The State, Institutions, And Economic Outcomes

THE STATE, INSTITUTIONS, AND ECONOMIC OUTCOMES The state sets the formal legal and regulatory rules that are part of a country's institutional environment. Along with informal societal rules, these institutions shape human behavior. The state is not just a referee enforcing rules from the sidelines - it is also a dominant player in the economic game. State agencies invest, direct credit, procure goods/services, negotiate contracts etc., profoundly impacting transactions costs and economic activity, especially in developing nations. Well played, the state's activities accelerate development. Poorly played, they cause stagnation or disintegration. The state establishes formal rules for all organizations, yet as an organization itself, it must also abide by those rules. Government's Main Economic Roles  Regulation: of entry, business conduct, results like profit margins. Direct controls are discretionary and selective across firms/industries. Indirect controls use incentives and disincentives. Deregulation since the 1980s has spurred globalization.  Promotion: Governments provide infrastructure for development and incentives for priority sectors, especially in developing countries with inadequate private investment.  Entrepreneurship: Governments establish and operate enterprises in many countries due to factors like inadequate private investment in unprofitable but important sectors. However, recently many countries have privatized extensively.  Planning: Government planning is crucial in developing countries to efficiently utilize scarce resources and build capabilities. As Nehru said, planning is key to rapid development with limited means. Economic Roles of Government Government plays a vital role in almost every economy, even capitalist ones. A substantial share of output satisfies public wants, much private income comes from the public budget, and public tax/transfers significantly influence income distribution. Budget policy impacts employment and prices. In predominantly private economies, government intervention is needed because the market alone can't perform all economic functions. Public policy must guide, correct and supplement the market. The proper public sector size is largely a technical, not ideological, issue. Economic Systems The economic system, rooted in political philosophy, determines private business scope. At one end are free market/capitalist economies with:  Private ownership of production factors  Income from sale of production services and business profits  Individual choice in consumption, occupation, savings, investment  No government interference, only public goods provision But all modern capitalist economies have regulations. At the other end are centrally planned communist economies where the state owns all production means, sets production goals, and controls the economy. Consumption patterns are dictated. In between lie mixed economies like India combining public and private sectors. Strategic industries are often state-dominated. The economic system and policies significantly constrain business opportunities.