Government Intervention

Updated on April 9, 2024

What Is Government Intervention?

Government intervention refers to the regulatory action taken by a government that aims to change decisions made by individuals, organizations, or groups regarding economic and social matters. Its primary goal is to maximize a country’s social welfare by correcting market failure.

Government Intervention

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Government intervention supporters defend using various economic policies to compensate for an economic system’s flaws, which give way to significant economic imbalances. According to them, demand and supply laws are not enough to ensure economic equilibriums, and the government must intervene to ensure the economy’s proper functioning. Different types of government intervention exist, like subsidies, taxes, etc.

Key Takeaways

  • The government intervention definition refers to a set of regulatory actions taken by a government to influence resource allocation and market mechanisms.
  • There are various advantages of government intervention. For example, it provides merit goods that are unavailable in the market. Moreover, it reduces income inequality and poverty in the country.
  • The concept has certain downsides. For example, it may disincentivize producers to be more efficient and innovative. Moreover, since the government decides what to produce, consumers may have fewer choices.
  • Governments may intervene for multiple reasons, such as reducing monopoly power and redistributing income and wealth.

Government Intervention In The Economy Explained

The government intervention definition refers to a regulatory action carried out by any government that directly impacts a market economy to change the free market equilibrium. It is necessary because of the market inefficiencies and failures. To pursue specific social and economic goals and improve welfare, the government introduces rules and regulations to deliver unachievable results under a free market.

Governments have multiple tools at their disposal to intervene when issues arise. For example, they may utilize the introduction of new programs, funding, taxes, etc. A government may also intervene if local governments cannot handle natural disasters. Such disasters may occur owing to economic problems, not just humanitarian or physical issues.

The significance of such an intervention depends on the type of economic system a nation adopts. In the case of a command economy system, such intervention is significant. The government identifies what is best for the economy and allocates the available resources accordingly. Moreover, it makes decisions related to the manufacturing and distribution of goods. Under this system, the private sector’s role is minimal; it can even be zero.

On the other hand, a free market economy functions in reverse and focuses on minimizing intervention. It operates freely via a demand and supply mechanism. This mechanism ensures a more efficient allocation of resources than the command economy system. Moreover, under a free market economy, a government’s role is typically restricted to imposing rules for recognizing and safeguarding private property ownership. That said, the private sector plays a crucial role in this system.

Moreover, in the case of a mixed economy system, the interventions are more when compared to a market economy. That said, it is not as diverse as a market economy. Both the government and the private sector play a crucial role.

One must remember that the roles and importance of the private sector and the government varies between nations. For example, Cuba and China are inclined towards a command economy. On the other hand, in the US and UK, the private sector plays a more crucial role in managing economic resources.

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Reasons

Governments may intervene to fulfill certain objectives. Let us look at some of them.

  • Changing consumer behavior
  • Safeguarding people via consumer protection policies
  • Preserving the environment 
  • Providing indivisible services and non-market products
  • Securing the domestic economy
  • Improvement in market functioning
  • Providing basic infrastructure
  • Limiting monopoly power
  • Redistributing wealth and income
  • Providing basic healthcare and education

Types

Let us discuss the different types of government interventions in detail:

#1 – Price Controls

These are government regulations related to prices, wages, or their rates of change. A government may impose such regulations on a wide range of offerings. Alternatively, it can impose regulations on any market involving a single good. Price controls are of two types —

  • Price Floor – This is the minimum price one can charge for goods and services. It aims to safeguard suppliers.
  • Price Ceiling – This is the maximum price suppliers can charge for a product or service. Its purpose is to safeguard consumers by ensuring that the offerings are affordable for as many consumers as possible.

#2 – Subsidy 

Subsidies are incentives that a government gives businesses or individuals through grants, tax breaks, or cash to increase the supply of specific goods and services. For example, it can be a payment to suppliers, enabling them to minimize their cost of production and increase their output. This, in turn, allows individuals to access products and services at a lower price, leading to an improved standard of living.

#3 – Tax

Taxes are the primary source of income for governments. They utilize taxes to fund various programs and repay debt. Moreover, a government usually utilizes the funds to increase economic capital by offering public goods, for example, trains, bridges, roads, national defense, etc. This economic capital is crucial for increasing an economy’s production capacity over the long term. Governments can impose taxes on taxpayers directly, for example, via income tax. Alternatively, they may impose taxes indirectly, for example, through value-added tax or sales tax.

#4 – Regulations

Regulations ensure that economic activities run properly. There are multiple government regulations, each of which impacts economic activity differently. Let us check out some of the different regulation categories.

  • Environment: For instance, governments launch multiple regulations concerning the environmental effect of business operations on the environment. The introduction of environmental safety standards is one example.
  • Employment: The government issues laws, rules, and regulations concerning fair recruitment, wages, and workforce safety and health.
  • Competition: Governments impose certain regulations, for example, mergers and acquisitions and antitrust regulations, to promote fair competition. Moreover, this category involves deregulation, for instance, eliminating the limits on foreign investors’ share ownership.
  • Consumer Protection: This category protects consumers from unfair practices concerning price rules, product descriptions, and safety and health standards.

Some other ways in which governments may intervene are as follows:

  • Raising or dropping interest rates: Governments increase or decrease interest rates to ensure liquidity and stability in the economy.
  • Bailouts: This refers to an injection of funds into an organization or business facing a potential bankruptcy threat.

Examples

Let us look at a few government intervention examples to understand the concept better.

Example #1

The UK government acted with its biggest-ever intervention to ensure that the rail fare increases do not exceed 5.9%, which is 6.4 percentage points less than the retail price index figure on which the increases are historically based.

The rail fares will officially increase in March 2023. However, like in 2022, the government will freeze the fares for January and February, thus giving passengers additional time to buy cheaper tickets at the current rate.

Because of the unprecedented inflation, the government has aligned the surge in fares to the average earnings growth of July 2022 rather than the retail price index. Thus, it has halved the increase, ensuring that the surge is easier on family finances.

Example #2

Suppose a significant portion of Country A’s population, primarily low-and-middle-income families, doesn’t have health insurance. As a result, the country’s government offers a healthcare subsidy as a tax credit that enables eligible citizens to access medical facilities easily. 

Effects

Let us look at some government intervention effects.

  • It can increase the efficiency of the firms operating within a market. Moreover, interventions such as deregulation lead to more competitive markets.
  • Introducing price caps or profit regulation reduces the profits earned by firms within the market. Hence, businesses may not be able to achieve supernormal profits. That said, these policies can make firms more efficient.
  • Certain interventions like performance targets and minimum quality standards positively impact the quality of the products and services offered by firms.

Pros And Cons

Let us look at the pros and cons of government interventions:

Pros

  • It reduces the potential political risk.
  • Government intervention reduces poverty and inequality via the tax and benefit system.
  • The government can intervene to provide public and merit goods unavailable in the free market.
  • It keeps the nation safe with military protection and offers consumers security when selecting products.
  • Another key advantage of government intervention is that it can safeguard the environment’s long-term interest.

Cons

  • Government ownership can lead to fewer options for individuals.
  • Political pressure groups may influence the government.
  • The lack of incentives may lead to inefficient production.
  • Sometimes, people may find the government regulations overbearing on their choice.
  • A government can cause its issues. For example, certain government decisions can lead to an inefficient outcome.

Government Intervention vs Laissez-Faire

The concepts of government intervention and laissez-faire can often be confusing for individuals new to the world of finance. However, one can eliminate such confusion by knowing the differences between them. So, let us look at the key distinguishing characteristics of each of these concepts.

Government InterventionLaissez-faire
This refers to the actions taken by a country’s government to interfere with the decisions of individuals and firms to achieve the objective of overcoming market failure. This is an economic philosophy of free market capitalism; it opposes government intervention. 
Government intervention proponents believe that supply and demand are insufficient to ensure economic equilibrium, and governments must intervene to ensure that the economy functions correctly. Laissez-faire advocates believe that the market regulates itself through demand and supply. 

Frequently Asked Questions (FAQs)

1. Which government interventions cause a consumer or producer surplus?

Subsidies, price controls, and other interventions may increase producer or consumer surplus. That said, one must remember that according to economic theory, losses sustained by the other side may outweigh any gain. This net harm causes deadweight loss.

2. Is government intervention good?

The proponents of this concept believe that it offers multiple benefits. For example, it safeguards the environment and ensures the health and safety of the public. That said, free market economists believe that the intervention must be strictly restricted as it often leads to inefficient allocation of resources.

3. Are government interventions to alleviate poverty sustainable?

Such interventions to alleviate poverty can be sustainable over a long period if the policies include sufficient provisions of products and services, which include fee healthcare, subsidized housing, and free education of good quality.

4. How firms can respond to government intervention?

Firms can adapt and make changes to their operations. Alternatively, they can respond by withdrawing their operations from the nation altogether.

This article has been a guide to what is Government Intervention. We explain its reasons, types, examples, effects, pros, cons, and comparison with Laissez-Faire. You may also find some useful articles here –

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Comments

  1. George says

    I found it very relevant.

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