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ARTICLE

The Awesome Powers of Government

The Contrast Between Government and Business Power Is Striking

MARCH 01, 2004 by MURRAY WEIDENBAUM

Government possesses far more mechanisms that influence actions in the private sector than most people realize. The typical business firm faces an impressive array of government powers.

Government as Paymaster. The oldest policy tool available to government is to hire people and put them on its payroll. Government employees represent such diverse professions as teachers, foresters, and revenue agents. Payrolls provide a cadre of public officials whose actions can then be controlled in terms of their influence on the rest of society. This is the tip of the iceberg because small proportions of government resources are devoted to compensation of its employees.

At first blush, direct government hiring seems to have little impact on the economy, but often government sets the standards in the United States. The now prevailing eight-hour day began in the federal government. In specific personnel categories, such as secretaries and teachers, government hiring patterns influence the entire labor market.

Government Purchases. Substantial portions of government budgets are devoted to ordering goods and services produced in the private sector. Products purchased range from high-tech space-exploration vehicles to standard off-the-shelf pens and pencils. The importance of the government market is obvious to key defense-oriented industries such as aerospace, electronics, ordnance, and shipbuilding. In addition, public-sector buyers—from national, state, county, and municipal agencies—purchase items from virtually every industry. Government procurement can be the difference between a good year and a mediocre year for many companies. Thus many businesses have a strong incentive to influence government.

At the national level military contracts to private industry are the major category of purchases from business. State and local government agencies, in contrast, contract mainly for roads and school buildings and various categories of office supplies. The procurement process is an important way in which government influences private-sector actions. The public sector’s methods of doing business are very different from standard commercial operations. Moreover, for the companies that produce primarily for military and space markets, the government is virtually a monopoly buyer. It exerts powerful control over the contractors’ internal operations by forcing them to act in many ways like a government agency and also to be “socially responsible.” Requirements imposed by government on private industry range from hiring and training minority groups to adopting federally set wage and hour standards.

Transfer Payments. A third policy tool available to government is to provide money to individuals—what economists call transfer payments and what the public at large refers to less euphemistically as handouts. The key example is the monthly Social Security check sent to senior citizens. Here the impacts are more indirect than in the case of government procurement. Such expenditures strongly influence the amount of consumption by the recipients and thus affect the size and composition of consumer markets.

Government spending for transfer payments, most of which are labeled entitlements, has become so massive in recent years that trends in that category can be a significant factor in the entire economic outlook.

 

Raising Demand

Government Subsidies. Government subsidizes private activity in many ways. By absorbing a portion of the cost of production, subsidies raise the demand for the subsidized products in relation to other items. Generous subsidies are provided to many sectors of the economy—and sometimes are referred to pejoratively as business welfare: agriculture (farm price supports), fishing (financing for new vessels), nuclear energy (government payments for developing new products), transportation (aid to urban mass transit), housing (low-rent public housing), and mining (special tax benefits). Subsidies are also received by a variety of special clienteles, such as minority enterprises.

Subsidies often contain a regulatory component. For example, government subsidies to shipbuilders can be vital in decisions to build ships in domestic yards rather than overseas. But to qualify for federal subsidies, the ships must incorporate specific national-defense and safety features spelled out by the government. These added features raise both acquisition and operating costs.

In many ways government is a competitor for funds or influence. Thus the Tennessee Valley Authority competes with private utilities, the Government Printing Office with commercial publishers (especially mapmakers such as Rand McNally), and the U.S. Postal Service with private parcel delivery services (United Parcel Service and Federal Express, most notably). Government enterprises also compete with private enterprises in the large markets represented by the government’s own purchases. This competition between the public and private sectors is more visible at state and local levels, in such areas as health, recreation, trash collection, and security services.

Government Loans. The government also acts as a banker, lending money to private firms and individuals as well as to many other categories of borrowers. The gamut of federal lending extends to exporters (Export-Import Bank), farmers (Farmers Home Administration), real-estate developers (Federal Housing Administration), and small enterprises (Small Business Administration). Sometimes low-interest government loans merely substitute for available private funds. But, more frequently, the government credit is provided for projects whose expected returns are so low that private markets will not finance them. Government loans are anything but the proverbial free lunch.

Government as Underwriter. Even without spending its own money, government can strongly influence private economic activity. One way the public sector does that is by use of its credit power. The method used most frequently is the guarantee of private loans, as in the dramatic case of Chrysler and the less well-known but more frequent guarantees of new ship construction and exports. Because much of the risk is shifted from the private lender to the government, borrowers who are not considered creditworthy by normal commercial standards are given access to funds. Also, the government fosters the creation of quasi-government credit corporations, such as in the agricultural and housing credit areas (the farm credit banks and the federal home loan banks). The use of the government’s credit alters the flow of funds in the economy and thus strongly influences who gains access to resources.

Because they do not seem to require (at least initially) the direct expenditure of government money, loan guarantees have been proliferating, as have other uses of the government’s credit. As seen in the bailouts of insured but failed savings-and-loan associations, the government’s contingent liability can at times be converted to direct expenditure—and in very substantial amounts.

Government Regulation. A major area of government involvement in business is the use of the regulatory power. The alphabet soup of regulatory agencies has become well known: CFTC, CPSC, EEOC, EPA, FAA, FDA, FEC, FERC, FMC, FTC, ITC, MSHA, NLRB, NRC, NTSB, OSHA, SEC, TSA, and on and on. Regulations range from broad-gauged requirements for pollution control to rules on the sales of lemons in a given month, from wide-ranging rules on worker health and safety to specialized restrictions on transactions in futures markets. Aside from the limited use of government personnel to design and enforce regulations, the bulk of the costs generated is “off budget” because the expenses incurred are mainly for compliance by private companies and individuals being regulated. Such outlays do not show up in the government’s budget; thus regulation has become especially popular. The cumulative effects of regulation on business performance—and on consumers—are pervasive. The concern about terrorism has generated a new wave of regulation.

Taxation. The government tax collector does more than share profits with individuals and with the owners of companies. Tax considerations are a major influence on business decision-making. The liberality of depreciation provisions and the level of marginal tax rates affect the threshold for making new investments. In contrast to these across-the-board provisions, many sections of the internal revenue code are aimed at promoting—or inhibiting—specific sectors of business (such as real estate, new energy sources, and overseas activities).

Government regularly employs its tax power to provide incentives for designated private activities. Using the carrot of tax incentives, governments often foster what they consider to be greater social responsibility on the part of business. In the United States specific internal-revenue provisions include tax credits for hiring certain categories of people (minority groups) and tax deferrals for income from exports. The latter is an example of the complex interaction between tax policy and other government activities.

At times there is a direct link between taxes and controls. For a company’s retirement contributions to qualify as a federal tax deduction, a pension program must meet detailed requirements spelled out in regulations issued under the Employee Retirement Income Security Act (ERISA).

Government as Business Partner. In addition to affecting business practices through policy or legislative mandates, governments sometimes manipulate the private sector directly by entering into partnerships with business enterprises. The involvement of government in the ownership of business is common in less-developed countries or in nations with a history of public control of business. In a few cases, the federal government has purchased equity positions in small defense contractors that lack adequate financial resources to meet the military’s needs.

As businesses become more global in their operations by expanding into foreign markets, they often establish joint ventures and other associations with their host governments. For instance, McDonald’s became the first U.S. firm to penetrate the Russian economy when it opened a restaurant in Moscow in 1990. The restaurant, located near the Kremlin, is a joint venture with the Moscow City Council.

 

Fed’s Influence over Interest Rates

Monetary Policy. The conduct of monetary policy by central banks such as the Federal Reserve System is a prime example of government actions that profoundly affect business but are not normally considered an aspect of business-government relations. The Federal Reserve strongly influences interest rates, the flows of money and credit, inflation rates, and the overall level of business activity in the economy. The Fed is a creature of the Congress and, although technically independent of the executive branch, often responds to presidential leadership. The power of the Federal Reserve System via its purchases and sales of treasury securities and its setting of discount rates and bank-reserve requirements greatly affects the economic and financial environment in which companies operate.

The cost and availability of credit can be key influences on the performance and at times the very existence of business firms. A company’s board of directors may spend almost as much time discussing the outlook for the prime rate as the finance committee’s report. During wartime and under other emergency conditions, governments often augment indirect monetary (and fiscal) instruments with direct controls over wages, prices, and the use of materials.

Moral Suasion. From time to time, national leaders call on the people to take actions on a voluntary basis. Especially when an activist president occupies the White House, the U.S. government tries to persuade (or “jawbone”) the private sector to support it on specific issues. Several presidents have called on business to do such “patriotic” things as limit wage and price increases or eliminate discrimination in the workplace. Such displays of presidential leadership can be compelling because of the vast array of government powers—the proverbial stick in the closet—available to reinforce the “request” for voluntary action.

In 1990, following the Iraqi invasion of Kuwait, President George H. W. Bush jawboned the oil companies not to raise prices too much. The large producers promptly complied. Ironically, the result was to squeeze the high-cost smaller dealers who found it more difficult to absorb the higher cost of crude oil as established in world markets.

In that same year, Health and Human Services Secretary Louis Sullivan criticized R. J. Reynolds for marketing a new brand of cigarettes aimed at African-American consumers. As an African-American physician, he possessed a great deal of moral authority. Within 24 hours, RJR canceled plans to test market the new product. A year later some members of Congress objected vociferously to the plan of Japan’s Fanuc Ltd. to buy 40 percent of a Connecticut machine-tool builder that helps make nuclear weapons. Although the legal authority to reject foreign purchases of American companies on national security grounds had lapsed, Fanuc backed off.

In 1993 then-Senator Paul Simon of Illinois (now deceased) warned producers of television programs and TV networks to take aggressive action to curb violence on television or face congressional intervention. In response to earlier Senate hearings, the networks had already agreed to issue warnings to audiences prior to showing programs with substantial amounts of violence. In late 1996, after further public criticism, the major television networks established a voluntary system of describing the content of various categories of programs.

More recently, in 1998, the Department of Defense requested aerospace giant Lockheed Martin not to acquire Northrop Grumman, another large aerospace company (the Department of Justice also indicated its potential opposition). Even though the shareholders of both companies had approved the merger, these important defense contractors yielded to the wishes of their major customer.

Ralph Nader has noted that business, too, has its power, and that is true. Actions by multibillion-dollar corporations can have strong positive or negative effects on a community or an entire region of a country. Yet the contrast between government and business power is striking. The largest company cannot tax you; the smallest unit of government can. The most profitable corporation cannot throw you in jail; the smallest municipality can.


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