An Outline of the
American Economy

Part 1
Introduction

PART 6

The Role of Government in the Economy

What is the role of the federal government in the American economy? What should it be? Although based largely on the concept of free enterprise, and organizing economic activity through open and competitive markets, the U.S. economy also has a tradition of government intervention for specific economic purposes -- including limiting monopoly, protecting the consumer, providing for the poor, handicapped and elderly, and preserving the environment.

Government intervention in the U.S. economy began increasing rapidly following the Great Depression of the 1930s, and continued to grow through the 1960s and into the 1970s. But beginning in the late 1970s, a large number of Americans began questioning the usefulness of what they considered excessive government regulation. By the 1980s, this increasing controversy had brought about partial deregulation of several industries including telecommunications, the airlines and the railroads. But in the early 1990s the costs and benefits of the deregulation of these industries were still being debated, while for other industries there was concern over the possible need for increased regulation.

LAISSEZ-FAIRE VS. GOVERNMENT INTERVENTION

The theoretical basis of government policy toward American business has been provided for more than 200 years by "laissez-faire." Laissez-faire, or "leave-it-alone," in a translation from the French, is a concept allowing private interests to have a virtual free rein in operating business. The 18th-century Scottish economist Adam Smith strongly influenced the development of ideas about laissez-faire and, indirectly, the growth of capitalism in America. He argued that the actions of private individuals, motivated by self-interest, worked together for the greater good of society if markets were competitive. Although Smith did favor some forms of government intervention -- mainly to establish the ground rules for free enterprise -- it was his criticisms of mercantilism and his advocacy of laissez-faire that earned him popularity in America.

But dedication to laissez-faire has not prevented private interests in the United States from turning to the government for help on numerous occasions. Railroad builders accepted grants of land and public subsidies in the 19th century. Industries facing strong competition from abroad have appealed for a greater degree of protectionism in trade policy. American agriculture, almost totally in private hands, has benefited by government assistance in numerous ways. Manufacturers, labor unions, bankers and others have sought government assistance in many forms, from tax breaks to outright subsidies.

In other words, there has been a constant give-and-take between the theory of laissez-faire and concrete demands for government help for specific economic purposes. Yet many men and women in business believe that there is too much government regulation. They feel that some of the rules they must follow are unnecessary. Besides, they say, filling out forms to satisfy government rules costs money and adds to the prices they must charge. Many other Americans believe, however, that strict regulations are needed to keep businesses from cheating or harming workers or consumers in order to increase business profits. Proponents of either of these views are often labeled in terms of contemporary American politics. That is to say, a conservative is usually defined as one who generally favors private initiative and opposes government intervention; a liberal is usually defined as one who supports private enterprise but is more willing to accept government intervention, and perhaps enthusiastically support it.

GROWTH OF GOVERNMENT INTERVENTION

In the American economy, the balance between laissez-faire and government intervention has not been constant over time. Rather, in the early days of the nation, government leaders refused to do almost anything to control business. Except for helping support the development of agriculture and granting financial support to companies building the railroad system in the late 19th century, the government played little role in business affairs.

As the 20th century approached, however, the consolidation of U.S. industry into increasingly powerful groupings spurred the growth of a nationwide movement of citizens supporting economic reforms. Many of those who supported these reforms came from the ranks of business itself, especially small businesses. With this movement came increased support for government intervention and control of the economy. Gradually the government began to take action. In 1890 Congress passed the Sherman Antitrust Act, a law aimed at restoring competition and free enterprise by breaking up big business combinations known as monopolies. In 1906 laws were passed to make sure that food and drugs were correctly labeled, and that meat was inspected before being sold. In 1913 the government established a new federal banking system, the Federal Reserve, to regulate the nation's money supply and to place some controls on banking activities.

The largest changes in the government's role occurred as part of the "New Deal," President Franklin D. Roosevelt's response to the Great Depression. During this period in the 1930s, the United States endured the worst business crisis and the highest rate of unemployment in its history. To ease hardships, President Roosevelt and the Congress enacted many new laws including measures regulating sales of stock, recognizing the right of workers to form unions, and setting rules for wages and hours for workers. In addition, stricter controls were put on the manufacture and sale of food, pharmaceutical drugs and cosmetics.

The many laws and regulations enacted since 1930 have altered the shape of the American economy. There is virtually nothing a person can buy in the United States that is not affected by some kind of government regulation. Food manufacturers must tell exactly what is in a can or box or jar. No pharmaceutical drug can be sold until it is thoroughly tested and then approved by a federal agency. Many types of businesses must pass inspections by government workers for compliance with health, safety or both types of regulations. Automobiles must be built according to safety standards, and must carry pollution-control devices. Prices for goods must be clearly marked and advertising must be honest. These are just a few of the ways in which the government currently protects consumers.

Laws and regulations also protect American workers in many ways. Laws prohibit discrimination in hiring; forbid hiring children for most jobs and set rules for using children in others (such as acting): set standards for working conditions; and protect the rights of independent labor unions to organize, bargain and strike peacefully.

Additionally, in the 20th century, the federal government's role in the U.S. economy has expanded to include major efforts to meet the economic needs of the poor, the old and the disabled, and to protect the environment.

FEDERAL EFFORTS TO CONTROL MONOPOLY

One of the first economic abuses that the government attempted to correct in the public interest was the excessive concentration of business. At the end of the 19th and beginning of the 20th centuries, the United States went through a period of rapid economic concentration characterized by the merger of small companies into bigger ones. Many big companies entered into agreements to limit supply and raise prices; often they drove weaker firms from business by cutting prices and taking losses until competitors went bankrupt. Then the surviving companies could take over the assets of their former competitors and raise prices.

Growing numbers of Americans were alarmed by increased concentration and called for action. The government responded in 1890 with the Sherman Antitrust Act, which made it illegal for any person or business to monopolize trade, or to contract, combine or conspire to restrict trade. In the early 1900s, the government used the act to break up the Standard Oil Company and several other large firms that had abused their economic power. But the courts set guidelines for applying the act that restricted illegality to the "unreasonable" restraint of trade. A company might own or control a majority of the output in a certain industry, but if the court considered its behavior reasonable, it was not necessary to break up the company. Many companies continued to grow by merging with or buying competing firms.

In 1914 Congress responded to continuing economic concentration by passing two laws designed to bolster the Sherman Antitrust Act: the Clayton Antitrust Act and the Federal Trade Commission Act. The Clayton Antitrust Act tried to define more clearly what was meant by restraint of trade. It outlaws price discrimination that gives certain buyers an advantage over others; forbids agreements in which manufacturers sell only to dealers who agree not to sell a rival manufacturer's products; and prohibits some types of mergers and other acts that could lessen competition. The Federal Trade Commission Act established a government commission aimed at preventing unfair and anticompetitive business practices.

In 1912 the United States Steel Corporation, which controlled more than half of all the steel production in the United States, was accused of monopoly for operating as a price leader in the steel industry. But the lawsuit brought against the corporation was not settled until 1920. In a landmark decision, the Supreme Court ruled that U.S. Steel was not a monopoly because there was no "unreasonable" restraint of trade. A careful distinction was drawn between bigness and monopoly.

Since World War II, the government has been active in its antitrust prosecutions. Four important examples give evidence of the scope of these efforts:

• In 1948, in the Portland Cement case, the Supreme Court's ruling abolished the system under which quoted prices included "normal" freight charges from a specified location regardless of the actual cost of transportation from the plant involved.
• In 1957, the Supreme Court ruled that the DuPont Company, a huge chemicals concern, had to divest itself of its shares of General Motors stock because DuPont's major shareholding resulted in domination of General Motors.
• In 1961, the electrical equipment industry was found guilty of fixing prices in restraint of competition. The companies agreed to pay extensive damages to consumers, and some corporate executives went to prison for the illegal planning of price fixing.
• In 1982, a 13-year-old lawsuit against American Telephone and Telegraph Company (AT&T) by the Justice Department was settled, with AT&T agreeing to give up its 22 local Bell System operating companies. In return, AT&T was allowed to expand into previously prohibited areas including data processing, telephone and computer equipment sales, and computer communication devices.

PROTECTING THE ENVIRONMENT

Only relatively recently has the federal government justified a significant amount of intervention into the economy to protect the environment. Although the first important U.S. pollution control law was passed in 1899, this law -- which made it a crime to dump any liquid wastes except those from sewers into navigable waters -- was almost never enforced. During the next 60 years, few other federal pollution control laws were passed.

Beginning in the 1960s, however, Americans began increasingly to express concern about the impact of industrial growth on their nation and the world. Engine exhaust from the growing numbers of automobiles on the roads was blamed for the appearance of "smog" and other forms of air pollution in larger cities. Many environmentalists openly suggested that some economic growth would have to be sacrificed in order to protect the environment. Soon much legislation was passed to control pollution. One early accomplishment was the Clean Air Act of 1963, and its later amendments, which set goals and procedures for reducing automobile exhaust pollution. Other major laws enacted to control the spread of pollution include the 1972 Clean Water Act and the 1974 Safe Drinking Water Act.

In a major achievement for environmentalists, the U.S. Environmental Protection Agency (EPA) was established in December 1970, bringing together in a single agency the many federal programs to protect the environment. This resolved years of public debate over how best to protect the health and welfare of citizens from the hazardous byproducts of an industrial society. Many Americans had protested the government's lack of organization for exercising control over pollutants -- such as industrial smoke, open dumps, and untreated sewage and chemical wastes -- which were being discharged into the air, water and land.

The EPA's mandate is to control and abate pollution in the air and water, as well as that due to solid waste, pesticides, noise and radiation. The agency has the authority to coordinate and support research and antipollution efforts of state and local governments, private and public groups, and educational institutions. It sets and enforces tolerable limits of pollution, and establishes timetables to bring polluters into line with standards. Since most of the requirements are of recent origin, industries are given reasonable time, often several years, to conform to standards. Regional EPA offices develop, propose and implement approved regional programs for comprehensive environmental protection activities. Monitoring data show some improvements; for example, there has been a nationwide decline in virtually all categories of air pollution.

However, in 1990 it was felt that still greater efforts to combat air pollution should be undertaken; important amendments to the Clean Air Act were passed by Congress and signed by President George Bush. Among other things, the legislation incorporated an innovative market-based system designed to secure a substantial reduction in sulphur dioxide emissions that cause what is known as "acid rain." This type of pollution was thought to be causing serious damage to forests and lakes, particularly in the eastern part of the United States, as well as neighboring Canada.

THE REGULATORS: WATCHDOG AGENCIES

By the early 1990s there were more than 100 federal regulatory agencies to which Congress had delegated power. All of these agencies have one thing in common -- they are designed to protect the public interest. They regulate activity in a wide range of fields, from trade to communications, from nuclear energy to product safety to employment opportunity.

The operations of regulatory agencies are influenced by the executive, legislative and judicial branches of government. The agencies are directed by commissioners or boards with the proviso that the two major political parties be equally represented. Commissioners are appointed by the president and confirmed by the Senate for a fixed term, usually five to seven years. Congress oversees the way funds appropriated to the agencies are spent, and the courts review any disputed decisions. Each agency has a staff, often more than 1,000 persons.

To the outsider it may appear that the agencies perform the function of courts. Agencies hold hearings that resemble court trials when officers of corporations or others are accused of violating federal laws or regulations. As in courts, the defendants are represented by legal counsel. Whatever ruling the agency makes is subject to review (and possibly reversal) by federal courts. Each year the agencies collectively issue more than 100,000 rulings, far more than all federal courts. The great majority of these rulings are not disputed by the parties involved.

The agencies are isolated by law from the president and, in theory, from partisan politics. However, critics of regulatory agencies have charged that commissioners are sometimes pressured by members of Congress on behalf of their constituents, or influenced by the business interests they are supposed to regulate. In addition, agency officials acquire intimate knowledge of the businesses they regulate, and some officials are offered high-paying jobs in those industries once their tenure at an agency is ended. Also, some complain that government regulations dealing with business often become obsolete after they are written since business conditions frequently change.

Some of these factors appear to have been present in a series of events that crippled and almost destroyed America's savings and loan (S&L) business, an integral element of America's "thrift" industry, during the 1980s and early 1990s. Traditionally, S&Ls collected small savers' deposits and invested them in long-term home mortgages. They were ubiquitous; at one time or another, almost all Americans got S&L financing for buying their homes. For many years interest rates paid on deposits at S&Ls were kept low, but millions of Americans put their money in S&Ls because they were considered to be an extremely safe place to invest: deposits of up to $40,000 guaranteed by the Federal Savings & Loan Investment Corporation (FSLIC), an agency of the U.S. government; and the kinds of investments S&Ls were permitted to make were tightly controlled to avoid excessive risk.

Starting in the 1960s, however, general interest rate levels began rising, and by the 1980s were so high that most S&Ls could not compete for deposits. This put them in a dire financial squeeze. Responding to their problems, the government in the 1980s began a gradual phasing out of interest rate ceilings on interest paid by S&Ls (as well as by banks) while raising the insured deposit ceiling to $100,000. This action produced large and widespread losses on S&Ls' mortgage portfolios, which were for the most part collecting lower interest rates than S&Ls were paying depositors. Again responding to complaints, Congress relaxed restrictions, allowing S&Ls to engage in consumer, business and commercial real estate lending. Some regulatory procedures governing S&Ls' capital requirements were also liberalized. Fearful of becoming obsolete, S&Ls expanded into such highly risky activities as investing depositors' money in speculative real estate ventures, many of which proved to be unprofitable when economic conditions turned unfavorable, particularly in the West. But budgetary stringency and political pressure to deemphasize regulation had combined to shrink the regulatory staff and apparatus to the point where it was helpless to keep pace with the unfolding crisis. In this anything-goes atmosphere, some S&Ls were taken over by unsavory people who plundered them for themselves and their friends.

By the end of the decade, large numbers of S&Ls had tumbled into insolvency; about half of the S&Ls that had been in business in 1970 no longer existed in 1989. The FSLIC, which insured depositors' money, itself became insolvent. The S&L crisis had in a few years mushroomed into the biggest national financial scandal in American history. In 1989, Congress and the president agreed on a taxpayer-financed bailout measure known as the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). This act provided $50 thousand-million to close failed S&Ls, totally changed the regulatory apparatus for savings institutions, and legislated new portfolio constraints. A new government agency called the Resolution Trust Corporation (RTC) was set up to liquidate insolvent institutions. In March 1990 another $78 thousand-million was pumped into the RTC. But estimates of the total cost of the S&L cleanup continued to mount, topping the $200 thousand-million mark in 1991.

The S&L debacle was intertwined with the problems that high interest rates brought to other financial institutions, including banks and insurance companies (some of which also went out of business or were threatened with insolvency). Although the causes of the S&L crisis were numerous, deregulation, and more specifically excessive political pressure to keep regulators from doing their jobs at a time when tough enforcement of the rules was clearly in the public interest, played a major role. It was hardly surprising that many Americans were concluding that, while heavy-handed government regulation was bad, excessive laxness in enforcement of important regulations was equally bad, if not worse.

ECONOMIC GROWTH AND STABILITY

In the 1930s with the United States reeling from the Depression, the U.S. government began to take an active role to promote economic growth and stability. An important influence was that of John Maynard Keynes, an English economist who developed a way to analyze and explain economic depressions. His influential work, The General Theory of Employment, Interest and Money (1936), seemed for a time to revolutionize economic thinking in America. Keynes observed the interrelationships among income, savings, consumption, investment and interest rates; he believed that the amount of private investment taking place in an economy dictates whether or not the system stagnates or expands. Keynes was one of the first to argue that it was the special duty of government to actively influence the economy through fiscal policies. He saw government spending or tax reduction as the primary instrument for meeting the twin goals of expansion and stability.

Many of Keynes's ideas were included in President Franklin D. Roosevelt's New Deal program. After World War II, Keynes's full-employment policies were accepted by the United States as well as many other nations. During the Great Depression of the 1930s, Keynes said that nations should "spend their way back to prosperity." He believed the unemployed should be put to work and that incomes should be redistributed so the poor could have money to spend.

This perspective on how to deal with the economy proposed a much larger role for government than had been acceptable up to that time. Since the 1930s, the cleavage dividing American economists often has been related to the extent of validity they are willing to accord the Keynesian analysis. In the 1970s and 1980s Keynesian policies came under attack as allegedly responsible for contributing to the era of "stagflation," which was an undesirable combination of high inflation and slow growth. In the anti-big-government reaction that resulted, Keynesianism did not disappear, but began to play a much less influential role in formulation of economic policies, particularly in times when conservative administrations were in power.

SETTING ECONOMIC POLICY

When Congress passed the Employment Act of 1946, it declared that the promotion of maximum employment, production and purchasing power was to be the policy of the federal government. It authorized the president to appoint a three-member Council of Economic Advisers (CEA) to study economic conditions and advise the president of needed action.

This act focused on full employment, but it did not specify how the goal was to be achieved. The law recognized freedom and competition as important goals in themselves. The nation, the law stated, should rely on free enterprise -- not on government direction of business -- for running the vast economy.

The CEA advises the president on economic problems and helps set the tone of government policy as it decides what kind of action is required. The CEA has no direct authority, but keeps constant watch over changes in income, production and employment. It recommends economic policy to the president and helps in the preparation of reports to Congress.

The federal government's chief economic policy official is the secretary of the treasury. Created by Congress in 1789, the Treasury has responsibility for formulating and recommending fiscal (spending) and tax policy for the economy; managing the public debt; carrying out law enforcement related to federal taxes: serving as financial agent for the government; collecting the revenue from import duties and enforcing customs laws; and manufacturing coins and currency.

THE FEDERAL BUDGET

Federal spending constitutes one of the significant roles of the government in the U.S. economy. The federal budget provides an analysis of expected future income and a detailed plan of spending for the upcoming year. It must be enacted into law in order to legalize the collection of revenues and the expenditure of funds.

The budget is prepared under the supervision of the president, then submitted to Congress for modification and approval. Budget accounts are maintained by the Department of the Treasury and are audited at the close of each year. Except for areas of sensitive national security, all citizens have the right to review the audits and inspect how public funds were received and spent.

The successive stages in budgeting -- preparation, authorization, execution and audit -- are known as the budget cycle. The budget is designed to indicate major categories of revenue sources such as personal income tax, ad valorem sales tax and business tax. Expenditures are listed by government departments and agencies, and are often enumerated in broad terms such as amounts for health, national security or education. The document also shows the amount requested for each program, as compared with the amount actually authorized by Congress. These amounts are listed for three years so that anyone reading the budget can get a sense of the direction in which expenditures for a particular program are moving.

Preparation of the budget is a complex political process, beginning almost a year in advance. Almost every agency in government makes strong bids for funds it wants, often supported by special interest groups. The president makes the final decisions on how much to request from Congress for each program and what the total amount will be.

The initial congressional examination of the president's budget is made by the House of Representatives Appropriations Committee. Through subcommittees, it holds hearings for each department and agency included in the budget. The requests for funds are defended in open sessions by officials of each agency. Hearings are often very detailed; members of Congress often question closely those officials who spend money.

An appropriations bill is then presented to the entire House of Representatives, where it is passed and sent to the Senate. The Senate Appropriations Committee holds hearings of its own and sends its recommendations to the full Senate. A committee from each body then meets to reconcile differences in the two budgets, item by item. The resulting bill is then enacted into law and sent to the president for his signature. Should the president veto the appropriations bill, it goes back to Congress. If a two-thirds vote of each House approves the bill, it becomes law despite the veto of the president. If the necessary number of votes cannot be mustered, a new compromise appropriations bill has to be worked out and voted into law. The total budget for all agencies and departments of government is broken down into 12 to 15 different bills.

The president's budget request reflects the economic policy priorities and goals of the administration. In general, the government seeks to stabilize the economy by spending more or less money during the year. Stability is generally considered in terms of full employment, control of inflation and deflation, and national economic growth. Other considerations can include distributing funds equitably among various regions of the country, meeting needs of the poor, and attempting to achieve a relatively balanced budget. Achievement of the latter goal seems uncertain in view of the fact that most federal budgets over the last quarter of a century or more have been in deficit.

In 1974 Congress set up a staff of its own, the Congressional Budget Office (CBO), to advise it on the likely economic effects of different spending programs and to provide information on the costs of proposed policies. The CBO also monitors the overall effects of government spending on the economy, including the federal budget. Work of the CBO has helped improve congressional discipline. This budget-making process permits Congress to establish its own national priorities, which can then be negotiated with the president.

The U.S. budget process, then, is complex and comprehensive. It permits input by citizens at many critical points, and it is always a compromise among the various interests and political philosophies of the American people.

An Outline of the American Economy