The Political Environment

The Political Environment

Some countries in the world can be labelled 'command' economies (e.g. China, Cuba, and North Korea). This involves the allocation of resources being decided upon by the government (the public sector), with little or no private sector activities.

The UK (like most of the developed countries in the world) is a mixed economy, that is, its goods and services are provided partly by the public sector (the government) and partly by the private sector (which consists of privately run businesses and organisations).

A government is said to adopt a 'laissez-faire' approach to managing the economy if it allows the operations of the free market to exist (i.e. it does not intervene in the economy in order to change the workings of the market mechanism from deciding how to allocate resources).

However, most governments adopt an 'interventionist' approach to managing the economy and there are a number of policies that the government can use to influence the workings of an economy.

This is a government policy, which aims to influence the economy by raising finance (through taxation) and then spending this finance on public services such as education, health, and transport). Taxation can be classified in 2 ways:

  1. Direct and Indirect: Direct taxation is tax that is paid directly from the income, wealth or profit of an individual or a business (e.g. income tax, corporation tax). Indirect Taxation is tax that is paid on goods and services, (e.g. VAT and excise duty).
  2. Progressive, Regressive and Proportional: A progressive tax is one where the proportion of income that is paid in tax rises as the income of the taxpayer rises (e.g. income tax). A regressive tax is one where the proportion of income that is paid in tax falls as the income of the taxpayer rises (e.g. the 'community charge'). A proportional tax is one where the proportion of income that is paid in tax remains the same as the income of the taxpayer rises (e.g. V.A.T).

The main taxes in the UK are:

  1. Income tax: This is a tax on individuals' incomes and it is the single most important source of revenue for the government.
  2. National Insurance contributions: This is also paid by every employee, and the money raised goes towards financing state pensions, sick pay and unemployment benefit.
  3. Corporation tax: This is a tax on the profits of businesses.
  4. Capital Gains tax: This is a tax on the profits (or 'capital gains') that are made on investments (shares and other assets).
  5. Inheritance tax. This is a tax on the value of assets left on the death of an individual.
  6. Excise duties. These taxes are levied on fuel, alcohol, tobacco and gambling.
  7. Value-Added tax. This is a tax on individuals' expenditure.
  8. Council Tax. This is a tax that is levied by local councils, as opposed to central government. It is based on the size, location and value of domestic property. The money raised is spent by the local councils on libraries, parks and refuse cleaning.

The government will spend the money that it raises through taxation on a variety of items, including social security, health, education, defence, public order, transport and housing.

If the government needs to spend more money on these items than it raised through taxation in a particular year, then it is said to have a Budget deficit. It therefore needs to borrow the extra money that it requires through selling Treasury Bills to individuals or to businesses. This is known as the Pubic Sector Borrowing Requirement, (or P.S.B.R).

If the government raises more money through taxation than it needs to spend in a particular year, then it is said to have a Budget surplus. It can therefore repay some of its borrowings from previous years. This is known as the Pubic Sector Debt Repayment, (or P.S.D.R).

This is a government policy designed to control the amount of spending in an economy, by altering the money supply, interest rates, exchange rates and the amount of credit that is available to customers. For example, in the past, if the economy was believed to be overheating and inflation was considered to be too high, then the government was likely to increase the base-rate (that is the interest rate which all banks use in order to set their own rates of interest).

By increasing interest rates, making borrowing less attractive to both individuals and to businesses, as well as increasing the amount of the repayments for people who already had a loan or a mortgage. Therefore, fewer people applied for loans and mortgages, and expenditure in the economy was reduced, thus reducing the rate of inflation.

However, the control of interest rates is now no longer in the hands of the government, but instead it is decided upon by the Monetary Policy Committee (M.P.C) at the Bank of England.

Similarly, by restricting bank loans or by placing more stringent restrictions on giving credit agreements to individuals, the government can use monetary policy to restrict the amount of money that consumers and businesses will borrow, therefore reducing their demand for goods and services. This, in turn, should allow inflation to fall.

Regional Policy. This is a government policy that attempts to reduce regional inequalities of employment, income and wealth. The government can use regional policy in one of two ways:

  1. Giving a variety of incentives to existing businesses to relocate to less affluent areas of the country in order to create employment and wealth in these areas.
  2. Enticing new businesses to set-up in these less affluent and depressed areas.

The measures that the government can use include giving grants to the businesses, offering rent-free and rate-free premises, providing training programmes for employees, giving financial and legal advice and support, and providing cheap loans and mortgages.

The Department of Trade and Industry (D.T.I) has labelled several areas in the UK as Assisted Areas, which areas which require revitalisation, but which have huge development potential (i.e. an abundant labour force, relatively low wage-rates, and significant amounts of under-utilised land and premises).

Nationalisation occurs when businesses and industries are transferred from the private sector to the public sector. It is often argued that consumers benefit from lower prices with a nationalised industry (public corporation), since it does not need to make massive profits, and therefore it can charge a price to consumers that barely covers the costs of production.

Any loss incurred can be subsidised by the government. Further to this last point, nationalisation often results in loss-making services (e.g. rural bus routes) being kept running and therefore providing a vital service for many small communities, which may not exist if the network was privatised.

Privatisation refers to the transfer of public sector organisations and resources to the private sector. It generally falls into three categories:

  1. Deregulation: the removal of any government rules and regulations from the operation of an industry, often allowing new competitors to enter the industry.
  2. Contracting out: private sector contractors are given the opportunity to place a bid to secure public sector contracts (e.g. refuse collection and cleaning contracts).
  3. The sale of public corporations: These are transferred to the private sector and become Public Limited Companies (P.L.Cs) which are floated on the stock market.

The Conservative government from 1979 - 1997 was a firm believer in the privatisation of public corporations for a number of reasons:

  1. It generates a large amount of revenue for the government. This 'windfall' can be spent on areas such as education, health, etc.
  2. The public corporations become far more efficient when in the private sector, since they have to become competitive and provide a service to the consumer at a profit in order to survive.
  3. It widens share ownership amongst the population.
  4. Revenue that is raised from the sale of these public corporations can be used to reduce taxes.

The following businesses were privatised by the successive Conservative Governments of Margaret Thatcher and John Major between 1979 and 1997: British Telecom, British Gas, British Airways, British Steel, Rolls Royce, British Petroleum, British Airports Authority, British Water Authorities, Electricity Boards, Jaguar Cars, and Sealink.

The privatisation of many of these public corporations has resulted in many cases in a rapid increase in their profitability, as well as a significant rise in the price of their services. Many public corporations have faced strong competition and have been forced to improve their image and their marketing in order to protect their market share.

S-cool exclusive FREE TUTORIAL offer!