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estricting international trade (e.g. tariffs and quotas), and by imposing price controls (e.g.
ceilings and floors). Governments can encourage free and competitive markets by permitting
free entry into markets, free international trade, free market prices, and by prohibiting
anticompetitive behavior (e.g. cartels).
3. Free international trade. Even governments that generally promote free and competitive
markets often restrict international trade. In Chapter 16, we will see that nations benefit from
specialization and trade according to comparative advantage. Free international trade is a type
of technological advance, in that it allows for more production with the same amount of
resources. Governments can encourage free international trade by resisting the political
temptation to restrict trade for the benefit of special-interest groups and by maintaining flexible
exchange rates.
4. A stable price level. In the long run, price level stability depends on proper monetary policy.
A government must avoid excessive money supply growth in order to avoid excessive
inflation. Excessive money supply contraction must also be avoided, to avoid deflation. Either
inflation or deflation can have a damaging effect on the level of investment. Lack of investment
hinders economic growth.
5. A small government. The basic economic problem is scarcity. The private sector tends to use
resources more efficiently than the public sector. There are necessary functions of
government, which justify the transfer of limited resources from the private sector to the public
sector. Among these are the protection of private property rights (e.g. through national
defense, police, the court system, etc.), provision of public goods (e.g. national defense,
highways, infrastructure, etc.), control of externalities (e.g. pollution), promoting competition
(e.g. through antitrust laws), and some degree of income redistribution.
But as the government grows larger, more resources are being transferred from the generally
efficient private sector to the generally less efficient public sector. A larger government also
necessitates higher tax rates. High tax rates weaken private property rights and increase the
amount of deadweight loss from taxation (see Chapter 13). A larger government also
increases the opportunities for socially wasteful rent seeking and increases the opportunities
for corruption.
The governmental policies that have proven to be conducive to economic growth generally call for
a passive role for the government. The government protects but does not interfere with private
property rights. The government maintains competitive markets, but does not try to influence who
wins the competition.
Example 5: Officials are necessary in a football game to ensure that the players compete fairly,
following the rules. But football officials are not to block, tackle, or otherwise try to influence which
team wins the game.
Industrial Policy
Some economists (and many politicians) favor a more active role for the government. The
government can provide aid to those industries that have (in the government’s opinion) the
greatest potential for future growth. This aid might come in the form of tax breaks, government
subsidies, government loans at low interest rates, or protection from foreign competition. This
strategy for promoting economic growth is called industrial policy.
Industrial policy – government aid to those industries that have the greatest potential for future
growth.
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If the government implements industrial policy, certain problems are likely to be encountered:
1. Aid may be determined by politics, not economics. Aid may go to the industries with the
most political influence, rather than those with the greatest potential for future growth.
14 - 5 Economic Growth