Theory of Economic Policy

October 11, 2017
Theory of economic policy

No attempt will, or need be, made at a comprehensive survey of the extensive and growing literature on the modem institutional approach to the analysis of economic policy. A few remarks, however, may help to put this study and the Sandiford and Rossmiller paper into perspective and draw out the distinction particularly between public choice theory and the traditional marginalist approach.

The orthodox approach to economic policy concerns itself with the maximisation of "economic welfare" which is said to be optimised by free-market forces in a position of general equilibrium. In the real world, market failures and imperfections occur, such as sharp fluctuations in prices, which give wrong signals to producers, and "externalities", which are costs that individual producers impose on the rest of the economy but that play no part in their output decisions. The intervention in the real world by a benevolent government is assumed to be able to correct or improve matters through the use of policy instruments at its disposal -taxes and subsidies, tariffs, intervention buying, expenditure on research, etc. These are instruments that can be employed only by governments and should be designed to do the least possible damage to non-beneficiaries whilst moving the economy as a whole towards maximum gross domestic product (GDP) and optimum "economic welfare".

The above description of the working of the market mechanism and the functions of government sets the scene for the tasks of economists and government advisers. Their job is conceived as offering impartial advice to politicians that will minimise any damage to those adversely affected through interference with the market whilst at the same time maximising the benefits to immediately interested parties and secondary groups. The policy is to be judged as efficient in so far as its costs (e.g., to tax payers and-other damaged parties) are minimised whilst the benefits of increased net income overall are maximised.

This kind of thinking as a method of analysis is recognisable as one applied by most practising economists and also as one that politicians for their part have come to expect of their advisers. The technical literature is extensive, and some of it familiar, and need not therefore be quoted as it is associated with the writings of well-known names in economics - Pigou, Pareto, Samuelson and many others.

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