Trigger 5

Problem: Economic system

LO 1: What is the role of government in an economy?

LO 2: What is monetary policy?

LO 3: How do countries attract foreign direct investment

What is the role of government in an economy?

Economists, such as Adam Smith supported the idea of laissez faire (leave us alone), which meant that governments would not interfere with markets (S, N). “An ideal market economy is one where all goods and services are voluntarily exchanged for money at market prices. Such a system squeezes the maximum benefits out a society’s available resources without government intervention” (Paul Samuelson, in S, N). The Finnish government owns for example Altia (Alko), as well as shares in Elisa, Finnair Yleisradio. In total, they own 16 stock exchange companies, worth a total of 24 billion euros (Isosävi 2017). One of the reason why the government owns companies are, because they want to ensure that e.g. the sale of alcohol is limited, hence Alko is the sole seller of strong alcohol in Finland. In addition, the market may not be sufficient to maintain the basic economic and technical functions of society in the event of various disruptions and exceptional circumstances. Therefore, various security measures are being prepared to maintain vital functions in society as close as possible to normal conditions even in these circumstances (Huoltovarmuus 2020).

Tax subsidies have been criticized in many ways. In the view of the Ministry of Employment, the tax rebates and price reductions granted to the traditional industry are ineffective. The Ministry of the Environment on the other hand, estimates that the subsidies are likely to encourage increased use of electricity and fossil fuels, although Finland’s goal is to reduce emissions (Yle 2018).

The government of Finland also subsidies companies e.g. in the energy, development and agriculture businesses. In 2017, all municipalities paid a total of 958,9 million euros in subsidies to 25 956 applications. 

What is monetary policy?

“Monetary policy consists of the process of drafting, announcing, and implementing the plan of actions taken by the central bank, currency board, or other competent monetary authority of a country that controls the quantity of money in an economy and the channels by which new money is supplied. Monetary policy consists of management of money supply and interest rates, aimed at achieving macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity. These are achieved by actions such as modifying the interest rate, buying or selling government bonds, regulating foreign exchange rates, and changing the amount of money banks are required to maintain as reserves” (Chappelow 2019).

The European Central Bank (ECB) and the national central banks (NCB) of all 19 countries currently belonging to the euro area jointly agree on the monetary policy for the whole Eurosystem (Suomen Pankki 2020). The main and most important objective of the single monetary policy is to maintain price stability. In addition, it supports general economic policies, such as full employment and sustainable development (Suomen Pankki 2020).

“Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that says monetarily sovereign countries like the U.S., U.K., Japan and Canada are not operationally constrained by revenues when it comes to federal government spending. In other words, such governments do not need taxes or borrowing for spending since they can print as much as they need and are the monopoly issuers of the currency” (Warren Mosler in D’souza 2019).

How do countries attract foreign direct investment

Firms move partly or completely their operations abroad, due to e.g. benefits:

1. Take advantage of lower labour costs in other countries (e.g. India is one of biggest recipients of FDI, where labour costs are much lower than in the OECD.
2. Take advantage of proximity to raw materials rather than transport them around the world.
3. Avoid tariff barriers and other non-tariff barriers to trade.
4. Reduce transport costs. For example, by producing cars in the UK, Nissan has lower transport costs for selling to the UK market.
5. Opportunities for using local knowledge to help tap into domestic markets. For example, by investing in a foreign country and working with local workers, a multinational can gain a better insight into what works well for local markets (Pettinger 2018).

Recipient countries benefit in the following ways:

1. Capital inflows create higher output and jobs.
2. Capital inflows can help finance a current account deficit.
3. Can benefit from improved knowledge and expertise of foreign multinationals.
4. Investment from abroad could lead to higher wages and improved working conditions, especially if the MNCs are conscious of their public image of working conditions in developing economies. (Pettinger 2018).

FDI’s can create issues, such as:

1. Gives multinationals controlling rights within foreign countries. Critics argue powerful MNCs can use their financial clout to influence local politics to gain favourable laws and regulations.
2. FDI may be a convenient way to bypass local environmental laws. Developing countries may be tempted to compete on reducing environmental regulation to attract the necessary FDI.
3. FDI does not always benefit recipient countries as it enables foreign multinationals to gain from ownership of raw materials, with little evidence of wealth being distributed throughout society.
4. Multinationals have been criticised for poor working conditions in foreign factories (e.g. Apple’s factories in China) (Pettinger 2018).

Source: United Nations Conference on Trade and Development 2019.

Countries attract FDI with e.g. China:

1. The largest internal market in the world, with 1.3 billion potential customers
2. A well-developed production sector (manufacturing sector and heavy industry)
3. A favourable geographic location 
4. Top economy in terms of purchasing power parity (PPP) thanks to rapid growth of the economy
5. Lower labour costs
6. Tax benefits (Santander 2020)

Finland for example attracts FDI, with professional employees, a working teleoperating system and a stable government as well as safe inflation (Tikkanen 2020)

References

Tikkanen, H 2020. Phone call 07 March 2020.

Santander 2020. CHINA: FOREIGN INVESTMENT. URL: https://santandertrade.com/en/portal/establish-overseas/china/foreign-investment. Accessed: 07 March 2020.

United Nations Conference on Trade and Development 2019. Global foreign direct investment slides for third consecutive year. URL: https://unctad.org/en/pages/newsdetails.aspx?OriginalVersionID=2118. Accessed: 07 March 2020.

Pettinger, T 2018. Foreign Direct Investment. URL: https://www.economicshelp.org/blog/4987/economics/foreign-direct-investment/. Accessed: 07 March 2020.

D’souza, D 2019. Modern Monetary Theory (MMT). URL: https://www.investopedia.com/modern-monetary-theory-mmt-4588060. Accessed: 07 March 2020.

Suomen Pankki 2020. Monetary policy. URL: https://www.suomenpankki.fi/en/learn-economy/learn-economy/monetary-policy/. Accessed: 07 March 2020.

Chappelow, J 2019. Monetary Policy. URL: https://www.investopedia.com/terms/m/monetarypolicy.asp. Accessed: 07 March 2020.

S,N. Role of the Government in a Market Economy. URL: http://www.economicsdiscussion.net/government/role-of-the-government-in-a-market-economy-economics/26174. Accessed: 07 March 2020.

Yle 2018. Yle selvitti pitkään piilossa olleet verotuet: Suomen valtio antaa satoja miljoonia euroja pörssiyhtiöille, jotka maksavat samaan aikaan jättiosinkoja [Yle clarified long-hidden tax subsidies: Finnish state gives hundreds of millions of euros to listed companies, which at the same time pay huge dividends]. URL: https://yle.fi/uutiset/3-10095106. Accessed: 07 March 2020.

Huoltovarmuus 2020. Huoltovarmuus Suomessa. URL: https://www.huoltovarmuuskeskus.fi/tietoa-huoltovarmuudesta/huoltovarmuus-suomessa/. Accessed: 07 March 2020.

Yle 2018. Suorat Yritystuet kasvoivat jälleen [subsidies grew again]. URL: https://yle.fi/aihe/artikkeli/2018/12/10/suorat-yritystuet-kasvoivat-jalleen-katso-hakukoneesta-ketka-saivat-eniten. Accessed: 07 March 2020.