could reduce price fluctuations, reduce risk
and animal weight loss.

5.7.2 Improve information


Information is important for facilitating effective marketing. While traditional information
systems seem relatively effective for livestock markets, one unfortunate consequence of
regulated prices is a lack of information on real market prices.

5.7.3 Improve institutional infrastructure


Improving the institutional infrastructure may be the most important government role in
marketing. Government interventions should promote an open and stable institutional
framework. This may take the form of improving security (i.e. protecting property rights and
contracts) and controlling corruption and violence.
A major difference between "traditional" and "modern" markets lies in the degree of personal
involvement of marketing agents. In a "modern" market system, personal involvement is
minimum; traders operate through institutions which guarantee legality and value. While in
traditional livestock markets transactions are guaranteed by a broker who is known to the traders,
transactions in modern markets are guaranteed through regulations and supporting legislations.
Unfortunately, attempts to provide these regulations have often been badly handled. As a result,
traders have shifted back to operating within the informal sector.
Box 5.6: Government intervention in livestock.
In Africa, government interventions in the market have primarily been in terms of providing
abattoirs, meat packing facilities and milk processing plants. These interventions set prices,
grades and standards for livestock products. Such interventions are usually implemented in order
to control consumer and producer prices through a monopoly framework. Control would be over
grades and quality for standardisation, health or export. The view held is that private trading is
exploitative and inefficient. Thus, government monopolies would produce economies of scale.
These interventions may, in fact, result in inappropriately-located processing facilities, such as
abattoirs in pastoral, low-density areas which cannot supply to plant capacity. In practice, it is
difficult to exploit the potential economies of scale because of chronically under-utilised
capacity.
Capacity under-utilisation is also caused by price policies which pay low prices to producers,
uniform across regions and seasons. The result is an unwillingness by producers to supply at the

controlled price level. Instead, goods are diverted to the informal economy, because private
agents may be able to offer higher farm-gate prices. The result is less use of existing processing
capacity, higher average processing costs and a general decline in the economic viability of the
system.
Institutional attempts to "organise" trade through restrictive licensing or limiting the number of
intermediaries have forced traders to move into the informal sector. In some Sahelian countries,
authorities have tried to limit or reduce the number of traders and organise them along artificial
functional lines. The result has been less competition, less new entry into the market and the
creation of informal markets. Attempts at regulation should promote rather than discourage
competitive marketing to reduce costs. Finally, any new interventions should be made gradually,
since new policies often cause severe market disruptions.
Most governments have not been able to resist the temptation to intervene directly in markets,
particularly by setting prices to create low prices for urban consumers. In general, price-control
efforts reduce the efficiency marketing systems.
Direct government intervention in the form of marketing boards is now also recognised as
generally undesirable. The result has often been to incur additional costs and wastage which
might not occur in a competitive marketing situation. Problems of marketing boards tend to be:
Government management styles and procedures can be too cumbersome for
efficient marketing.

Few incentives exist for efficiency.

Low salaries can produce corruption.


Marketing boards are too often a convenient means for taxing producers and traders.
Since, for marketing boards to operate efficiently, marketing channels need to be few and
concentrated, livestock markets are generally not suited to them.
Box 5.7: The case of Alphabeta: Price intervention.
In Alphabeta, the government adopted a system of uniform producer prices for milk delivered to
the National Dairy Co-operative (NDC). The government gave no consideration to seasonal and
regional variations in milk supply and production. Because informal milk market prices could
not be effectively controlled by the government, they varied seasonally. During the dry season,
when milk was in short supply, producers sold their milk to the informal market which offered
higher prices. The effect of the uniform price policy was, thus, to divert milk to the informal
market during the dry season. During the flush season when informal milk prices were low, milk
was delivered to the NDC. The result was under-supply to the NDC during the dry season and
over-supply in the flush season. The consequent need for additional manufacturing capacity to
cope with the flush supply led to capacity under-utilisation during the dry season and higher
overall processing costs. Further, uniform producer prices in all locations, no matter how remote,
led to higher transportation costs. The higher processing and transportation costs were passed on

to consumers in the form of higher dairy product prices.


5.8 Marketing and national policy objectives

An effective marketing system can contribute to national policy objectives. This section relates
the features of marketing to the five main broad groups of policy objectives as identified in
module 2.
The independence objective aims at obtaining and preserving a satisfactory degree of political
and economic autonomy. Although in general increased trade could be seen as acting contrary to
this objective, an effective domestic marketing system reinforces independence by enabling a
nation to supply its own needs more easily. For example, improvements in the West African
livestock marketing system could enable regional supply of high-quality beef which in some
cases is now imported. Regional marketing systems which replace supplies from world market
sources work towards regional independence.
The self-sufficiency ratio, discussed in module 2, reflects the performance of the production and
marketing systems combined. If the marketing system is defined broadly to include the external
trade factors, then changes in the NPC (module 4) are a measure of changes in the incentives
given by the marketing system to domestic producers in comparison with imports. But when
NPC is calculated, the least reliable data are typically the costs of internal marketing for both
domestic products and imports. They are the key issues in any discussion of the performance of a
marketing system in respect to independence objectives.
The economic efficiency objective focuses on increasing the level of real national income and
its growth rate over time (maximising real income). The attainment of this objective is the most
important contribution of an effective marketing system. In a country where livestock production
is important, improvements in livestock marketing can make a significant contribution to
national economic efficiency and thus growth. The contribution of marketing to this objective is
a result of the optimal allocation of resources which can occur with the meaningful price signals
that a well-working market can deliver. Producers and traders will move in response to price and
other market signals to activities which return the greatest value to the economy. Over time and
on a large scale, the increased wealth made possible from an effective marketing system can add
significantly to national income growth. Livestock, because of its positive income elasticity of
demand, offers opportunities for creating wealth not only for rural smallholders but for the
economy as a whole, due to the development of many new marketing services.
The resource conservation objective concentrates on preserving the natural resource base to
ensure the above two objectives. An improved marketing system may or may not contribute to
this objective. Indeed, market activity in general is often criticised for working against the goal
of resource conservation. It is sometimes argued that, especially in dry areas in Africa, resource
degradation has increased due to integration of these areas into world commodity markets. In
South America, forests have been cut in order to raise livestock for export. If some economic
actors are given the opportunity to exploit natural resources without being responsible for the
long-term damages and costs, resource degradation could indeed occur. Large firms exploiting
natural resources for the market must be monitored by appropriate government agencies.

On the smallholder level in Africa, there have been some cases where increased market
integration has caused environmental degradation. One such example is making charcoal from
trees in rural areas to supply urban demand in Addis Ababa, an activity which accelerated with
the change of government in 1991. But here the factor which led to the problem was uncertainty
of land ownership and use rights. The effect of market integration on natural resources is closely
tied to property rights and land tenure issues (module 7).
There is no conclusive evidence either way concerning the impact of African livestock markets
on the environment. Traditional land tenure systems may moderate the effects. Improved
marketing which causes producers to offer more cattle for sale, rather than hold them for wealth,
may increase offtake rates and eventually reduce the stock using natural grazing resources.
The stability objective attempts to avoid abrupt and large changes in income, in the price and
availability of domestically-produced basic commodities and inputs. One of the main forms of
instability in the livestock sectors of countries with unreliable rainfall is a huge increase in the
flow of livestock into markets when drought strikes, as farmers sell their stock when they are
threatened by starvation. The huge increase in livestock flows, at a time when many potential
consumers are also suffering from drought-induced declines in income, quickly leads to a total
collapse in livestock prices. An improved livestock marketing system is unlikely to avoid this
problem. Better marketing of inputs such as feed and operating capital may allow some farmers
to withstand a drought situation until prices return to normal. In general, effective marketing
systems create stability in supply and prices by allowing surplus regions to supply areas with net
demand, smoothing price and availability differences. Whether this will be effective at the
national or even regional level is uncertain, as the 1992 Southern African drought has shown.
The equity objective promotes the fair distribution of income and wealth within society, among
different types of farms, among regions and between producers. Again, the impact of greater
market integration on this objective is not necessarily positive or negative. If some economic
agents are able to control large market shares, they may increase wealth at the expense of others.
This is unlikely to occur in African livestock markets which are typified by a large number of
small producers and traders. Indeed, a shift from monopoly marketing boards to free market
trade carried out by numerous private enterprises is almost certain to improve the distribution of
income and thus aid the equity objective.
Important points (5.6-5.8)
Marketing interventions should be preceded by an evaluation of existing marketing systems.
Some commonly used methods of market evaluation are:
- assessing the degree of market efficiency in terms of marketing margins
- price analysis
- evaluation of marketing services
- structure, conduct and performance analysis market information and intelligence.
Marketing margin is the difference between the farm-gate price and the retail sale price

received. However, there arc, several basic types of marketing margins, based on market levels
or stages being considered.
A value is added to the cost of a product at each successive stage of the marketing system.
Marketing margins of more that 15% indicate unacceptable market performance. However,
great care. must be used in making conclusions based on marketing margin values alone as many
other factors influence the performance of a marketing system.
Price analysis, as a method of marketing evaluation, examines the price correlation between
markets separated by space and through time
Marketing services, as an indicator of the effectiveness of marketing systems, are difficult to
evaluate. However, the cost of a commodity and marketing structure give an idea of the
effectiveness of marketing -services.
Structure, conduct and performance analysis is used with margin analysis to evaluate
marketing systems. This approach holds that the structure of a market controls the conduct of the
participants and consequently the performance of the marketing system. Accordingly, continuous
monitoring of structural issues should form the basis of market evaluation.
Market information is crucial for producers, wholesalers and consumers taking decisions on
what to buy and sell. Information on prices, traded or available quantities, forecasts of future
supplies and demand and general market conditions are needed for such decisions.
Government policies and resulting interventions should play a facilitating rather than a direct
role in markets.
Three appropriate types of government intervention in marketing systems are:
- improving market infrastructure
- improving information
- improving institutional infrastructure,
An effective marketing system contributes to national objectives by:
- Enabling a nation to supply its own needs of goods and services.
- Facilitating optimal allocation of resources.
- Creating stability in supply and prices by integrating surplus and deficit.
- Improving the distribution of income under competitive marketing.
http://www.fao.org/wairdocs/ilri/x5547e/x5547e1b.htm

The Problems of Price Controls


By Fiona M. Scott Morton
his article is excerpted from the latest edition of Regulation (Vol. 24, No. 1, 2001), the Cato
Review of Business and Government.
One of the most important issues to Americans is how to manage prescription drug prices,
especially for seniors who depend on Medicare coverage. Some policy advocates are urging the
federal government to contract directly with drug manufacturers to purchase drugs for seniors
at prices set by the government. Despite the high-minded intentions of these advocates, such
price controls could be very harmful to Americans future health.
When prices are held below natural levels, resources such as talent and investor capital leave an
industry to seek a better return elsewhere. This means that there will be less discovery and
innovation, and fewer new drugs will become available to consumers. Often this change happens
over the long term longer than the tenure of any policy-maker. Thus, it is vitally important to
remind policy-makers of the effects of price controls whenever they are proposed as government
policy.
DISRUPTING SUPPLY AND DEMAND
The determining of market prices through the dynamic interaction of supply and demand is the
basic building block of economics. Consumer preferences for a product determine how much of
it they will buy at any given price. Consumers will purchase more of a product as its price
declines, all else being equal. Firms, in turn, decide how much they are willing to supply at
different prices. In general, if consumers appear willing to pay higher prices for a product, then
more manufacturers will try to produce the product, will increase their production capacity, and
will conduct research to improve the product. Thus, higher expected prices lead to an increased
supply of goods. This dynamic interaction produces an equilibrium market price; when buyers
and sellers transact freely, the price that results causes the quantity demanded by consumers to
exactly equal the supply produced by sellers.
But when government adopts a price control, it defines the market price of a product and forces
all, or a large percentage, of transactions to take place at that price instead of the equilibrium
price set through the interaction between supply and demand. Since supply and demand shift
constantly in response to tastes and costs, but the government price will change only after a
lengthy political process, the government price will effectively never be an equilibrium price.
This means that the government price will be either too high or too low.
When the price is too high, there is an excessive amount of the product for sale compared to
what people want. This is the situation with many U.S. and European farm programs;
government, in an effort to increase farm incomes, purchases the output that consumers do not
want. This, in turn, prompts farmers to raise more cows and convert more land to pasture or
cropland. However, the higher prices discourage consumers from buying farm products, causing
an excess of supply (e.g. a butter mountain). Government then exacerbates this situation by
continuing to purchase the excess crop at the set price.

Serious problems also result when government sets prices below the equilibrium level. This
causes consumers to want more of the product than producers have available. When the federal
government restricted gasoline price increases in the 1970s, long lines formed at gas stations and
only those motorists who waited long hours in line received the scarce gasoline.
In both cases of government price controls, serious welfare loss results because not enough of the
good is sold. The wasted chance to create both producer and consumer surplus from those sales
is known as deadweight loss because it is income that is lost forever. In addition to creating
deadweight loss, an artificially high price transfers profits from consumers to producers; these
rents are often wasted because producers spend them on lobbying and other influence activities
to maintain the regulated price. In the case of a low price, producers transfer profits to
consumers. Consumers, in competing for a limited amount of the controlled product, may waste
as much as they gain from getting it at a low price. For instance, the people who waited in the
1970s gas lines probably shouldered as much cost from the lost time queuing as they saved from
the price controls on gasoline. (Researchers Robert Deacon and Job Sonstelie have even argued
that the gas lines cost consumers more than they saved from the controlled gas prices.) Thus, the
artificially low prices not only hurt producers, but also consumers.
PRICE CONTROLS AND HISTORY
Government gains favor with voters and constituents when it lowers the price of popular goods.
Government also gains favor from lobbyists and firms when it raises prices to promote the health
of the industry. Given these benefits to policymakers, it should not surprise us that price control
is common in the history of western economies.
Early twentieth century economist Henry Bourne documented the effects of price controls on
France in the years following the French Revolution, when city residents found it difficult to
purchase grain. The grain shortages were not due to any agricultural problems; Bourne noted that
1793 France was a prosperous agricultural nation capable of feeding itself. Instead, the threat of
famine was due to internal procurement and distribution problems created by the government.
For example, agents for the city of Paris, the military, and the government competed with each
other in trying to purchase grain. This created local shortages where none had existed before, and
led to social unrest.
The city of Paris, in an effort to appease the public, decided to subsidize flour. This prompted
bakers from neighboring towns to travel to Paris to purchase flour, creating even more shortages
in the city.
The French Convention, which governed the nation at that time, tried to address the problem by
establishing maximum prices for grain and instructing farmers to supply it to local markets. As
one might expect, farmers did not cooperate with the new law. Markets were empty of grain;
further shortages developed; official tallies of grain supplies failed to find and keep track of
stocks; urban riots continued.
The Convention passed another law later in 1793 extending maximum prices to other essential
supplies. Those price controls, in combination with government requisitioning and corruption,

created chaos in the French economy. Merchants responded by reducing the quality of their
goods and the black market blossomed, Bourne noted. It was the honest merchant who became
the victim of the law. His less scrupulous compeer refused to succumb. The butcher in weighing
meats added more scraps than beforeother shopkeepers sold second-rate goods at the
maximum [price]. The common people complained that they were buying pear juice for wine,
the oil of poppies for olive oil, ashes for pepper, and starch for sugar.
The last century provided many examples of price control-generated economic problems in
communist Europe. Economist David Tarr noted some of these problems in his study of the
distribution of domestically produced television sets in communist Poland. Because the Polish
government kept TV prices artificially low, demand far outstripped supply and televisions
became scarce. A consumer who wanted a TV had to sign on to a waiting list. In most cases, the
consumer had to visit the store every day to keep his place on the list. Tarr calculated that the
social cost of the queue for television sets was 10 times the size of the standard deadweight loss
and that the cost of the price controls on televisions to the Polish economy was more than the
industrys total sales.
In the 1980s, the Ministry of Finance in Japan regulated brokerage fees and prohibited firms
from competing for customers on that basis. However, as documented by economists Kevin
Hebner and Young Park, large corporate customers were very important and lucrative for the
securities dealing industry. The industry found other, possibly corrupt, ways to compete for
corporate business. Securities firms would guarantee corporate investors that certain funds would
achieve a minimum return, effectively reimbursing the client if the investment declined in value.
Securities companies funded this expensive practice with profits earned from the governmentfixed charge for brokerage services to both small and large customers. Hence, the securities firms
turned the price control scheme into a transfer scheme that moved resources from household
savers to large corporate investors.
If government prevents firms from competing over price, firms will compete on whatever
dimensions are open to them. In the era of U.S. airline regulation when the Civil Aeronautics
Board set prices, airlines tried to attract customers with food, empty seats, and frequency of
flights. This form of competition can be as expensive as competing on price. Despite high prices
and protection from new entrants, established carriers competed away their rents and did not earn
high profits.
PRICE CONTROLS TODAY
Despite this worrisome history of price controls, government continues to follow the practice. In
some cases, government disguises these policies with elaborate pricing schemes, but they still
lead to serious problems for producers and consumers.
Rent Control
Rent control provides a classic example of the distortions created by price controls. There are
various forms of rent control, but they all take the shape of legally imposed below-market rates
for rental housing. The results are well documented and perverse. First, a shortage of rental units

arises as landlords become less interested in renting at below-market rates. Instead, the landlords
choose to live in the units themselves, rent them to relatives, or sell them.
This shortage leads to a host of related distortions. For example, since there is a queue of people
willing to rent each apartment and landlords are not permitted to discriminate based on price, the
landlords will discriminate on whatever characteristic they please. Landlords may also ask for
under-the- table payments from tenants or require renters to hand over an initial fee in order to
sign the lease. Moreover, landlords have little incentive to maintain apartments; it is more
difficult to recoup the cost of improvements through the government- established price and, at
the same time, there is a strong demand for apartments regardless of their condition.
Consequently, the quality of housing stock declines and the area may come to attract less affluent
residents. This hurts neighborhood businesses. New housing stock is less profitable to construct
if government controls rental prices; thus fewer investors will engage in that activity and
economic development will slow.
In 1990, the federal government passed legislation setting new price levels that state
governments would pay for pharmaceuticals provided by Medicaid. The rules varied across
drugs, but in some cases Medicaid was entitled to pay no more than the lowest price that the drug
company charged to any other customer.
Such a scheme may sound reasonable, but it distorts incentives in the drug market. Medicaid
uses the existing network of chains and independent pharmacies to distribute drugs to its
members, but many of these organizations do not have the scale to bargain for good prices nor
the control to influence the prescribing physician. In these circumstances, they would not
normally get the lowest price in the market; that goes to large buyers and HMOs or others who
can move market share.
Faced with having to charge Medicaid the lowest price given to any other customer,
pharmaceutical firms reduced discounts. The legislation resulted in an increase in drug
expenditures for many private buyers as drug manufacturers tried to raise prices on government
sales.
MARKET FAILURE
One of the reasons that governments invoke price controls is to ensure that goods and services
are sold at a fair price. In a situation with numerous well-informed consumers purchasing from
multiple sellers who can develop a reputation for high or low quality, the free market works well.
The market price is fair due to the competition between innovators and between buyers.
However, there are occasions when entrants are discouraged or the information available to one
or more parties is poor.
In such cases, government may impose price controls in an effort to protect citizens from
exploitation. This might occur if patients had to choose drugs without the help of physicians, for
example. In such a case, patients might need government protection from high prices for the
wrong medicine. Our modern healthcare system largely removes this concern by employing
informed physicians, pharmacists, and formulary committees who affect drug choice.

Early Puritan communities, described in Hugh Rockoffs book Drastic Measures: A History of
Wage and Price Controls in the United States, abandoned detailed wage and price controls
shortly after imposing them in 1630 and 1633 because they were ineffectual. Subsequent laws
against excessive prices were more vague and, according to Rockoff, aimed to prevent sales
influenced by fraud, ignorance, or short-run monopoliesrather than lowering the equilibrium
price in a particular market. His interpretation is that the Puritans faced under-developed
colonial markets and so competition could not be relied upon to regulate prices and protect
consumers.
A market failure, such as lack of entry, can be mitigated with the right price control, at least in
theory. The difficulty lies in the execution. Typically, no entity is well informed enough to be
able to exactly identify the imperfection, choose the correct price to rectify the situation, and
then provide ongoing adjustment and enforcement.
Competition is a better tool than price controls for protecting consumers; the Puritans appear to
have realized that and gradually ceased using them. As Rockoff writes, One would expect that
as markets grew, producing a smoother flow of informationthe need for regulation would have
decreased. Indeed, that seems to have happened.
More typically, governments try to fix the bad effects of price controls with subsidies to the
discouraged activity. In the case of the pharmaceutical industry, these subsidies go to research
and development. A subsidy could restore the free market outcome by lowering the cost of
research. Again, however, the difficulty arises in choosing the level of the subsidy, deciding
whether and how to award it to for-profit corporations, and avoiding inefficient lobbying and
corruption. In practice, these are very difficult issues to manage in a way that benefits
consumers.
LOWERING PRICES THROUGH THE MARKET
The private sector has found several successful methods for reducing the price paid by a buyer.
In most cases, government can use similar techniques to get a low price for prescription drugs
without disrupting the competitive market.
The most common approach is to take advantage of scale. A buyer representing a large volume of
market transactions can negotiate for a better price by threatening to backward integrate or to
move its business to a competing supplier (if the product is not patent- protected). Moreover, a
large buyer provides efficiencies to the seller. Lower transaction costs (one invoice, one
negotiation, one shipment), guaranteed volume, and economies of scale create cost savings for
the supplier that the two parties can share. The private sector provides countless examples of this
approach; for example, big supermarket chains pay lower prices for packaged goods than corner
stores because of large-scale central purchasing.
A slightly more subtle point of relevance to the pharmaceutical industry is that a buyer with
significant volume can often get an even lower price by helping its supplier increase market
share. Insurance organizations can agree to educate or encourage physicians to prescribe a

certain drug. In return for altering market share in the provider network, the drug manufacturer
offers the provider a lower price.
A buyer can explicitly foster competition where none exists. For example, several large
corporations in the Detroit area recently began funding a small, low-cost airline named Pro Air
that operates out of that airport. The Detroit airport is otherwise dominated by Northwest
Airlines, which charges relatively high prices due to the lack of competition. General Motors,
Masco, and Daimler-Chrysler each pay Pro Air a fixed sum of money per month in exchange for
a certain number of flights for their employees. This gives the start-up airline stability and causes
its competitors to realize that it cannot be driven out of business. By encouraging the entry and
survival of a low-cost competitor to Northwest Airlines, the companies save both on the flights
their employees take on Pro Air, and also through any price reduction Northwest undertakes in
response to the competition.
Another way to obtain lower prices through the market is for an independent organization to
provide information on the competing alternatives to individual buyers. Using this information,
an informed consumer can identify the product that best fits her needs and can demand a
discounted price when purchasing a different product. Many large corporations take this
approach with health plans for employees; the employee may choose among a set of approved
plans and the corporation provides ratings or a scorecard to help employees compare the plans.
The ratings cause plans to compete for customers on the price and quality dimensions.
CONCLUSION
The imposition of price controls on a well-functioning, competitive market harms society by
reducing the amount of trade in the economy and creating incentives to waste resources. Many
researchers have found that price controls reduce entry and investment in the long run. The
controls can also reduce quality, create black markets, and stimulate costly rationing. In the case
of pharmaceuticals, the most damaging area is likely to be the reduction in innovation, which
will harm all future generations of patients.
Although policymakers know that price controls can be very harmful, they continue to have
strong incentives to legislate low prices for themselves. This often leads to the adoption of more
sophisticated price controls. The government pegs its price to some reference price in the
economy rather than choosing a fixed number, or sets its price a fixed amount below that of other
customers. These schemes destroy welfare by inserting a new incentive into what would
otherwise be a well- functioning market; either the price to non-government customers is higher
or the price to poorer customers rises. More generally, the reference price chosen by the
government rises because of the price control, not because of a change in the underlying forces
of demand or supply.
The overwhelming evidence against price controls naturally leads to consideration of other
methods of lowering purchasing costs. The private sector uses a number of methods that are both
effective and consonant with a market economy. Such approaches, when used by the private
market, are much less damaging to economic welfare than a government price contr

http://www.cato.org/publications/commentary/problems-price-controls

Why We Need More, Not Less, Government


n the face of increasing threats to our wellbeing and the inability of the market or individual
efforts to effectively address them, we need to expand public sector programs. For decades,
conservatives have been pushing for smaller government, and have consistently called for
reduced social spending, less regulation, and more tax cuts. But not everyone agrees. When the
financial crisis hit in the fall of 2008 and the economy began to melt down, suddenly there were
calls for bigger and more active government. Many people wanted a massive federal stimulus
plan to ward off an economic depression, and others demanded the widespread re-regulation
of financial markets to prevent a recurrence of these problems.
On top of this, many Democrats have argued for increased government involvement in a wide
variety of areas, ranging from education and energy development to infrastructure repair and
health care reform. But is this broad expansion of the public sector really justified?
Whether we need more government in this country really depends on the answer to three other
questions. First, is there room for improvement in government programs? Have we reached the
limits of what government can do in most policy areas, or could expanding these current
programs produce significant added benefits for the public? Second, are any of our current social
and economic problems worsening? Are we facing new and serious threats to our wellbeing? If
so, this would logically indicate the need for more government. And finally, can we rely on
markets and individual effort to solve these current and emerging problems? If so, then we dont
need more government. But if markets and individual initiative are not up to the task, this
bolsters the case for a more collective, governmental approach. All three of these questions are
complex ones, but as this article will show, we can begin to get some definitive answers to all of
them. These answers strongly indicate that we do need more government not less in the
United States.
Room for Improvement
As impressive as the accomplishments of government are in the U.S., there is clearly room for it
to play a much more constructive role in peoples lives. In fact, many Americans sense this
already. One of the most common complaints about government is that it is not doing enough to
address a whole raft of problems. Sure the air is cleaner than it was, but we still have major smog
problems in many cities. Of course we have done much to reduce poverty among the elderly, but
a high level of poverty among the general population still exists. And while energy efficiency has
improved, we still have an economy that is dangerously dependent on oil and other fossil fuels.
Some may be tempted to conclude from these situations that government simply cant do
anything more to help that we have reached the limits of what government can do in these
areas. But this is not the case. We know that government could actually do much more. How do
we know this? Because governments in many other advanced democracies have already done
much more to effectively address these problems.
In another article, Governments Forgotten Achievements, I cited a study done by Derek Bok
which showed that a myriad of government programs have in fact been successful in addressing
many of our social, environmental, and economic problems. But this study also found that there

is considerable room for improvement. Bok discovered this by comparing the accomplishments
of the U.S. in important policy areas to the accomplishments of the government of other major
democracies primarily those in Western Europe. What Bok found in this comparative study
was not comforting: Over the past several decades, America has moved ahead more slowly than
most other leading countries in most areas of activity that matter to a majority of the people.1 Of
the more than sixty areas examined, the efforts of the U.S. government were below average in
two-thirds of the cases, and at or near the bottom of the list in more than half.
Among the areas where we have under-performed other democracies:
Growth of per-capita income.

Gender earnings gap.

Reducing pollution.

Income inequality.

Cost of health care system.

Coverage of health care system.

Life expectancy.

Access to affordable long-term health care.

Infant mortality.

Job-related illness or injury.

Effective job training.

Safeguards for laid-off workers.

Ability of workers to establish unions.

Number of families in poverty.

Severity of poverty.

Affordability of owning a house.

Affordable rental housing.

Crime rates.

Segregation by income and race in cities.

Student performance in math and science.

Availability of child care.

Child nutrition.

Children enrolled in pre-school.

Availability of parental leave.

The fact that we lag behind our democratic neighbors in so many policy areas
demonstrates unequivocally that our government could accomplish even more than
it has done already. There is a real possibility that increased government efforts
could do much more to improve our lives in significant ways. The greater success of
other democratic governments in addressing serious economic and social problems
shows that it can be done and that we could be following their lead.

We Can Do Better at Fighting Poverty


Lets consider just one particular policy area, poverty, where we lag far behind other
democracies. We have an abysmal record in reducing the level of poverty in this country. It went
down in the 1960s, but for the last 40 years it has hovered stubbornly at around 11-13%. Today,
over 43 million Americans continue to suffer severe economic hardship. Conservatives consider
our failure to reduce poverty as evidence of the inherent limitations of government. They
conclude (wrongly) that since our current anti-poverty policies have failed, that there is nothing
the government can do and that it should get out of the business of trying to eliminate poverty. It
is this attitude that has animated Republican attempts to cut back on programs for the poor, such
as welfare and job training. For them, our failures in poverty policy only contribute to the case
they are making for a more limited government.
But the record of fighting poverty in Europe clearly demonstrates that governments are quite
capable of addressing poverty much more effectively. Anti-poverty policies in the U.S. only lift
36% of people out of poverty, while government policies reduce poverty in Germany by 76%, by
83% in the Netherlands, and by 89% in Sweden.2 Not surprisingly, all of these other countries
end up with much lower rates of poverty. While our poverty rate continues to hover around 12%,
Germany, the Netherlands, and Sweden have reduced their poverty rates to 4%, 4% and 2%
respectively.
These are very impressive differences. And it is not a mystery how these other countries have
been more successful in addressing poverty. First, these countries simply spend more on helping
people out of poverty welfare payments are higher, unemployment benefits are more generous
and last longer, and so on. Spending more money helps lift more people out of poverty. In
addition, social welfare policies in these other countries are much more universal they include
everyone, not just limited groups. Everyone has national health insurance; everyone qualifies for
day care subsidies, and so on. Because of this, the social safety net is much more complete and
effective than in the U.S., and this means that fewer people are likely to slip into poverty because
of personal disasters such as a serious illness, a divorce, or the loss of a job. Most other
democracies also pursue policies that help to raise wages. They encourage rather than discourage
the formation of unions and they set a much higher minimum wage both of which help to lower
the number of the working poor in these countries.

As Bok found, poverty is just one of dozens of areas in which the U.S. lags behind other Western
democracies. Clearly our government could be doing much more to address a wide variety of
problems and could make even greater strides in improving the lives of Americans. This fact by
itself is a powerful argument in favor of more government in the U.S.
Things are Getting Worse
The case for more government is strengthened even more if it can be shown that some of our
current problems are worsening and/or that we face significant new threats to our quality of life.
In the wake of the 9/11 attacks, few Americans disagreed with the idea that we needed major
new government initiatives to deal with the growing menace of terrorism. Likewise, it also
makes sense that we would need more government if we are facing other worsening problems.
And in fact we are. Lets just consider a few of them.

Growing Economic Insecurity. The effects of the deep recession continue to linger for
many families. Long-term unemployment has become chronic and is at its highest rate
since the Great Depression in the 1930s. Add to this the millions who can only find parttime work, and we have more than 40% of Americans who want a full-time job but
cannot find one. A Rockefeller Foundation report found that over 20% of Americans have
experienced a drop of more than 25% in income. The bottom line is that more and more
families are facing economic disaster: out of a job, their savings gone, and nowhere to
turn for help.

Unsafe Food. The last decade saw increasing threats to our food system. Problems have
ranged from e. coli infected beef and peanut butter to tainted spinach and botulism-laced
chili sauce. Every year seems to bring new instances of Americans getting sick and dying
from the food they eat.

Financial System Breakdown. Deregulation and lax enforcement allowed the financial
industry to operate with little public oversight. One disastrous result was the mortgage
loan crisis that eventually wiped out billions of dollars of investors' assets and brought on
a severe recession. The 2010 financial reform bill addressed some of these issues, but
many crucial proposed regulations were blocked by the fierce lobbying of the financial
industry. The bill left in place two of the main causes of the financial crisis: the ability of
banks to engage in high-risk speculation, and the use of dangerous derivatives like the
credit-default swaps that led to the collapse of AIG. The financial system is still at risk.

Health Care Crisis. There is almost universal agreement that the U.S. health care system
is increasingly in crisis. Tens of millions have been uninsured and costs have been
spiraling out of control. Amazingly, the elderly must spend a larger proportion of their
income on their medical expenses today than they did in the early 1960s before the
passage of Medicare.3 The 2010 health care reform bill did address the issue of lack of
access for many Americans. But whether this bill will rein in the growth of health care
costs is very doubtful. Many experts believe that new significant policy changes are
necessary to address this cost issue.

Growing Environmental Problems. A number of environmental problems are getting


worse. The most obvious one is global warming, which will bring with it extensive
coastal flooding, agriculture crop declines, rising danger from tropical diseases,
increasingly severe weather, and so on. But there are also other environmental issues that
are getting worse rather than better. Consider the plight of U.S. fisheries. Over-fishing has
resulted in disastrous declines in fish stocks off New England, the Gulf of Mexico, and
other areas. Increasing toxic waste from discarded computers and other electronics is
another emerging problem.

Increasing Economic Inequality. The rich are getting richer and the poor are getting
poorer and the middle class is shrinking all threatening to further divide American
society along class lines. Income inequality is getting worse. Between 1979 and 2009, the
incomes for the richest 5% of families grew by a whopping 73%; and incomes for the
richest 20% by an impressive 49%. But the increases for the bottom 60% of families have
been pitiful in comparison their gains were a meager 7%. Today over half of all income
in this country (50.3%) goes to the top fifth income class of families. The income going
to the top 5% of richest families is actually more than the combined income of the bottom
40% the 110 million Americans living on low and moderate incomes. The inequalities
in wealth are even larger with the top fifth richest families owning a staggering 84.7%
of all the wealth of the country, the next 40% owning only 15.1%, and the poorest 40%
owning less than 1%. Most other Western democracies have a much fairer distribution of
income and wealth. In Sweden, for example, the poorest 40% own 32% of the wealth.

Crumbling Infrastructure. Around the country, crucial infrastructure facilities roads,


bridges, sewers, etc. are rapidly deteriorating. For example, 27.5% of the nation's
bridges (162,000) are structurally deficient or functionally obsolete. In addition, the
nation's 16,000 wastewater systems face enormous needs. Some sewer systems are 100
years old and many treatment facilities are past their recommended life expectancy.
Currently, there is a $12 billion annual shortfall in funding for these infrastructure needs.
Also, airport capacity increased only 1% from 1991 to 2001, yet air traffic increased 35%
during that same period. The American Society of Civil Engineers argues that we must
dramatically increase funding to solve these and other infrastructure problems and it
estimates that it will take at least $1.6 trillion to bring these facilities into an acceptable
state.4

New Disease Threats. A whole host of new and evolving diseases now threaten public
health in the United States. They range from the Hantavirus to new drug-resistant strains
of microorganisms. Globalization and tourism mean that new diseases are more easily
finding their way into this country. The West Nile virus and eastern equine encephalitis
have already arrived. The main concern now is that a more virulent and deadly form of
swine-flu or bird-flu is going to eventually come to the United States, with potentially
devastating results.

Cyber Security Threats. Threats in cyberspace have risen dramatically in the last 15
years. Individuals are vulnerable to viruses, worms, financial scams, and identity theft.
Embezzlement, fraud and other cyber crimes cost businesses billions of dollars a year.

More importantly, key parts of the economic infrastructure are vulnerable to cyber attack,
including the banking system, the telecommunications system, and the electricity grid.
Cyber-attack tools are spreading rapidly worldwide and are being employed by foreign
nationals and foreign intelligence services. Cyber warfare and cyber terrorism are very
real threats to our national security.

Looming Retirement Crisis. Social Security is in good shape at least for the foreseeable
future. But the other two forms of support that retirees hope to rely on private pensions
and private savings are in terrible shape for most people. Fewer and fewer companies
are offering fixed benefit pension plans, and it is estimated that U.S. companies are
underfunding current pension plans to the tune of $350 billion a disaster waiting to
happen. Stagnant wages have made it difficult for many workers to save any money for
retirement: 36% of workers contribute nothing to their retirement and 43% have less than
$10,000 saved for their "golden years." As a result, many Americans will be facing
poverty or at least a much lower standard of living when they retire.

Deteriorating Public Education System. Many local public school budgets are in crisis,
with teachers being laid off and textbooks in short supply. There is a growing divide
between the quality of public education offered in rich communities and that in poor
communities. Due to either aging, outdated facilities, severe overcrowding, or new
mandated class sizes, 75% of our nation's school buildings remain inadequate to meet the
needs of school children. State colleges and universities -- which produce three quarters
of all degrees in the United States are also in trouble. Class sizes are spiraling, and
needed maintenance is being neglected. In addition, states have been raising their tuitions
and cutting financial aid. A study by the National Center for Public Policy and Higher
Education gave the public college and university systems in 43 states a grade of F for
affordability.5 This means that many low- and middle-income students simply cannot
afford college anymore a half million were turned away for lack of money in 2004
alone.

The existence of these and other growing problems clearly justifies the expansion of public
sector efforts to deal with them. And increasingly, many Americans have realized that more
government action is necessary in many of these areas. A 2010 poll found that when people look
ahead 10 to 20 years, they say by 42% to 18% that the federal government will become more
rather than less important in terms of improving the lives of the American people.
Can Markets Substitute for Government?
Of course, even if we have serious social, economic, and environmental issues facing us, this
may not necessarily require more government. There might be better, non-governmental ways to
solve these problems. Conservatives have long maintained that we would be better off relying on
the market or on individual efforts, rather than government. Lets consider both of those claims.
First, can the market really solve most of these problems? There are several reasons to be
skeptical of this claim. First, as was discussed in some detail in the article Capitalism Requires
Government, many of our countrys current problems are in fact caused by our market-based

economy. Free-market economies are incredibly productive, but they inevitably bring with them
a whole host of social and economic troubles. Clearly issues like poverty and increasing
economic inequality are directly traceable to how the market distributes income and wealth. Our
looming retirement crisis is due in large part to the effort of businesses to increase profits by
abandoning their traditional pension programs. And there is a good deal of evidence to indicate
that our health care system is overly expensive in large part because we rely so much on the
private sector for insurance. As these examples illustrate, the market is often the source of our
problems, not the solution.
It is also clear that we cannot depend on markets to solve their own problems. Conservatives and
libertarians are fond of arguing that markets are "self-correcting." If we would just leave them
alone and not burden them with onerous regulations, they would correct their own problems.
This is one of the core assumptions underlying the push for the deregulation of markets that has
been a hallmark of the Republican Party. But in recent years, we have seen that this idea of selfcorrecting markets is often more myth than reality.
A good example of how markets do not fix their own problems is the food supply system. In the
last decade, we have seen one food safety problem after another, including contaminated spinach,
E. coli infected beef, and salmonella tainted peanut butter. These problems have sickened tens of
thousands of Americans and in some cases have led to death. Many food businesses have little
incentive to adopt costly safety standards, in part because they know that in many cases it is
difficult to trace the sources of food-borne illnesses. The food industry has claimed that it can
rely on private food inspectors, but these auditors are hired by the very companies they inspect
and have often failed to point out problems in facilities. In the case of peanut butter, the
offending plant had gaping holes in the roof and walls, was infested with rats and roaches, and
had employees washing mops in the same sinks as peanut butter production equipment. And yet
the private inspector reported that "The overall food safety level of this facility was considered to
be: SUPERIOR." After the salmonella outbreak was made public, that inspector told a food
safety expert: "I never thought that this bacteria would survive in the peanut butter type
environment. What the heck is going on?"
Another classic example of markets failing to correct themselves is the mortgage loan fiasco and
the resulting economic crisis. For years conservative had been working hard to de-regulate the
financial industry. They asserted that regulations did more harm than good. In 2006, Bush
Treasury Secretary Henry Paulson argued that "the solutions to our nations problems are not
always found in Washington." And he maintained that one of the two main threats to financial
markets was "excessive regulation."
Other conservatives argued that any regulation of financial markets should be "voluntary." As
traditional financial regulations were being stripped away, right-wing analysts insisted that Wall
Street could be relied on to police itself and thus protect the public interest. We now know that
this was wishful thinking. Even Bush's head of the Securities and Exchange Commission,
Christopher Cox, had to admit in the fall of 2008 that "The last six months have made it
abundantly clear that voluntary regulation does not work."6

These are just two examples of why we can't rely on markets and business to solve society's
problems. There are plenty more. Past experience has shown that corporations will not always
provide safe working conditions or livable wages, that private schools cannot ensure that all our
children get a decent education, that companies will not clean up their pollution on their own,
and that let the buyer beware is not going to protect us from dangerous products. No if we
want to address these kinds of problems, there is really no alternative to public sector programs.
Can Individual Efforts Substitute for Government?
The other alternative that conservatives offer to more government is more effort on the part of
individuals. They argue that we need to empower individuals to take responsibility for their own
problems, and thus reduce their dependency on government. This was the principle behind a
major set of Republican initiatives that they called the ownership society. Policies like 401(k)
retirement plans, individual health savings accounts, privatized Social Security, and private
education were seen as ways to allow people to take control of their own fates and solve their
own problems. As a leading libertarian intellectual, David Boaz, has explained it:
An ownership society values responsibility, liberty, and property. Individuals are empowered by
freeing them from dependence on government handouts and making them owners instead, in
control of their own lives and destinies. In the ownership society, patients control their own
health care, parents control their own children's education, and workers control their retirement
savings.7
This may sound good to some people, but the record of these kinds of programs does not inspire
much confidence. Consider, for example, how 401(k) plans have helped to solve the retirement
crisis. The 401(k) option has been around for decades and so it is a good test for this approach to
retirement security. Unfortunately, it is flunking that test. On the one hand, these plans have been
a boon for businesses. They have been able to greatly reduce the money they spend on retirement
for their employees. They no longer have to invest in fixed benefit pension plans. Moreover,
most donations to these 401(k) accounts come from the workers themselves. Mutual funds firms
have also benefited from these accounts as well. But most workers dont seem to be getting much
security from them. First, only half of the American workforce even has access to these accounts,
and only 40% of those feel that they can afford to contribute to one. Also, the vast bulk of the
money contributed to these plans comes from already well-off employees not your average
worker. The myth is that the average worker now has tens of thousands of dollars in these funds
ready to provide for a comfortable retirement. But in reality, the median amount of funds for
these account holders whats most typical is a mere $13,000.8
As Jacob Hacker has explained, despite the growth in the total funds in these accounts
especially during the 1990s stock market boom most workers are actually worse off in terms of
their retirement prospects than they were before.
To be sure, defined-contribution accounts [401(k)s] grew handsomely during this period,
especially in the 1990s. Yet, at the same time, median defined-benefit holdings [pensions]
declined as employers stopped offering defined-benefit programs. So too did expected Social
Security benefits, thanks to the cutbacks in Social Security passed in 1983. When all the gains

and losses are added up, the median family approaching retirement that is the family exactly in
the middle of the retirement wealth distribution ended the 1990s with 11 percent less in
retirement wealth than the median family had in 1983.9
Today, of course, the situation for 401(k) accounts is even worse. In the stock market collapse
that followed the mortgage loan crisis, workers lost billions of dollars in these accounts. Many
people had to put off retirement. Those already retired were threatened with poverty and many
were forced to try to find work again. And imagine how much more dire this situation would be
if the Republicans had had their way and we had privatized Social Security and allowed people
to invest this money in the stock market.
Clearly, as companies rapidly retreat from providing people with reliable retirement plans,
individual efforts, like 401(k) accounts, are not going to be able to provide the kind of economic
security that most people need as they grow old.
Health Savings Accounts (HSAs), another much vaunted approach being push by the Right, are
also doing little to help with the ever growing problems of health care in the United States. In
this approach, individuals buy health insurance plans with very high deductibles such as $2,000
and then make up the difference in money they save in their own HSAs. But despite a big push
by Republican lawmakers and corporations, polls show that most people dont like this approach
and would rather have regular, low-deductible health insurance. These plans mostly appeal to the
wealthy (who can afford high out of pocket expenses) or the young and healthy (who dont need
much care). However, draining these people out of the traditional health insurance programs
means that premiums will have to go up for the less well-off and the less healthy people in this
insurance pool. In addition, when average Americans are forced into these plans, they can often
run into trouble. Studies have shown that HSA users are much more likely than those with
traditional medical coverage to have trouble paying their medical bills. They are also much more
likely to avoid or postpone treatment for serious medical problems because of the cost.10
Shifting Risks from Society to Individuals
But there is a deeper problem with the individualistic approach one that goes beyond the
inadequacies of these particular programs. The whole ownership society approach is actually a
way of shifting economic risks from businesses and government on to the backs of individuals. It
makes us responsible for dealing with all the significant financial risks that we face in an
advanced capitalist society getting sick, retiring, becoming disabled, losing our job, and so on.
But in fact, individuals are usually the least able to deal with these risks and that is why we
have used government to create all sorts of social insurance programs (like Social Security and
Medicare) to spread these risks among society as a whole and create more economic security for
all of us.
Jacob Hacker has written an entire book about this topic, called The Great Risk Shift. In it, he
gives an eloquent description of why we originally embraced the government-based, social
insurance approach back in the 20th century. He explains the basic political and economic
insights that led to the creation of Social Security and other collective efforts to deal with
common risks:

Social insurance transformed individual misfortunes into common problems. It made the
inevitable dislocations of capitalist society into risks that could be managed and distributed,
rather than blows of fate that could only be feared and suffered. The insurance in social
insurance came from the power of aggregation: Risks that could devastate an individual or
community could be managed if they were spread across many individuals and many
communities. The social in social insurance came from the principle of shared fate, the
reassurance that we are all in this together. All insurance pools risks. Only social insurance
pools risks on terms that enable the poor as well as the rich, the aged as well as the young, the ill
as well as the healthy to afford protection. The crafters of the Social Security Act believed that
insurance had to be available and within the means of those who needed insurance most.
At the heart of this belief was a simply conviction: broadly distributed threats to economic wellbeing sickness, injury, disability, unemployment, penurious old age were not the
responsibility of individuals alone. They were a widespread and often unavoidable feature of an
interdependent industrial society. And because they were, the cost of these risks should be
distributed widely across the citizenry, not concentrated on those unlucky enough to experience
them a goal made possible by the unique power of government to compel participation and
require contributions. Government could pool the risks of millions of citizens. It could guarantee
that even workers of limited means are able to afford basic protections.11

As Hacker makes clear, social insurance programs are one of the greatest inventions of modern
democratic government and they have gone a long ways toward making all of our lives much
more secure. We could be doing even more with social insurance programs, as they have done in
Europe, but it is this proven approach that has been directly under attack by conservatives. They
want us to move from a we are all in this together society to a you are on your own society.
But this individualistic, anti-government approach cannot provide the kind of economic security
that most Americans need and want.

Public Support for More Government


Many Americans are aware of the serious problems we face as a country and say they
want more government involvement to help solve them. For example, over 60% of Americans
say that they want the government to spend more on education and health, 69% favor more
generous government aid to the poor, 77% say the government should do all it takes to protect
the environment, and 83% favor raising the federal minimum wage. And with numbers like
these, this is clearly not just liberals talking. There have to be a lot of moderates and even
conservatives that recognize the need for more government in these areas. In fact, a 2010 poll by
the Center for American Progress found that 40% of conservatives and libertarians support a
larger federal government role in areas like improving public schools, reducing poverty, and
developing new energy sources.12

Only More Government Will Do


To sum up, there is a great deal of evidence that strongly suggests that Americans would be
better off with more not less government. We know from the experience of other advanced
democracies that our government could be doing more to address many of the problems we face
as a society. We also know that some of these problems are getting worse, and other additional
serious problems are emerging. Finally, it is clear that non-governmental approaches markets
and individuals efforts are in many cases not sufficient to deal with all of these problems.
Of course all of this does not tell us exactly what new kinds of public efforts are needed. We still
need to carefully analyze proposed policies and programs to figure out which ones will be most
effective in addressing these social, economic, and environmental problems. And there is also the
difficult question of deciding how much we can afford to spend to alleviate these problems. As
the article on the deficits makes clear, we can afford to spend a lot more on these problems than
conservatives say we can. But this still leaves the question of how much we want to spend. In
any case, one thing that we do know for sure at this point is that if the government does nothing
more, or actually does less, our quality of life is going to suffer. In todays world, we need a wellfunded public sector that will do more to reduce the risks we face and to improve the lives of all
Americans.

1. Derek Bok, The State of the Nation (Cambridge, MA: Harvard University Press, 1996)p. 387.
2. Timothy M. Smeeding, Lee Rainwater, and Gary Burtless, Luxembourg Income Study
working Paper No. 244: United States Poverty in a Cross-National Context, (Differdange,
Luxembourg, Luxembourg Income Study, 2000).
3. Jacob S. Hacker, Privatizing Risk without Privatizing the Welfare State: The Hidden Politics
of Social Policy Retrenchment in the United States, American Political Science Review, Vol. 98,
No.2, May 2004, p. 253.
4. American Society of Civil Engineers, "Report Card for America's Infrastructure: 2003
Progress Report," http://www.asce.org/reportcard/index.cfm
5. National Center for Public Policy and Higher Education, Measuring Up 2006: The National
Report Card on Higher Education. http://measuringup.highereducation.org.
6. The Paulson and the Cox quotes are from OBM Watch, The Bush Legacy: An Assault on
Public Protections, http://www.ombwatch.org/node/3877
7. David Boaz, Ownership Society Defined.
http://www.cato.org/special/ownership_society/boaz.html

8. Jacob Hacker, The Great Risk Shift (Oxford: Oxford University Press, 2006) p. 122.
9. Ibid.
10. Think Progress, Health Savings Accounts Fail to Provide Savings or Address Costs.
http://thinkprogress.org/2006/01/31/sotu-health-savingsaccounts-fail-to-provide-savings-or-address-costs/
11. Hacker, The Great Risk Shift, pp. 41-42.
12. Guy Molyneux and Ruy Teixeira, with John Whaley, "Better, Not Smaller: What Americans
Want from their Federal Government," July 2010.
http://www.americanprogress.org/issues/2010/07/what_americans_want.html
By - The Washington Times - Friday, November 13, 2009
Former President George W. Bush said Thursday that America must resist the temptation to
allow the government to take over the private sector, taking a subtle shot at his Democratic
successor by warning that too much state intervention and protectionism will squelch the
economic recovery.
As the Obama administration has made far-reaching moves into the auto, real estate, health care
and financial sectors to fight the economic recession, Mr. Bush, without mentioning the president
by name, said, The role of government is not to create wealth but to create the conditions that
allow entrepreneurs and innovators to thrive.
As the world recovers, we will face a temptation to replace the risk-and-reward model of the
private sector with the blunt instruments of government spending and control. History shows that
the greater threat to prosperity is not too little government involvement, but too much, said Mr.
Bush, who has remained out of the limelight since leaving office and rarely criticizes his
successor.
Mr. Bush has addressed private groups since leaving the White House in January, but Thursdays
speech, delivered at Southern Methodist University in Dallas, was his first major public policy
address since leaving office.
Obama administration officials have defended many of their economic moves as emergency
measures to deal with the economy they inherited from Mr. Bush. They note that some of the
most intrusive policies including the $700 billion Wall Street bailout were instituted under
Mr. Bushs watch.
At SMU, the future home to the George W. Bush Presidential Center, the former president sought
to explain his decision to have the government intervene at the peak of the financial crisis last
fall, a decision he called one of the most difficult of my presidency.

I went against my free-market instincts and approved a temporary government intervention to


unfreeze credit and prevent a global financial catastrophe, he said.
Although many economists credit that early action with halting the economic free fall, Mr. Bush
said the only long-term path to prosperity is to free up the private sector and to push for open
foreign markets to U.S. goods.
Trade has been one of the worlds most powerful engines of economic growth and one of the
most effective ways to lift people out of poverty. Yet a 60-year movement toward trade
liberalization is under threat from creeping protectionism and isolationism, Mr. Bush said.
In one of his first major decisions on trade policy, Mr. Obama in September imposed a tariff on
tires from China, making good on a campaign promise to the United Steelworkers union to
crack down on imports that hurt American workers.
In his speech which set out his goals for a new policy institute focused on economic growth,
education, human freedom and global health Mr. Bush said he entered politics because
because I saw society drifting away from the values at the heart of the American dream.
I pledged to govern based on principles that empower people to improve their lives and
strengthen our nation. I believe that free markets open the path to opportunity, that a successful
society requires personal responsibility, that freedom is universal and transformative, and that
every human life has dignity and value.
The core of his new presidential complex scheduled to open in 2013 will be the George W.
Bush Institute. The nonpartisan think tank will house scholars from around the world and
advance Mr. Bushs most dearly held effort as president: promoting human freedom.
As I said in my second inaugural address, extending the reach of freedom is the urgent
requirement of our nations security, and the calling of our time, he told about 1,500 students,
faculty, friends, community leaders and supporters.
He plans to continue to support dissidents and reformers around the world, including those from
many of the hostile nations with which Mr. Obama has pledged to engage in dialogue.
From labor camps in North Korea, to political prisons in Cuba and Burma, university halls in
Iran, coffeehouses in Venezuela, and other places, dissidents and reformers are seeking strength
and support. When America stands for liberty, they take heart. When we do not, the dictators
tighten their grip, Mr. Bush said.
Several fellows have been recruited for the institute, including the first fellow in human
freedom Oscar Morales Guevara. Mr. Guevara used Facebook to launch a movement called
One million voices against the FARC, the brutal leftist separatist movement in Colombia. A
month later, more than 12 million people in 40 countries rallied against the network.

Former first lady Laura Bush will play a role as well, overseeing womens initiatives and
education her signature issue during her tenure in the White House. With Sandy Kress, former
chairman of the Dallas County Democratic Party, as the issues steward, the institute will seek to
evaluate how best to recruit, prepare, evaluate and reward principals and administrators.
The presidential complex at more than 200,000 square feet, second in size only to former
President Ronald Reagans library in Simi Valley, Calif. will include an archives and museum.
The archives will hold 4 million photos; thousands of boxes of documents; and hundreds of
millions of e-mails not one of which was sent by me, he said to laughter.
But the policy institute will be forward-looking.
Its an interesting way to make a presidential library, which is usually about what happened in
the past, a vehicle to continue to talk about how to change the future, said Mark Langdale,
president of the George W. Bush Presidential Center.
Also at the museum will be a replica of his Oval Office, a Texas rose garden, Mr. Bush said,
and the bullhorn I used in my first visit to ground zero at the World Trade Center three days
after the terrorist attacks of Sept. 11, 2001.
Mr. Bush, who is writing his memoirs, seemed to enjoy the spotlight and, as a self-confessed C
student, his return to college.
Its pretty exciting for a 63-year-old to be back on the college scene. I enjoy popping in on a
class from time to time. Come to think of it, that was my strategy as a student, he said to
laughter.
His post-presidency also has provided some interesting opportunities, he said, including a job
offer to be a greeter at Elliotts Hardware.
Copyright 2015 The Washington Times, LLC
Read more: http://www.washingtontimes.com/news/2009/nov/13/bush-warns-of-too-muchgovernment/#ixzz3SkRbkKE2
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The Chinese government has much less control over its currency than most people
think it does

Chinas external debt is exploding. The $38 billion in foreign-currency loans that Chinese
companies had borrowed from US, European and Japanese banks in the fourth quarter of 2012
had multiplied to nine times that amount by that same quarter in 2013to more than $349
billion, according to the most recent data from the Bank for International Settlement (BIS).
Counting claims by Hong Kong banks, those debts now easily exceed $1 trillion (pdf, p.5).

This is scary-sounding stuff. Just the phrase external debt evokes Argentine sovereign debt
default, a Thai-style currency crisis or the litany of other catastrophes that occur when emergingmarket economies borrow too much abroad.
But many argue that, thanks to its $3.95 trillion in foreign-exchange reserves and its closed
capital account, China neednt worry about such problems.
Those arguments make sense. Unlike other emerging-market countries, China doesnt need those
foreign currencies to finance trade or overseas investment. It borrows because those foreign
loans are an easy source of the money that Chinas financial system needs to keep banks lending
to each other, preventing unprofitable Chinese companies from defaultingand thereby allowing
Chinas leaders to promise 7.5% GDP growth this year.
But just as Chinas relationship with external debt is different from other emerging-market
countries, so too are its risks.
While rising torrents of foreign borrowing keep its system liquid, they have also left Chinas
central bank with less control over the financial system than it had just two years ago. And
that reliance on foreign borrowing makes the country much more vulnerable to a liquidity seizeup than manyincluding Chinas leadersrealize.

Where did all those greenbacks go?


To understand how Chinas capital inflows have evolved so rapidly, lets first start with a riddle.
In May, China posted a $36-billion trade surplus, its biggest since January of 2009.

Now usually when the world wants more stuff from China than China wants from the world, it
drives up demand for the yuan, since Chinese exporters accepting foreign currency (which well
generalize as dollars in this piece for convenience) need to pay their expenses in yuan. On top
of that, the mammoth trade surplus was one of a slew of indicators suggesting the Chinese
economy was stabilizing, implying the currency has more room to strengthen.
That demand for yuan should make it strengthen against the dollar, driving up the price of
Chinas exports relative to those of other countries. Big inflows of dollars caused by trade
surpluses normally whip the Peoples Bank of China (PBoC) into a dollar-buying frenzy, with the
central bank selling yuan and adding more dollars to its foreign exchange reserve in order to
counteract that yuan-demand (more on those mechanics here). Especially when, despite upbeat
economic data, the Chinese economy is still looking peaked enough to need that extra export
fillip.
Last month, however, Chinese banks (a proxy for the PBoC, given that they typically sell dollars
on to the central bank) bought a measly $6 billion in May:

Without the PBoCs intervention, the influx of dollars from that $36 billion trade surplus would
usually drive up the value of the yuan, vis-a-vis the dollar. It did, but just barely. After a small
bout of strengthening, the yuan closed out May less than 0.2% stronger than it had started the
month.

Why Chinese companies swap yuan for dollars


So where did those dollars go, if they werent purchased by Chinese banks? The answer to the
riddle of the missing greenbacks is that Chinese companies started hoarding dollars big-time in
May. (Though Chinas capital account is closed, the government allows Chinese trading firms to
borrow dollars from offshore banks to manage currency risk.)

But why? What would prompt a Chinese company to hold their deposits in dollars, all of a
sudden? The answer goes back to that external debt.
Say that company had borrowed in dollars from a bank offshore, changing them into yuan in the
mainland. But when the yuanor something that influences the yuan, like the state of
the Chinese economystarts to look shaky, the safe thing to do is to change those yuan back into
dollars. Otherwise the company risks owing more yuan for every dollar of their offshore debts
when those come due. Even if they dont have to pay those debts immediately, accumulating
dollars now protects them against losses later if the yuan keeps shedding value.
In other words, whether Chinese companies convert their dollars depends on whether they
are bullish or bearish on the yuan.

Flashback to 2012
Youll notice in the chart above that 2014 looks a lot like late 2011 and early 2012. Dollar
deposits became popular around then, likely in response to the abrupt weakening of three
things: the housing market, the economy, and the yuan. The housing market began slowing
sharply in the last quarter of 2011, continuing into the new year. Then in the first quarter
of 2012, economic growth fell unexpectedly, says Andrew Polk, an economist at The Conference
Board, a research group.
In 2012, people were expecting the economy to go back up to 8%some analysts were even
saying 10%. But the economy really underperformed; it hit [7.6% in Q2], he says. By the
middle of the year, currency expectations [that the yuan would keep weakening] became pretty
entrenched. So you see foreign currency deposits build up and then potentially what it looks like
is that people started moving them offshore.

And it wasnt a small sumabout $225 billion (paywall) seeped across Chinas borders from
September 2011 to September 2012, according to the Wall Street Journals tally.
One of the key things the PBoC did to stop that outflow of capital, says Polk, was to strengthen
the yuan against the dollar, pushing the currencys value up nearly 2.2% between August and
December of 2012.

Dj vu all over again?


Similar to what happened in 2012, the economy started looking shaky at the beginning of this
year, led by the housing markets rapid deterioration in late 2013. The yuan, too, began
weakening. And now dollar deposits are jumping. But despite the obvious similarities, one thing
has changed dramatically.

Chinas new creditor: foreign banks


In the first five months of 2012, as the economy sagged, Chinese companies deposited $34
billion in dollars in their bank accounts. During that same period of 2014, that sum had surged to
$127 billion. To whom do they probably owe those dollars?
Foreign banks, mostly. As mentioned above, by the fourth quarter of 2013, the latest period for
which there is data, Chinese net borrowing from foreign banks had mushroomed to nine
times what it was a year earlier, according to BIS:

Though BIS data arent perfectly complete, they give a good sense of the trend.

The weird world of Chinese trade finance


Some foreign banks lend directly to Chinese corporate customers. But another portion of
what foreign banks are actually lending to China isnt what most people think of when they hear
the word loan.
For instance, these loans arent necessarily issued directly from a foreign bank to a Chinese
corporate customer; theyre often first loaned to a Chinese bank that needs dollars to meet the
borrowing needs of its mainland customers in the export/import business. The majority is shorttermusually between three and six monthsand issued in the form of trade finance
instruments such as letters of credit (LCs) instead of loans.
Generally speaking, these are agreements between an exporter and an importer on payment and
delivery of goods, that use a bank to help guarantee the transaction. But since Chinas closed
capital account prevents the free flow of money over its borders, its a little more complicated
than that. Heres how it works: the Chinese bank issues a LC to a Chinese company when
it presents a trade order, which the bank then uses as collateral for dollar loan taken out in its
Hong Kong branch. The amount is switched back into yuan and deposited into the traders
mainland account. When the loan comes due, the trader pays back that mainland branch office in
whatever currency suits. The branch then turns around and settles the payment with its Hong
Kong office.
Since this kind of finance is short-term, backed by underlying business activity, and ultimately
guaranteed by Chinese banks as the counterparties, foreign banks consider these loans to
be generally un-risky. This business has opened up in part because, comforted perhaps by

Chinas sterling external credit ratings and its relatively strong economic growth, foreign banks
have grown willing to lend.
As for customers, they benefit from cheaper interest rates on offshore dollar borrowing or, if
theyre borrowing indirectly, the on LCs at Chinese banks, which average around 2.5% for six
monthsmuch less than what it costs to take out a loan to pay for importing goods.
Chinese banks, meanwhile, are keen on this booming business for different reasons. Slowing
growth in yuan deposits has left them with less and less to loan outmaking it harder
to earn money. Issuing LCs and facilitating dollar loans lets them boost revenue with
commission fees. And even though the LC rate is piddling, banks still get better interest margins;
since Chinas banking regulator doesnt count LCs as loans, the bank doesnt need to set aside
capital or a deposit buffer against the LC. In many cases, they require margin deposits, helping
bump up their lending base.
The Chinese government doesnt track the use of LCs. However, Richard Xu, an economist at
Morgan Stanley, estimates that Chinese banks currently have issued about 3 trillion yuan ($482
billion) in outstanding LCs, with the volume of LCs issued outpacing Chinese trade growth in
2011 and 2013.

(Morgan Stanley)

For a country with $3.95 trillion in foreign reserves, this is kind of strange, says Victor Shih, a
professor at University of California, San Diego, and an expert on Chinas political economy.
You have to ask yourself, Why do Chinese banks need so much foreign currency? It makes no
sense, Shih says. China supposedly runs a huge trade surplus. And theres a lot more inward
foreign direct investment into China than outward. So you would think that they have enough
dollars to finance whatever trade needs that they have.

So if the Chinese companies dont need those dollars to finance trade, what do they need
them for?

Chinas booming trade in fake trade


In fact, quite a few Chinese borrowers for dollar loans are faking their trade transactions, as
weve reported in the past. Instead of financing exports or imports, some Chinese companies are
borrowing from offshore banks in order to profit from cheaper dollars and lower interest rates
than those to be had on the mainland (economists call this a carry trade). They then invest
those yuan in high-yielding things like real estate or wealth management products, retail
investment products that fund risky projects via Chinas off-balance-sheet shadow banking
system.
As long as the yuan keeps strengthening against the dollar, a company can be confident it
will profit both from the currencys rising value and difference between the overseas interest rate
and those it receives on the mainland, which in 2013 could exceed 15%.
Its impossible to know for sure what percentage of trade finance is fake. But its clearly big. For
instance, in Q4 2013, Chinas trade surplus was only $91 billion, a lot less than the $349 billion
in foreign loans (or $1 trillion, including claims by Hong Kong Banks)and thats ignoring the
fact that some of those $91 billion in recorded exports that came from fake invoicing.
Not all of that is backed by foreign lending. And some of it is for legitimate trade. And again,
compared to the overall $22.7 trillion in debt, according to some estimates, $1 trillion in foreign
loans really isnt all the much.
What we do know, however, is that these short-term speculative inflows are claiming a rising
share of the overall stream of money pouring into China, as you can see in the official capital
account data (link in Chinese):

The PBoCs February surprise


Of course, its not like the Chinese government is oblivious to all this. It might seem odd that
Chinas leaders let this trade to flourish when one of the big reasons theyve stalled opening up
the capital account is the worry that doing so could allow capital flight to hobble the financial
system, the way it did to their neighbors during the Asian financial crisis in 1997.
Given what happened in 2012, its not a strictly theoretical fear, as we mentioned before. Plus,
when these sorts of inflows surge, the demand for yuan ups its value, as we mentioned
before, pummeling exportersterrible news for a country where leaping labor costs are already
driving manufacturers to Vietnam and Bangladesh. In 2013 alone, some $500 billion of this hot
money, as its sometimes called, flowed into China, largely via the fake-trade channels.

(Nordea Markets)

As you can see in the above chart by Nordea Markets Amy Yuan Zhuang, those inflows were
still massive going into 2014. Whats changed?
Unlike in 2012, the big drop in the yuans value wasnt caused by darkening economic outlook;
the PBoC engineered it. In an unexpected move, starting in mid-February, the PBoC
began pushing down the yuans value; the currency is down 3% in value since the end of
January.
Why would the central bank risk encouraging a reprise of 2012, when Chinese companies started
buying up dollars and wiring them out of the country? While its widely assumed that the PBoC
did this to discourage companies from sneaking in hot money to bet on the yuans
appreciation, it probably didnt hurt that cheapening the yuan boosts export competitiveness.
Finally, the PBoC likely hoped to slow the amount of money flowing into risky investments via
shadow banking channels.
However, Shih says the government had another goal as well. Tellingly, not only did the PBoC
cause the yuan to weaken by setting its trading range unusually low, but it also
aggressively bought dollars for yuan, creating a glut of liquidity:
The PBoC printed renminbi, pumped it into the market and bought dollarsand that artificially
increases the money supply and drives down interest rates, says Shih. Im sure they moved the
renminbi also to punish speculators, but another objective, which they accomplished, is to

generate money supplythereby driving the interest rate down and satisfying the political
objective of the Chinese government to keep growth momentum at 7.5% this year.

Foreign-currency trade finance: a big bonus for the PBoC


The reason Chinas leaders accept the risk of 2012-style capital flight, says Shih, is the same
reason that they engineered the yuans February decline: liquidity.
Until recently, the PBoCs foreign-exchange reserves supplied the dollars Chinese traders needed
to buy overseas goods. Through a couple layers of bank bureaucracy, what essentially would
happen is that the company would hand its yuan to the PBoC in exchange for dollars it ultimately
forked over to the foreign exporter.
The renminbi literally gets destroyedit leaves the money supply, and that causes deflation,
says Shih. Meanwhile, the PBoC is trying to rollover all this domestic debt, so they want the
money supply to keep expanding.
Put a little differently, Chinas use of investment to drive growth allowed companies to borrow
heavily; as the economy slows, squeezing the cash flow they need to repay debts, the only way to
prevent mass default is for Chinese banks to keep re-extending loans (called rolling over loans
or evergreening). Banks arent getting paid, but if Chinas going to even dream of hitting that
7.5% GDP growth target, they have to keep issuing new loans. So the government has to keep
finding ways to shunt more money into the financial system.
Enter foreign lenders.
The PBoC prints yuan, hands it to Chinese banks, which print up LCs for Chinese companies (or
help facilitate the trade credit directly with a foreign bank). Foreign banks then issue dollar loans
with the LC (or an asset) as collateral, and those dollars are swapped for yuan, given back to the
Chinese company, which then invests it in China. Et voilinstant liquidity, no deflation.
Or, at least, no deflation as long as the money keeps coming in. Shihs point explains why capital
outflow is so dangerous; once Chinese companies start switching their deposits to dollars, theyre
draining liquidity once again.

Collateral damage
But its not just the whims of Chinese companies that determine this. By relying on foreign
lenders to create Chinas liquidity, the PBoC has loosened its control over money supply as well.
So far, it doesnt seem to have mattered to lenders that, even though this dollar-lending
is technically short-term, in practice economists think Chinese banks are rolling over many
billions of these debts indefinitely.
Why would banks do something so risky? Because Chinese companies have produced collateral
against the loans. One popular form is metal, which Chinese borrowers can store in what are
called bonded warehouses in Chinese ports that secure the metal as collateral. By some

estimates, nearly one-third of all short-term foreign-exchange loans are backed by commodities
such as copper or steel.
The problem, as weve covered in the past, is that Chinese companies sometimes pledge the
same collateral to take out different loans. That means if the loans go bad, a slew of creditors are
left with competing claims to the same hunk of collateral.

The curious case of the 123,000 tonnes of missing metal


That brings us to the scandal now rattling Qingdao, the seventh-busiest port on the planet. Stateowned Citic Resources Holdings, a mining and trading company, recently admitted that it
couldnt find 123,500 tonnes (136,000 tons) of aluminaabout $50 million worththat it
had stored in a Qingdao warehouse. Both Chinese and Western banksincluding Citigroup and
Standard Charteredhave issued loans backed by collateral thats supposed to be sitting in the
Qingdao port, according to the Wall Street Journal (paywall).
It might seem strange that it took 123,000 tonnes of alumina to disappear for Western banks to
take notice of Chinas risky business practices. Then again, companies that are state-owned seem
safe, since theyre in theory guaranteed by the government. Loans backed by collateral should
also be safe. As for interbank lending, foreign banks have tended to calculate the risk of the
Chinese bank theyre lending to, not the underlying risk of where that money ultimately ends up.

Recalculating risk?
The emergence of more Qingdao-like episodes could change that calculus. Already, Standard
Bank and GKE Corp, which is partially owned by Louis Dreyfus, have warned that they
might suffer losses related to Qingdao port collateral, reports the South China Morning Post
reports (paywall)and Standard Chartered says its now reviewing its metal financing to certain
Chinese companies.
Those are the banks that have direct exposure to Chinese companies. In the case of LCs and
other loans funded via interbank lending, that would suggest that the ultimate credit exposure
comes from Chinese banks, says Silvercrest Asset Managements Patrick Chovanec, an expert
on the Chinese economy, though he adds that its not always clear where the ultimate risk lies.
Still, UCSDs Shih says a lot of these loans arent hedged (meaning protected in the case of a
sharp drop in the yuans value). If more foreign banks start worrying that some of their loans too
are supported by a vanished heap of metal, or sponsored by a Chinese bank will flimsy risk
management or unhedged lending practices, they too might become more skittish about lending
to China.

Sudden stops
One of the biggest fears that arises when a country comes to rely excessively on external debt is
whats called a sudden stop. Thats what happens when the net flow of money into a country
slows sharply or stops, either because foreign investors slash investments, creditors stop lending,
or domestic residents move their cash out of the country.

Yanking money out of an economy tends to drive down asset prices in sectors such as real estate,
igniting a banking crisis, and can shrivel the value of a countrys currency. A chain reaction of
sudden stops caused the Asian financial crisis in 1997.

The PBoCs track record of currency defense.

3.95 trillion reasons why Chinas unlike other emerging


markets
Could China experience a sudden stop if foreign lenders started refusing to let Chinese
companies roll-over loans, or if they cut back on lending altogether? Not likely, says
Silvercrests Chovanec.
Chinas $3.95-trillion foreign exchange reserve gives it plenty of money to pay foreign debts and
maintain the yuans value, he says, making it different from most countries that have watched
their economies implode due to sudden stops. Plus, foreign loans arent even one of Chinas
primary sources of funding; theyre just one channel flowing into Chinas $5-trillion shadow
banking system.
Im not saying [external debt is] not an issue, but its really more of domestic issue. The
problem is fundamentally the reliance on runaway credit expansion of all kinds of channels,
rather than a particular reliance on foreign funding like Southeast Asian countries in the 1990s,
says Chovanec. Like all those forms of credit expansion, if [foreign-currency loans] were reined
in at any point, it could create big problems.

External debt is still debt


But if the PBoC has ample reserves with which to keep its currency stable, what problems could
a sudden outflow of dollars create?

To me the biggest risk is not that foreign currency loans are big enough that they could create a
sudden stop like in Argentina, but that the PBoC doesnt react to liquidity conditions in the
proper way, says The Conference Boards Polk. They could create their own liquidity crisis by
underestimating the scope of what foreign currency flows can do.
Take, for example, the abrupt disappearance of liquidity after the PBoC cracked down on fake
trade invoicing in May 2013. The central bank then exacerbated this crackdown by handling it in
a way that Polk describes as looking pretty hamfisted, causing Chinas financial system
to freeze up for a week and prompting money to flee across the border to Hong Kong.
That episode could mean the PBoC simply doesnt grasp how much capital is flowing in and out
of China.
Still, even if foreign-currency lending were to cause another cash crunch, the PBoC at least
knows now that it would need to print more money as it uses its reserves to meet foreign debt
obligations. That likely means no external debt crisis. But what about a regular debt crisis?
As Michael Pettis, a finance professor at Peking University, highlights in a recent note, this gets
to the core quandary facing the PBoC. The problem in China, he writes, is not the stock of
foreign debt but the commitment to a growth model that requires an unsustainable rise in debt
simply to keep the engine running.
http://qz.com/223991/the-chinese-government-has-much-less-control-over-itscurrency-than-most-people-think-it-does/

Too much government meddling?

At a time when many countries are struggling, the debate over governments involvement
in the free market is becoming more prominent. Jules Gray looks at the different active and
passive options the public sector can consider, and how globalisation can help
Around the world, governments are exercising different degrees of fiscal and monetary meddling
in response to the financial crises. As the world recovers from the 2008 economic meltdown, the
question of how much intervention a government should exercise has reared its head, and has
been based on ideology, economic input, and panic.
The effect these economic changes have on international trade are phenomenal, and businesses
operating in new and existing markets must be aware of the atmosphere they will encounter.
Does the government heavily tax FDI in order to curb imports? Does the central monetary
authority allow interest rates to fluctuate rapidly? These are questions executives working to an
international remit must consider.
Around the world, countries have developed different ways of operating, but over the last few
decades a prevalence of free-market thinking has dominated developed countries, promoted in
the US by Milton Friedman and the Reaganomics that shaped that economy during the 1980s,
and by Margaret Thatcher and later Tony Blair in the UK.
However, doing business in these jurisdictions has become strained, as the free-market pushed
freedom too much and regulatory bodies have failed to limit rogue growth plans, the result of
which we are experiencing now in light of the subprime mortgage crisis. China, on the other
hand, has traditionally taken a more controlling role in their economy, with the communist state
carefully managing output and becoming more and more of a viable option for international
business and their balance sheets.
However, much of the soaring growth that the Chinese economy has seen over the last few
decades was instigated by the reforms of leader Deng Xiaoping between 1978 and 1992. Indeed,
it was Xiaoping who moved away from the ideological restrictions of communism to a more
pragmatic system, welcoming international trade and opening its doors to corporate integration.
Global trade frowns on interventionism
International business is often put off by the idea of an interventionist government, for many
reasons. That said, the lessons of a free-roaming system with little regulation are becoming all
too clear in Europe and North America, where, in particular, negligent banking systems have
forced economies to a state of paralysis.
Opponents of interventionism argue that the central planning of an economy will be threatened
by the law of unintended consequences, as well as preventing the market from correcting itself.
Some argue that banks considered too big to fail should not have been propped up by the state,
and instead allowed to collapse, providing a far harsher lesson to the people that caused the crisis
than has otherwise been felt.

However, in practise, the decisions rest on how serious the consequences will be for the
economy. For example, Lehmann Brothers, on the one hand, was allowed to file for bankruptcy
in 2008, while just a few days later AIG was given state aid as it was felt it would have too
severe consequences for the US economy were it to collapse. The set back to international trade
in the US hasnt still fully been worked out yet.
The monetarist school of thought that emerged from the University of Chicago in the 1940s
claimed that free markets could best allocate resources within an economy, and encouraged
minimal government intervention other than controlling the interest rate through the money
supply. The main proponent of the Chicago School was economist Milton Friedman.
Friedman strongly believed that governments should allow the market to be free to operate
naturally, without excessive intervention from politicians. Known for his disdain of wastage of
centralised governments, he said of the US federal government: If you put the federal
government in charge of the Sahara Desert, in five years there would be a shortage of sand. He
also felt that a free market was the fairest way for an economy to operate, adding: The most
important single central fact about a free market is that no exchange takes place unless both
parties benefit.
Monetarists offer cash, Keynesians step in
As monetarists step in to toy with a currency and the flow of income, international businesses
involved with a nation with a monetary-heavy doctrine might find themselves struggling in a
crisis. Its often argued that a liquidity gap can be caused by too much monetary meddling, and
its roundly agreed by economists that fiscal policies are required to lift an economy from the
current Great Recession. For those executives considering working in countries infatuated with
monetary policy, itd be wise to look into fluctuating interest rates.
Strict government control over both monetary policy and intervention in the marketplace is often
cited as the best way to grow a stable economy and aid international business. Keynesian policies
believed that in order to mitigate the effects of recessions and depressions, governments should
take control of fiscal and monetary policy to stimulate growth. Global trade is said to benefit
from a well-considered Keynesian approach, in which imports and exports benefit from better
growth plans. In recent years for instance, the Australian government has encouraged growth
with the countrys neighbours being welcomed into the country by healthier domestic fiscal
planning.
However, businesses looking to expand into new markets should be wary of
governments attempting to operate too much with the private sector. John Maynard Keynes, the
author of Keynesian economics, said: The important thing for government is not to do things
which individuals are doing already, and to do them a little better or a little worse; but to do those
things which at present are not done at all.
Stop/go governments
As economies around the world suffered from the financial collapse in the US and Europe during
2008, much of the blame has been pinned on this light touch regulation that allowed financial
institutions to operate in such cavalier ways. It is argued that had restrictions remained, such as

the Glass-Steagall Act that prevented banks from excessive speculation that was repealed in the
1999 US banking reforms, much of the difficulty the banking industry has seen would not have
occurred.
Tighter regulations on banking practices have emerged, such as Basel III and Solvency II, which
are designed to maintain realistic capital levels and restrict speculation.
Governments have also been encouraged to stimulate growth by embarking on massive
investment in the state, propping up employment. This has provided multinationals with more
options, allowing them to better provide for their customers and seek out regions in the global
marketplace perceived as having friendlier attitudes to bigger growth potential.
On the flipside, many governments have been reluctant to sanction such high levels of spending,
seeing a better opportunity for growth in investment from the private sector, which they hope
will take advantage of better business environments such as highly trained local workforces.
Austerity measures promoted by the governments of Britain and Germany have called for a
cutback in public spending and a stabilisation of debt levels.
These strategies have had mixed results, with growth in the UK stalling and a double-dip
recession being blamed on the governments commitment to cutting back on expenditure.
Calls for an influx of infrastructure spending have received cautious reactions from the UK
government, who have attempted to get foreign sovereign wealth funds and large institutional
pension funds to build the projects, although with limited success. Last November UK
Chancellor George Osborne set a target of 20bn to be raised from pension funds th help with
infrastructure, but so far only 2.5bn has been raised as regulations limit what local government
pension funds can do with their money.
Addressing speculation in financial markets is seen by Keynesians as an important way to
control the private sector from harming the rest of the economy. France recently introduced a
financial transactions tax, which will take 0.2 percent off every share purchase. Analysts must
wait to see the results for international commerce of the new tax. Keynes himself felt it would be
the best way of preventing speculation damaging the economy, saying: The introduction of a
substantial government transfer tax on all transactions might prove the most serviceable reform
available, with a view to mitigating the predominance of speculation over enterprise in the
United States.
US writes global cheques
Following the Great Depression at the beginning of the 1930s, Franklin D Roosevelt set about a
series of reforms that would reshape the American economy and propel the country towards
global economic dominance. The free market, as Roosevelt saw it, would reshape domestic
commerce and welcome trade with other market economies, namely, Germany, France,the UK,
Spain, the Netherlands, and Canada.
Roosevelts New Deal was based upon the principles of the Three Rs, which encouraged relief
for the unemployed and poor, recovery of the economy, and the reform of the financial system to

prevent another catastrophic slowdown. This would become the founding principals of global
trade.
Many of the characteristics of the New Deal were designed to bolster the role of the state in
supporting the economy and acting as a safety net for the poorest in society. Throughout the
1930s, Roosevelt implemented a series of acts, including the Economy Act of 1933 that proposed
to balance the federal budget, initially pleasing deficit hawks. There was also banking reform
including the Glass-Steagall Act as well as monetary reform, regulation of securities, and the
Social Security Act.
It was this act, in 1935, that was the centrepiece of the entire programme, providing pensions,
unemployment insurance and welfare benefits for the most needy, greatly improving the living
conditions of much of the population (see fig 1). Although it took some time to kick in, as
employment grew, business travellers flocked to the newly resurgent US, in an attempt to align
business with the growing new world. While there was a great deal of reform in the financial
system, there was also huge investment in infrastructure, with the railways and roads getting
significant upgrades, while the Second World War provided the manufacturing industry with a
massive boost in demand.

During the 1980s, President Ronald Reagan set about a series of reforms that drastically cut back
the states involvement in the market and reduced taxation on businesses. This further generated
direct investment, allowing a period of sustained growth both at home and abroad. Friedman
himself was enthusiastic about the principles of Reagans policies, but felt that he could have
gone further: Reaganomics had four simple principles: Lower marginal tax rates, less
regulation, restrained government spending, noninflationary monetary policy. Though Reagan
did not achieve all of his goals, he made good progress.
Free markets encourage globalisation
Economic liberalisation occurred in a number of countries that had previously practised firmer
control over their economies. Although China still has a relatively tight grip on their economy,
the reforms implemented by Deng Xiaoping in 1978 resulted in a soaring growth of the
economy. Reforms included an end to the collectivisation of agriculture, a new openness to
foreign investment and the encouragement of entrepreneurs to start new businesses.Throughout
the following two decades, many state owned institutions were privatised, and protectionist
policies were removed. The impact of these reforms can be seen from the fact that nearly 70
percent of GDP in China is from the private sector. This liberalisation can be witnessed today in
the sheer volume of exports leaving Chinese soil, as well as the amount of multinationals keen to
do business with Beijing.
One consequence of liberalisation that emerged from the debt crisis and hyperinflation that
afflicted Latin America during the 1980s was democratisation. When stakeholders including the
IMF and the World Bank set about liberalising Latin American economies, and restricting the
input that governments had on economic policy, liberalisation and democratisation occurred,
according to economist Nikolaos Karagiannis in his book Key Economic and PoliticoInstitutional Elements of Modern Interventionism. In particular, Argentina emerged from their
financial crisis because of increased privatisation and an opening up to foreign investment,
making business a far more palatable option on those shores, something it has strayed from in
recent years.
With a need to address the economic troubles of many western economies in recent years, the
arguments about how much input governments should have in the running of the market have
become louder. On the one hand, governments have been encouraged to cut back on their
national deficits, with the best way to do this as a retreat of the state. However, in order to
stimulate growth, these economies have been encouraged to sustain employment by investing in
the same institutions.
International business must bear many of these considerations in mind when an
expansionary policy is on the cards. Both long and short term, executives stand to lose heftily
should they venture into territory governed by a central body with too much input, or too little.
http://www.worldfinance.com/home/special-reports-home/to-intervene-or-not-to-internvene

Free Market

DEFINITION of 'Free Market'


A market economy based on supply and demand with little or no government control. A
completely free market is an idealized form of a market economy where buyers and sellers are
allowed to transact freely (i.e. buy/sell/trade) based on a mutual agreement on price without state
intervention in the form of taxes, subsidies or regulation.
In financial markets, free market stocks are securities that are widely traded and whose prices are
not affected by availability.
In foreign-exchange markets, it is a market where exchange rates are not pegged (by
government) and thus rise and fall freely though supply and demand for currency.

INVESTOPEDIA EXPLAINS 'Free Market'


In simple terms, a free market is a summary term for an array of exchanges that take place in
society. Each exchange is a voluntary agreement between two parties who trade in the form of
goods and services. In reality, this is the extent to which a free market exists since there will
always be government intervention in the form of taxes, price controls and restrictions that
prevent new competitors from entering a market. Just like supply-side economics, free market is
a term used to describe a political or ideological viewpoint on policy and is not a field within
economics.

Free market refers to an economy where the government imposes few or no restrictions and
regulations on buyers and sellers. In a free market, participants determine what products are
produced, how, when and where they are made, to whom they are offered, and at what priceall
based on supply and demand.
A purely free market does not existbecause all countries choose to impose some level of
central decisions and regulations.
For example, many countries forbid producers from polluting, pricing below cost, or being a
monopoly. In addition, they often require minimum safety standards, disclosure of ingredients,
licensing of certain professionals, and protection of original ideas, to name just a few. Many
governments control money supply to minimize the negative effects of natural economic
expansion and contraction.
Free market can also be more of a subjective term.
In western democracies, governments that are elected by citizens pass regulations. Therefore,
these regulations protect a majority of citizens, and reflect their values. These markets feel free to
most of the citizens, even when they are highly regulated.

In autocratic governments, non-elected governments impose major market decisions. These rules
tend to feel oppressive, even if there may be fewer overall regulations.
The pros and cons of a free market are subject to debate all over the world, and are one of the
major dividing lines between capitalist and communist economies.