Government intervention

Government intervention is any action carried out by the government or public entity that affects the market economy with the direct objective of having an impact in the economy, beyond the mere regulation of contracts and provision of public goods.

Government intervention advocates defend the use of different economic policies in order to compensate the flaws of the economic system that give way to large economic imbalances. They believe the Law of Demand and Supply is not sufficient in order to ensure economic equilibriums and government intervention should be used to assure a correct functioning of the economy.  Examples of these economic doctrines include Keynesianism and its branches such as New Keynesian Economics, which relay heavily in fiscal and monetary policies, and Monetarism which have more confidence in monetary policies as they believe fiscal policies will have a negative effect in the long run. On the other hand, there are other economic schools that believe that governments should not have an active role in the economy, and therefore should limit its intervention, as they believe it will have a negative impact in the economy. They believe that the economy should be left to run in a laissez-faire way and it will find its optimal equilibrium.  Advocates of none or limited intervention include liberalism, the Austrian school and New Classical Macroeconomics.

As in most imperfect competition markets and especially in monopolistic ones, a firm may practice an abusive behaviour, which will translate into a loss of welfare. In such cases, government intervention will be praised both by consumers and those firms that seek for lower prices and a profitable share of the market. Regulations such as price setting, taxation or subsidies may be used in order to restore and maximise the initial efficiency of natural monopolies.

Nevertheless, the government must be cautious when setting and applying regulations, as an incorrect comprehension of the market structure may bring a higher cost to social welfare instead of the expected benefits. In order to achieve an optimal regulation level, governments should analyse and determine if natural monopolies can be sustained whenever they ensure a lower total cost. If this is the case, the government will have to guarantee that the firm does not make excessive revenues, and that fair prices are maintained. If, on the contrary, the total costs of the industry would diminish if new firms entered the market, the government should regulate their entrance. Essentially, what governments should do is to correctly balance the conflict between the industry’s efficiency and its profitability.