However, care must be taken not to overdo expansionary policies, lest growth leads to pressure on resources and accelerating inflation, which would only worsen the problem and severity of unemployment.
The government could also reduce unemployment levels by the reduction of immobilities, especially where structural unemployment is present in which changes in the pattern of demand for certain goods and services has resulted in certain industries becoming less active, shipbuilding being a primary example.
Immobilities can be reduced by several methods. For example, geographical immobility in which people are unable to take up a job which is available because they are living in another area. Occupational immobility too can be rendered where people do not have the right or necessary skills or knowledge for a job.
In the example of geographical immobility, this could be reduced with the use of regional policies, which can be used to help certain areas where major industries are in decline.
In the example of occupational immobility, this can be amended with the introduction of government training policies and retrainimg help. This would increase and help develop the skills and knowledge of the unemployed of which are of direct relevance in the workplace. This in the UK is currently in operation with the Learning and Skills Councils (LSC’s) whom organise local provision and by working in alliance with further education institutions organise for relevant skills and knowledge based training to take place. There is also that the Learning and Skills Councils will be able to meet local needs and ensure that they are met by a combination of on-the-job training and courses.
Retraining can also to help to reduce unemployment by giving people who are part of the way through there working lives different or improved skills and knowledge which are likely to be in demand in the future e.g. computer skills. Where people are occupationally immobile, this can enable them to take the jobs, which are available therefore reducing unemployment. This improved education and training will too increase the flexibility of the labour markets therefore making it easier for people (workers) to move to an alternative occupation.
I will now look at how the government can achieve and maintain low inflation levels. Inflation is an overall increase in prices in an economy. This reduces the worth or value of money as its purchasing power falls. The maintenance of low inflation levels is important to a government as they have a direct effect on unemployment, household’s disposable incomes, firm’s profits and the level of investment.
The government can attempt to reduce or maintain low levels of inflation using various policies. The three main policies the government can use and ‘manipulate’ are the monetary policy, the fiscal policy and the tax system in order to obtain and sustain low levels of inflation.
The monetary policy uses changes in interest rates to control the demand for money and therefore the rate of increase of bank lending. This in turn will influence the level of demand in the economy as a whole. If interest rates are increased by the monetary policy this would in the discouragement of borrowing for consumption, investment and house purchase. It would also mean that households would have less disposable income as they are paying higher prices for goods and services and mortgage repayments are too increased. As increasing interest rates increases prices this would result in the devaluation of the pound as its purchasing power has fell.
The fiscal policy too can be used through changes in the levels and direction of government spending and through changes in taxation to achieve low levels of inflation. It can do this through taxation by reducing taxes. This would increase household’s disposable incomes and therefore personal consumption. This too would result in increased profitability for firms and therefore the level of investment to increase. As a result of this firms could reduce prices due to increased profitability for firms this increasing the level of investment.
The government can also attempt to control inflation with the implementation of contractionary policies. Strict control of the growth money supply reduces aggregate demand and pressures in the labour market. Contractionary polices include price and income policies which can be used to control inflationary pressures for short periods of time.
Inflation levels are also important as they also affect unemployment levels in several ways. If inflation levels are high this would lead to decreases in household’s disposable incomes as the cost of goods and prices generally increase therefore reducing the amount of money to spend on firms goods and services this reducing the aggregate demand for the economy. This will result in a decrease of companies profits and/or sales revenue and bring about increases in their costs as stock is being produced however it is not being sold, or less is being sold.
Therefore many companies as they are making less profit or revenue may have to let workers go to reduce costs or prevent them from employing additional employees as this will reduce profits and increase costs even further.
I will now look at how the government can achieve equilibrium in the balance of payments, and why this is of great significance to the economy and aiding its growth. The balance of payments is a summary of transactions concerning visible and invisible goods and services, investment earnings and transfers (the current account) and financial assets and liabilities (the capital account) and the finance account.
There are several measures the government can take to deal with balance of payments disequilibrium. The options the government possesses in dealing with this problem are devaluation, deflation, interest rate policy, exchange controls and import controls.
First of all devaluing the pound will make imported goods more expensive and exports cheaper for foreigners. There are two ways at looking at the consequences of devaluation, through looking at the price effects, the elasticity approach, or through looking at the income effects, the absorption approach. Devaluation will make imports make more expensive in terms of the pound. As a result, domestic consumers will buy fewer imports and switch to domestic goods and services. On the export front, goods and services will become cheaper for foreigners and so they will buy more exports. The price in terms of the pound will of course remain the same before and after devaluation although the price will change in terms of foreign currency.
Therefore the revenue gained from exports is bound to increase since more will be sold at the same domestic price. Exporters may also decide to put their prices up following devaluation. Although there will be a slower increase in sales, revenue is bound to increase as long as the percentage change in price is smaller than that of the percentage change in the devaluation of the pound.
Deflation, a fall in the general price level, is another method to rid or reverse a current account deficit in order to achieve equilibrium balance of payments. A reduction in income will lead to a reduction in aggregate demand. This in turn will lead to a reduction in goods imported. In reality, if people’s disposable incomes are reduced they will buy fewer goods and majorily fewer imports. Deflation is a highly successful way of dealing with disequilibrium balance of payments. With deflation there are no associated inflationary effects as there are with devaluation. On the contrary, deflationary measures should help reduce inflation because governments are less likely to print money to pay for large budget deficits. Deflation is the commonest method used by governments to reverse a current account deficit.
Changing of domestic interest rates also has an effect on both the current and capital accounts. The raising of interest rates will result in an inflow of money on transactions in external assets and liabilities. Foreign investors will switch money from a foreign currency to the pound for two reasons. Firstly, they will be attracted by the higher interest rates available in comparison with other international interest rates. Secondly, raising interest rates will produce an inflow of money, increasing the demand for the pound, raising the price of the pound, and therefore encouraging purchase of the pound.
Higher interest rates will also reduce aggregate demand. As these higher interest rates will reduce consumption, particularly of consumer durables such as cars, kitchens etc, and will reduce investment. This will lead to a reduction in imports and an improvement on the current account balance.
The government may also use exchange controls to achieve and equilibrium balance of payments. The government can take action to reduce outward flows on transactions in external assets and liabilities. The Bank of England normally operates the scheme. All persons wanting foreign exchange make an application to the bank. The Bank of England then grants or refuses their request. In refusing requests for foreign currency they are effectively reducing the money supply of the pound on to the market, therefore raising the price of the pound or economy.
Another way for the government to ‘manipulate’ the balance of payments is via import controls. However, this is often discouraged in the international community, nevertheless despite the efforts such as the World Trade Organisation, import controls have remained a powerful weapon to governments. All governments use open or concealed import controls to some extent.
In the long run import controls may result in greater economic growth and increased spending power for domestic consumers. That increase in spending power could more than compensate for the loss in welfare due to high prices and less choice. Another benefit for import controls is the so-called infant industry argument. For example, if the government wanted to develop a new industry but import competition was so fierce that no entrepreneurs would be prepared to risk his or her capital. Applying import controls would allow such a new firm to make a good start. Eventually, import controls could be removed as the industry matured and is able to compete successfully on world markets.
The government’s fourth final objective is to achieve and sustain economic growth. Economic growth is defined as increase in output and real incomes and is usually measured using gross domestic product (GDP).
The government could take to various measures to obtain economic growth. The government could attract further investment; this would be either generated domestically or from abroad. This additional investment would increase the amount of capital per person in the UK and too increase productivity in the economy.
They could also enhance economic growth with education and training, this would also increase human capital, consequently making workers more productive and labour markets more flexible.
Changes in technology could also lead to the availability of bigger and better machinery, and help create better ways of managing people. The government could also encourage and increase economic through the strengthening of alliances with other countries and encouraging exports to new markets. This would increase demand for our country’s products and in turn increase economic growth.
