How Should Governments
Intervene in an Economy?
Rutvik Rele
Initially one may think that our economy is tightly controlled by
the government, however, it only takes a glance at the UK’s GDP
statistics to discover that less than 40% of our GDP comes from
government spending. This already shows that the free-market
dictates 60% of our GDP, assuming that governmental spending
is efficient. Now the question becomes how do we allocate the
remaining 40% of resources, excluding market failures; do we
waiver to a more laissez-faire allocation, similar to Britain dur-
ing the height of the British empire, where governmental spend-
ing was only 10% of the national income and entrust market
forces such as the invisible hand to equitably allocate the re-
maining resources. Alternatively do we instead trust our gov-
ernment and Keynesian economics to intervene further in an
economy in order to see additional economic growth?
On the one hand, John Maynard Keynes proposed governments
should intervene as problems may arise from insufficient aggre-
gate demand such as high unemployment. These problems were
not going to be solved through the free market which leaves the
government to solve them. Hence, he decided to base an econo-
my’s output of goods and services on a model that consisted of
four different components; consumption, investment, govern-
ment spending and net exports (the difference between the
amount a country exports and imports from other countries).
Keynes then proposed that if an economy enters a recession
(where two quarters of a year have short-run economic growth
which is negative); the economy is likely to have a negative mul-
tiplier effect resulting in even lower aggregate demand. This
may have resulted from various factors. For example, the multi-
plier may have been caused by uncertainty from the recession,
resulting in lower consumer confidence to spend money as well
as uncertainty for businesses to invest in firms. Businesses may
also reduce investment further due to a decrease in demand for
products occurring from a reduction in consumer spending.
This may lead to lack of international competitiveness as a re-
duction in investment may lead to lower relative labour produc-
tivity against other countries with more recently invested capital
equipment. All of this lead Keynes to the conclusion that it is
then the government's responsibility to intervene and spend
money in order to increase the output of the economy, avoiding
any insufficient aggregate demand, and get it out of a recession.
This governmental spending would additionally be returned
back to the government following an increase of real GDP, as
the rise also leads to an increase in real wages, therefore in-
creasing money gained through taxes.
However, not all economic theories are quite the same. Adam
Smith, an economist many consider to be the father of econom-
ics, suggested in his book “The Wealth of Nations” that humans
naturally have self-interest at heart and the only way to take
into account the public’s best interest is through the free-
markets’ own mechanisms; alternatively known as the invisible
hand of the market. Although, the structure of the government
is different than in 1776; some of the main problems still re-
main. Governments are subject to mistakes as they may be
swayed in order to keep public opinion high, for example if
there is a need for taxes to increase, they may not increase them
may result in that party being removed from power. It is also
further suggested from Ludwig Von Mises and Friedrich Hayek’s
work on the economic calculation problem that the government
cannot rationally decide prices of goods and services as they
have imperfect information. The free market, on the other hand,
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