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To understand the interaction between government

policy measures and industries affected by them,
three kinds of information must be available. They
a. The economic role of government
Knowing what governments are aiming at in
trying to influence the way the different parts of
the economy work gives us a general idea of the
kinds of economic transactions which
governments have with industry and which form
the subject of negotiation between industry and
b. The place of government in the structure of the
The form and intensity of negotiation depend on
how important government is to industry. If
government is large in relation to the economy,
there is a presumption that industrial firms will
have to invest heavily in negotiating skills,
particularly where such firms are highly
dependent on government contracts.
c. The trends in the size of government relative
to the economy
Although the relationship between government
and the rest of the economy may change only
gradually, change does occur and this
requires industrial firms to keep their strategy
under review. Also with international companies
operating in different countries, it is helpful to
know how both structure and growth in
government differ between countries.

The Economic Role of Government

The economic role of government can best be
defined by a classification of its economic
policy aims. Broadly speaking the political choices
made by electorates in Western-type democracies
influence governments to perform four functions.
The first is production of services which private
firms are either unwilling to produce or for some
reason are not allowed to produce (or at least not
exclusively). This public provision may be to
provide immediate benefits (e.g. defence, law
and order) or deferred benefits (e.g. investment
in roads).
These production activities may be divided into
two types.
a. Services which are not sold in the market but
are financed out of compulsory levies. It is
considered preferable in economic analysis to
treat the government here as a collective
consumer in a position to influence
the allocation of resources, rather than as a
producer because the output is intangible and
is not priced. For our purposes, what is
important is that the government has to
purchase in the market the current output of
private firms and the labour services of
households in order to fulfil its task. It can, of
course, rig the market. For example, the UK
government is not only an important purchaser
of vehicles for use in government departments;
it also buys almost exclusively only vehicles
produced in the UK.
b. Goods produced and sold in the market
by public corporations. Many countries have
state-owned fuel and power industries whose
operation is very similar to private industry
though the policy instructions laid down by
governments for their operation will usually
include objectives other than the making of
profits (see Module 8.)
The second function is the alteration of the
structure of private production in order to conform
with some conception of the allocation of resources
which is considered better than that resulting
from private market transactions. This aim has
already been illustrated in the example given
in Section 1.3. In the national accounts, this aim
will be reflected in the choice of taxes levied on
goods and services (e.g. taxes on expenditure),
in corporation taxes and in current subsidies.
The third function is to intervene in the distribution
of income generated by private market
transactions in order to conform with some
acceptable criterion of equity, for example a
minimum income guarantee. This will be reflected
in the national accounts principally in the choice of
taxes and in the provision of transfer
payments to households against which there is no
counterflow of current services. For
example, state pension payments are transfer
payments, and though pensioners do not render
current services in order to receive them, they may
have contributed to their finance through
compulsory levies on their past incomes. Transfer
payments do not form a direct link between
government and industry but major efforts by
government to alter income distribution have
considerable influence on the structure of
household purchases and therefore on the pattern
of demand for industrial products.
The fourth function is the stabilization of the
economy by attempting to reduce fluctuations in
income and employment and to control
movements in the general price level. The effects
of this action can be seen in both the volume and
the mix of transactions between the government
and the rest of the economy. Policy models of the
economy which place particular emphasis on the
control of the money supply and interest rates will
pay close
The Relative Size of Government
To demonstrate the relative size of government
three measures will be used:



None of these measures is entirely unambiguous
though they are often used without being clearly
defined. The purpose of this section is to clarify
these definitions one by one.
2.3.1 Government Expenditure
on Goods and Services as
Proportion of the GDP
Remembering that:

it seems entirely logical to express government

expenditure on goods and services
(both consumption and investment) as a
proportion of gross domestic product (GDP). The
result gives the proportion of total annual
resources used to produce government services
(which are largely unpriced).

Consequences of Growth in
It is customary to argue that if government is large
in relation to the rest of the economy, then it has
considerable influence over the private sector. This
influence will presumably grow as the ratio of
government expenditure to GDP grows. Therefore,
if the government wishes to control inflation, or
improve employment prospects or improve growth
prospects by increasing the ratio of capital
investment to GDP, then the greater its
relative size, the more likely it will be that such
policy objectives will be achieved. So the argument
goes. This is not the place to begin a survey of
modern macroeconomics; it is sufficient to say that
there is considerable controversy as to whether
altering the size and composition of government
expenditure (taxes and borrowing) can by itself
achieve such objectives in a way which can be
considered satisfactory. Certainly, the simultaneous
achievement of objectives is a complicated task,
particularly in the open economies of Western
industrial nations, where governments have no
direct control over the decisions taken by
overseas suppliers and buyers. Even if it has the
power to use the budget, or to regulate the
economy in some other way, the size of
government will not guarantee the achievement of
macroeconomic objectives.
The outline of the growth of government and its
causes points to a much more important limitation
on government action, which re-emphasizes the
point made in the previous module. As government
grows in power, those affected by its actions do not
stand idly by and let the government do what it
likes, but are given added reason for using the
instruments of political participation
(see Section 1.3.2) in order to protect and advance
their interests. Any expansion of government
activity, therefore, brings with it political
feedback. Much of the examination of political
feedback in countries with strong democratic
institutions concentrates on how politicians are
influenced by interest groups. This is, however, too
narrow a framework in which to look at
the bargaining relationships between government
and industry. While it is certainly true that
industrial interest groups do try to exercise
influence over politicians, the impact of
government at company level is felt much more
directly in negotiation with the administration, i.e.
with government departments which regulate
companies' activities, which tax and subsidize
them, and which purchase their goods. The
consequence of the growth in government which is
of relevance to this analysis is therefore derived
from the increasing extent to which the fortunes of
individual companies will be governed, not by their
success in competing against each other and
against overseas firms, but by the efficiency of
their investment in managerial resources able to
negotiate with government departments
and agencies.