1. Chapter 3
Economic Progress and the Role of
Government

2. Ten Elements of Clear Thinking about Economic
Progress and the Role of Government
1) Government promotes economic progress by
protecting the rights of individuals and supplying
goods that cannot be provided through markets.
2) Allocation through political voting is fundamentally
different from market allocation, and economic
analysis indicates that the latter is more consistent
with economic progress.
3) The costs of government are not only taxes.
4) Unless restrained by constitutional rules, specialinterest groups will use the democratic political
process to fleece taxpayers and consumers.

3. Ten Elements of Clear Thinking about Economic
Progress and the Role of Government
5) Unless restrained by constitutional rules,
legislators will run budget deficits and spend
excessively.
6) Government slows economic progress when
it becomes heavily involved in trying to help
some people at the expense of others.
7) The net gain to those receiving government
transfers is less, and often substantially less,
than the amount they receive.

4. Ten Elements of Clear Thinking about Economic
Progress and the Role of Government
8) Central planning replaces markets with
politics, which waste resources and retards
economic progress.
9) Competition is just as important in
government as in markets.
10) Constitutional rules that bring the political
process and sound economics into harmony
will promote economic progress.

5. Government Promotes Economic Progress by
Government Promotes Economic Progress by
Protecting the Rights of Individuals and
Protecting the Rights of Individuals and
Supplying Goods That Cannot Be Provided
Supplying Goods That Cannot Be Provided
Through Market
Through Market

6. How does Government promote social
cooperation and enhance its citizens’ economic
welfare?
1) By providing people with protection for their
lives, liberties, and properties (as long as the
properties and liberties were acquired
without force, fraud, or theft) and
2) By supplying a few select goods that have
unusual characteristics that make them
difficult to provide through markets.
– The protective and productive functions of
government.

7. Is Government Too Big?
Is Government Too Big?

8. Protective Function
• Protection of people and their property
against aggressors
• The enforcement of contracts
• The avoidance of restrictions, regulations, and
discriminatory taxes

9. Productive Function
• Supplying to one, means supplying to others
• Hard to restrict their consumption to paying
customers.
– Supplying public goods to the country
• Public Defense
• Public Parks

10. Public Good
• Non-rivalry and non-excludability
• Everyone can simultaneously obtain the benefit
from a public good!!
• One person’s benefit does not reduce the benefit
available to others.
• Because there is an inability to exclude creates a
free-rider problem.

11. Free-Rider Problem
• People can receive benefits from a public
good without having to pay for it.
• As a result, public goods tend to be
unprofitable for any private firm that decides
to produce and sell them.

12. Allocation Through Political Voting
Allocation Through Political Voting
Is Fundamentally Different from
Is Fundamentally Different from
Market Allocation, and Economic
Market Allocation, and Economic
Analysis Indicates That the Latter Is
Analysis Indicates That the Latter Is
More Consistent with Economic
More Consistent with Economic
Progress.
Progress.

13. What is the political process
• It is merely an alternative form of social
organization
• It is not a corrective device that can be
counted on to provide a sound remedy when
problems arise.

14. Democratic Government
•
•
•
Policies proposed by the government may or
may not be productive.
Policies favored by the voting majority do
not necessarily promote economic progress.
The benefits and costs faced by voters
belonging to different interest groups are
often disproportionate.
Source:
commonsenseeconomic.com

15. Unlike Democratic Governments,
When Markets Are Competitive
• Producers can not force consumers to buy
their products.
• They have incentives to undertake only
productive activities.
Source:
commonsenseeconomic.com

16. Let’s Compare Democratic
Governments and Markets
1. Majority rule provides the basis for
government action, while market activity is
base on mutual agreement and voluntary
exchange.
• The power to tax, makes it possible for the
majority to coerce the minority
• However, under the market conditions, the
transaction does not happen unless all parties
agree to the transaction
Source:
commonsenseeconomic.com

17. Let’s Compare Democratic
Governments and Markets
2. There is little incentive for voters to be well
informed about either candidates or issues. In a
large number setting, an individual voter will not
decide the outcome of an election.
• Rational ignorance effect
• In the market, consumers individually decide how
to spend their money, if the choice is poor, then
they are wasting their OWN money. The incentive
is thus to do your research on the product you are
buying!!
Source:
commonsenseeconomic.com

18. Let’s Compare Democratic
Governments and Markets
3. The political process imposes the same option
on everyone, while markets allow for diverse
representation.
• Government allocation fits a “one size fits all”
• But markets allow individuals to receive the
desired amount of the product
Source:
commonsenseeconomic.com

19. What Is Needed to Encourage Democratic
Governments To Be Productive?
• To reduce the likelihood that people can
participate in government projects without
paying, it is important to link benefits
proportionately to costs.
• A democratic majority vote does not
guarantee the passage of productive
proposals.
• Supermajority support (75% of the voters) will
increase the likelihood of passing productive
projects.
Source:
commonsenseeconomic.com

20. The Costs of Government
The Costs of Government
Are Not Only Taxes
Are Not Only Taxes

21. Which of the following is true of taxes?
a.
b.
c.
d.
Taxes increase the volume of mutually advantageous exchanges.
Tax increases are the primary cause of inflation.
Business taxes generate government revenue without imposing a
burden on consumers and households.
Taxes drive a wedge between what buyers pay and what sellers
receive.
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22. What are costs?
• The cost of any product is not only the
monetary costs, but what we are giving up to
get the product.
• Government is no exception to this!!
• Collective and Enforcement
• Time, talent, and money

23. Three types of costs incurred when
government levy taxes and provide goods
and services
1. The loss of private sector output that
could otherwise be produced
2. The cost of resources expended in tax
collection and enforcement of
government mandates
3. The cost of price distortions caused by
taxes and borrowing

24. What is the cost of this???
http://knowledgecenter.csg.org/drupal/content/obama-renews-call-inf

25. How does taxes distort prices??
• Taxes alter consumption and production
incentives.
• Consider supply and demand. Taxes increase
what consumers pay and reduce what sellers
receive. They reduce the volume of
exchanges and squeeze out some of the gains
from trade.
• Some exchanges will not occur because the
tax wedge makes them disadvantageous.
• Deadweight loss of taxation adds 9-16%
above the costs of compliance and regulation.

26. Summary of Taxes
• Taxes distort prices.
• Taxes transfer income from individuals to the government.
– Businesses do not pay taxes. Instead, they collect taxes from
customers, employees and shareholders.
• Politicians want to conceal the tax costs of their programs and
make you “think” businesses are paying

27. Special-interest groups will
Special-interest groups will
use the democratic political
use the democratic political
process to fleece taxpayers
process to fleece taxpayers
and consumers
and consumers

28. A Democratic Government
• Can contribute to economic progress when it
fills its protective and productive roles.
• However, more than a majority rule and
popular vote is needed to assure that it
restricts itself to those roles.
• Why? Incentives matter! Consider the
following three examples.

29. The Power of Special Interests
•
•
•
Special interest groups will
help politicians get elected
through donations and
getting workers to vote.
While the majority of
unorganized voters is
harmed, there is little
incentive to act in
opposition.
In varying degrees, all
politicians cater to special
interests.
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30. Example 2:
• “If a small but organized group cares a great
deal about a certain government policy, while
the majority is unorganized and apathetic,
then the special interest often prevail.”*

31. Consider This “Sweet” Example
•
•
•
In 2000, the sugar lobby contributed
$13 million to politicians.
The government restricts sugar imports
into the U.S. through quotas.
The average U.S. consumer pays $20 per
year in higher sugar prices while sugar
growers gain about $1.9 billion.
• IS THIS A SOUND GOVERNMENT
PROGRAM? DISCUSS.
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32. Example 3: Government Incentives
• Log-rolling: implicit vote trading among
legislators
• They vote for programs that benefit the
districts of other legislators in exchange for
votes for their pet projects.
• Federally funded dams, highways, housing
projects, Veterans Administration hospitals,
and job-training centers are often reflective of
logrolling.

33. Question: Restrictions that limit sugar imports,
subsidies for the construction of sports stadiums,
and federal spending on programs like the
construction of an indoor rain forest in Iowa all
provide examples of government programs that,
a. Are based on careful analysis
of benefits relative to costs.
b. Are designed to redistribute
income from the rich to the
poor.
c. Reflect the political
attractiveness of specialinterest issues.
d. Promote the general welfare.
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34. Unless restrained, legislators
Unless restrained, legislators
will run budget deficits and
will run budget deficits and
spend excessively
spend excessively

35. The Attractiveness of Deficit Spending
to Legislators
• Budget Deficit: Government spending that
exceeds revenues. Deficits are financed by
borrowing.
• Spending is attractive to legislators because it
allows them to take credit for programs that
benefit voters.
• Taxes are unattractive because they impose
visible costs on voters.
• Thus, legislators tend to spend more than they
are willing to tax.

36. The National Debt
• The cumulative effect of all past budget
deficits and surpluses of the federal
government.
• Check out the U.S. Debt.
• The U.S. Treasury borrows funds by selling
securities like U.S. Treasury Bills, Notes, and
Bonds.
• Borrowing makes the current cost of running
the government less visible.

37. Is that all the debt?

38. Deficit Spending and the National Debt
• Borrowing pushes the visible cost of running the
government and policies into the future.
• Bottom line.
– Why continue spending when in a deficit?
• Immediate benefits with deferred costs are politically
attractive!
• Deficit spending and public debt appear to
transfer costs into the future when current
politicians are no longer office.

39. Constitutional Changes That May
Restrain Legislators
• Require the federal government to balance its
budget like most states.
• Require a 2/3 or ¾ majority vote in both
branches of Congress to fund deficit spending
or increase its borrowing power.
• Require that Congress only spends an amount
equal to last year’s tax revenue.

40. Government Slows Economic
Government Slows Economic
Progress When It Becomes
Progress When It Becomes
Heavily Involved providing favors
Heavily Involved providing favors
to some at the expense of others
to some at the expense of others

41. Two ways individuals can acquire
wealth
• Production
• Plunder

42. Production
• Production is when people get ahead by
producing goods and service and earn income
from it

43. Plundering
• Plunder what others have produced.
•
•
It fails to generate additional income
It also consumes resources- decreasing the wealth
to society
• The gain of one is a loss to another

44. Should government help
Should government help
family farms?
family farms?

45. What about sport teams?
What about sport teams?

46. How does the government get
involved in these actions?
• A government can act as a neutral force
•
•
Protect property rights
Enforce contracts

47. The Net Gain to Those Receiving
The Net Gain to Those Receiving
Government Transfers Is Less,
Government Transfers Is Less,
and Often Substantially Less, than
and Often Substantially Less, than
the Amount They Receive
the Amount They Receive

48. Income Transfers
•
•
It is difficult to improve people’s well-being
through income transfers when benefits are not
attached to costs.
The unintended consequences of secondary
effects can get in the way.

49. Why weren’t the income transfers
Why weren’t the income transfers
more effective?
more effective?

50. Another example
Another example

51. Is income something that people
Is income something that people
produce and earn?
produce and earn?

52. Unintended Consequences of income
transfers
1. Reduce incentives of both taxpayer and transfer
recipient to earn income
• “Free” income reduces work effort and innovation
among transfer beneficiaries.
• Increased tax burdens stifle incentives to produce and
earn more among persons earning income and paying
taxes.
1. Competition for transfers erodes most of the
long-term gain of the targeted beneficiaries.
• When qualification requirements must be met,
resources and potential production are wasted as
individuals seek to qualify for the transfers.

53. Unintended Consequences of income
transfers
3. Protection from adversity arising from imprudent
decisions makes people more likely to increase
the likelihood of that adversity.
•
•
Consequences of adversity become less severe.
Potential recipients have less incentive to avoid
adversity.

54. The “War on Poverty” Illustrates
These Points
35%
30%
25%
“War”
20%
15%
10%
5%
0%
1947 1959 1965 1975 1985 1995 2005
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55. Can we apply this to the bank bailout?
Can we apply this to the bank bailout?

56. Central planning replaces markets
Central planning replaces markets
with politics, which wastes
with politics, which wastes
resources and retards economic
resources and retards economic
progress.
progress.

57. The “Man of System”
“The man of system is apt to be very wise to his own
conceit. He seems to imagine that he can arrange the
different members of a great society with as much
ease as the hand arranges the different pieces upon a
chess-board.”
-Adam Smith
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58. Aren’t elected officials and government
Aren’t elected officials and government
experts more likely to represent the “general
experts more likely to represent the “general
welfare” of the people than business
welfare” of the people than business
entrepreneurs?
entrepreneurs?

59. Five Major reasons why central planning
will almost surely do more damage than
good
1) Central planning merely substitutes politics
for market verdicts
2) The incentive of government-operated firms
to keep costs low, be innovative, and
efficiently supply goods is weak.
3) There is every reason to believe that
investors risking their own money will make
better investment choices than central
planners spending the money of taxpayers

60. Five Major reasons why central planning
will almost surely do more damage than
good
4) The efficiency of government spending will
also be undermined because the budget of
an unconstrained government is something
like a common pool resource.
5) There is no way that central planners can
acquire enough information to create,
maintain, and constantly update a plan that
makes sense.

61. Central planning merely substitutes politics
for market verdicts
• Subsidies and investment funds disbursed by
planners are influenced by political
considerations.
• “Old” firms tend to be favored over “new”,
growth-oriented firms.
• “Pork barrel” projects are still pursued.

62. Example of Pork Barrel Spending
Example of Pork Barrel Spending

63. The incentive of government-operated firms to
keep costs low, be innovative, and supply goods
efficiently is weak.
• Boosting efficiency or lowering costs generate little
political gain.
• They will be motivated to pursue a larger budget.
• Per-unit costs rise as increased inefficiencies get built
into the political allocation.

64. Investors risking their own money will make better
investment choices than central planners spending the
money of taxpayers.
• Private investors bear the consequences of poor
decisions directly but central planners do not.
• Private investors have a strong incentive to increase
productivity and keep costs low. In contrast, political
rather economic considerations are more important
for central planners.

65. There is no way that central planners can acquire
enough information to create, maintain, and constantly
update a plan that makes sense.
• Market prices generally channel information quickly
and accurately to both producers and consumers.
On the other hand a political process, particularly
one with checks and balances like those found in the
U.S., will respond slowly and often in a contradictory
manner.

66. Competition Is Just As Important in
Competition Is Just As Important in
Government As in Markets
Government As in Markets

67. Government & Competition
1. Leaders of public sector firms have little incentive to cut costs or boost
performance when there is little competition.
a. Inefficient programs are permitted to linger.
b. Failure to achieve goals is often rewarded by increased funding.
Consider increased funding in police departments with higher crime
rates.
2. In the market economy, profits and losses register performance.
Inefficient producers are weeded out and efficient ones are rewarded.
There is no parallel in the centralized government.

68. Government & Competition
3.Increased competition among decentralized
government units or between the
government and private sector creates
incentives for government officials to work
productively, seek efficiency, cut costs and
innovate.
4. Citizens with differing preferences and views
about government activities can vote with
their feet in a decentralized system; a
centralized system does not permit this.

69. Constitutional Rules That Bring the
Constitutional Rules That Bring the
Political Process and Sound Economics
Political Process and Sound Economics
into Harmony Will Promote Economic
into Harmony Will Promote Economic
Progress
Progress

70. Constitutional Checks
• The scope of government must
be limited.
• An unrestrained government
results in the fleecing of
citizens.
• Constitutional checks:
– 10th Amendment
– 5th Amendment
– http://score.rims.k12.ca.us
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71. A Positive Program for Prosperity:
7 Constitutional Suggestions
1. No government shall use its regulatory
powers to take private property, either
partially or in its entirety, for public use
without paying the owner the full market
value of the property taken.
http://www.usconstitution.net/xconst_Am5.html
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72. A Positive Program for Prosperity:
7 Constitutional Suggestions
2. The right of individuals to compete in a
business or profession and/or buy and sell
legally tradable goods and services at
mutually acceptable terms shall not be
infringed by Congress or any of the States.[i]
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73. A Positive Program for Prosperity:
7 Constitutional Suggestions
3. Congress shall not levy taxes or impose quotas on either
imports or exports.
4. A three-fourths approval of both Houses of Congress shall be
required for all expenditure programs of the federal
government. At least two-thirds approval of the legislative
branches of state government shall be required for the
approval of expenditures by state governments.
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74. A Positive Program for Prosperity:
7 Constitutional Suggestions
5. A three-fourths approval of both Houses of
Congress shall be required before the federal
government is permitted to borrow any funds
to finance a deficit in its annual budget.
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75. A Positive Program for Prosperity:
7 Constitutional Suggestions
6. A three-fourths approval of both Houses of
Congress shall be required for the federal
government to mandate any expenditures by
either state governments or private business
firms.
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76. A Positive Program for Prosperity:
7 Constitutional Suggestions
7. The function of the Federal Reserve System (Fed) is to
maintain the value of the currency and establish a stable price
level. If the price level either increases or decreases by more
than 4 percent annually during two consecutive years, all
Governors of the Federal Reserve System shall be required to
submit their resignations.
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