The combination of the wide range of interest groups concerned about government measures to control industry and the importance of such measures within the framework of economic policy in Western economies has a pronounced bearing on the method of analysis used in this Course.
Figure 1.1 Simple supply and demand diagram
An example employing a very simple supply and demand diagram (Figure 1.1) may illustrate how it is intended to modify the application of economic analysis for the purpose of analysing government policies. Imagine an industry in which there is pure competition and in which the supply curve has the familiar properties of being continuous and upward sloping, whereas the demand for the product may be represented by a continuous downward sloping curve which crosses the supply curve from above. Expectations of suppliers and their customers are fulfilled and an equilibrium price P and output Q are then determined. Now, assuming no change in the underlying conditions of supply and demand and in the expectations of suppliers and consumers, consider the possibility that the government decides that output is too high, perhaps because the equilibrium output Q is associated with an unacceptable level of pollution. It imposes a fixed tax per unit of output on the product. As one would expect, the analysis shows that, as a result of this tax measure, output will fall to Q’ and price rise to P’, the extent of the change in price and output depending on the elasticities of demand and supply. If this were the end of the story the reader would gain the impression that the policy decision is taken by some ‘observer’ outside the economy, perhaps equipped with a manual on welfare economics, who obtains ‘once-and-for-all’ reactions from producers who adjust price and output as required. Suppliers maximize profits, but subject to the additional constraint of the tax on their output, and this may be represented very simply by a decision flow system as follows:
| Government | Industry |
| ΔT1↑ | ΔP↑ |
| ΔQ↓ |
| Δ | = | ‘change in’ |
| T1 | = | tax per unit |
| P | = | price of product |
| Q | quantity of product |
The first problem encountered by government in implementing the policy just described concerns the information required. It needs to know the shape and position of planned supply and demand. Such information is not free, i.e. resources have to be employed by government in order to obtain it. Market research might be relied on to test the reactions of customers to any contemplated rise in price, and producers might be requested to provide estimates of the effects of a tax on costs and output plans. There are two points to be made about the supply of information: (a) advance notice is given of a possible policy change – for suppliers and customers, forewarned is forearmed; (b) the sources of information are those affected by the results of the policy, and they may have little or no incentive to supply complete or correct information. The government must either offer suitable incentives to supply the information or have coercive powers to exact it. Even then, the information supplied will rest on forecasts by customers and suppliers which are conditioned by uncertainty about future incomes and tastes and about future costs respectively. Alternatively, the government may decide to make an informed guess about the effects of the tax and to rely on the information supplied by the reactions of suppliers and customers to its imposition in order to provide more exact information which could be used to make any subsequent adjustments in the rate of tax. In short, both government and ‘governed’ have to evolve strategies which affect the process of change in moving from non-intervention to intervention in this particular market.
The second problem encountered by government is the extent to which it may have to take into account the so-called ‘feedback’ effects of the policy. Feedback depends on whose interests are affected by the policy change and the magnitude of the net benefits of costs perceived by interest groups. It will take the general form of trying to influence government in a way which maximizes the benefit or minimizes the costs of the policies. This influence may be exercised in a variety of ways ranging from political action through the ballot-box, lobbying parliamentary representatives and government officials, testing of government policies in the courts, to covert or open defiance of the law. These instruments of political participation may require individual companies to consider whether it is in their interests to employ them by acting alone or in combination with other companies.
The example given in Section 1.3 above can be used to illustrate feedback.
Consider a list of interest groups affected by the proposed policy. These will include:
The consumers of the product who, other things being equal, will have their real incomes reduced by the rise in price. If there are many of them, widely scattered geographically, the costs of organizing a consumer lobby to promote feedback designed to influence government, particularly by combined action, may be prohibitive, although their support of the government through the voting system may be affected.
The owners of the companies whose product is taxed. They may ‘invest’ in a number of courses of action taking a view of the costs and benefits at the margin of each one. Overseas-owned companies may threaten withdrawal of their services and lobby their own governments to support them in having the policy changed.
The employees of the companies whose employment prospects may be adversely affected. If unionized and if their unions are affiliated to other unions, they may employ collective action in order to promote the removal of the tax.
The suppliers of inputs to the industry, particularly if these inputs represent a large proportion of the output of ‘upstream’ companies.
The local or state government, particularly if the industry is concentrated regionally. The fall in output and employment may, other things being equal, reduce local revenues from those taxes whose yield varies with the output and employment of the firm. It may lobby the central government to seek to obtain some compensatory arrangement in order to offset revenue losses.
The government officials in the department or departments who administer the policy. The ease or difficulty in administering the policy may influence their demands for staff and other resources or, if resources are not forthcoming, may affect the effort devoted to operating the policy in a consistent and efficient manner.
Our example helps to make a general point about the approach used in this Course. An economic analysis based on a hierarchical relationship between some abstraction called the ‘government’ and another abstraction called a ‘company’ or ‘industry’, while useful as a first approximation to understanding how industrial policy affects the economy, must be incomplete. Such a simple model depicts companies (and other interest groups affected by policy measures) as passive adjusters to policies over which they have no direct or indirect influence. In fact, in Western industrial societies characterized by representative government, feedback effects are bound to be important, and taking account of these effects requires us to recognize that transactions between government policy makers and those affected by policies are more appropriately represented as a bargaining relationship. At first sight it might seem that bargaining characterizes only the formulation of industrial policy, whereas once that policy has been instituted, taking account of feedback, the execution of policy entails compliance by companies who must passively adjust to measures which have legal sanction. However, this assumes that all the costs and benefits perceived by the interest groups are correctly foreseen and that the interpretation of the law is never in dispute. The bargaining process is likely to continue to a greater or lesser degree far beyond the institution of a particular policy measure. In our example, companies and the government may be uncertain about the costs which would fall on the former in complying with the tax legislation; and likewise the government may have to adjust the tax rate in the light of changing cost and demand conditions which affect the ‘output’ of pollution. The execution of policy entails a continuous monitoring process by both government and industry in the light of their respective interests and, by implication, requires continuous bargaining between them.
The flow diagram in section 1.3 obviously requires considerable modification if it is to represent the reactions of those who are affected by the tax change. In order to convey the flavour of the bargaining relationship, it may be modified as shown in Figure 1.2, though neither all possible reactions nor the strength and influence of these reactions can be shown.
Figure 1.2 Modified flow diagram
