Why Economy Is Lagging and How to Improve It - Essay Example

When an investor has to decide whether to invest in a new product or another facility, with the success of his decision dependent on future revenues and costs, there is bound to be an irreducible element. In the same manner, when a consumer has to decide on a major purchase. Any decision the success of which depends on future events is likely to involve uncertainty. In such cases, the decision most probably will be postponed with the hope that the uncertainty will dissipate as new information becomes available. The more investment, purchasing, hiring, and other economic decisions are postponed, the lower the economic activity. The greater the uncertainty, the less forward-oriented economic activity there is likely to be, with adverse effects on investment, employment, and consumer spending.

Another reason why the economy is lagging is that there is a chain of events that leads to recession. That means a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail. When some adverse events occur the level of consumer purchases or government purchases or exports may decline. When business investors decide there is no need for any increases in productive capacity investment in plant and equipment goes from some substantial to near zero. Similarly, inventory investment goes from some positive amount to a large negative amount as businesses sell off the inventory and do not replace it. Meaning that when something happens that discourages the other components of demand the adjustment is marginal, but business investment goes into free fall.

Business in plant and equipment is a major element of demand for products. Although in most governments it is smaller than consumer demand, it is highly sensitive to actual or proposed changes in taxes and regulations. Purchases investments are dependent on the expectation of future economic growth and therefore there is a feedback effect. A decrease in private investment purchases results in a decrease in production and the decrease in production leads to a decline in expectations of production growth. A decrease in production leads to labor layoffs and lower consumer incomes. The lower consumer incomes lead to lower consumer purchases and fewer tax revenues for governments leading to a reduction in government purchases. The net result is declining in private investment purchases is the cause of recessions.

Great recessions are accompanied by a decline in the level of private investment. The loss of this source of demand for goods and services is attributed to a drastic increase in the unemployment rate and all of the other adverse consequences. In such cases, the collapse of investment is driven by recording high real interest rates, which in turn are due to deflation brought about by mistakes in monetary policy governments. The resultant condition is that the real GDP will start to increase but at a slower rate that cannot absorb the current pool of unemployment that had been created by the recession in production.

According to (Peter, 1993) there had been a financial crisis in September of 2008 but that in itself was not what caused national sales and production to decrease. It was the loss of confidence on the part of businesses about the future of the economy that produces the decline in demand. The financial crisis was an influence on the loss of confidence, but it was the loss of confidence itself that was the cause of the recession in production. Private investments are essential to economic growth and are the most important component of aggregate demand. A decrease in private investment produces recessions. This decrease is the immediate cause of recessions.

There are several various ways to improve the lagging economy. This includes but is not limited to; cutting the corporate tax rate, renewal of unemployment benefits, cutting government spending, and proactive use of monetary and fiscal policies.

The use of fiscal policy by the government to actively manage aggregate demand can improve the economy(Lawson,2009) For example the golden rule used in the UK allows the government to borrow more during slowdowns because the government is measured throughout the economic cycle. More technically it means that the government fiscal policy is allowing automatic stabilizers to work.
Maintaining a strong and flexible supply side of the economy can also improve the lagging economy. This means that businesses will be able to adapt to worsening economic conditions. This can be through innovation, cutting costs, and searching for new exports markets (Allan and Danske, 2010)

In general, to reinforce and improve lagging economies governments can adopt an extraordinary expansionary stance of macroeconomics policies. 

Reflecting the discretional fiscal stimulus adopted, and more importantly tax shortfalls and inertia in expenditure programmers, government deficits have to increase by a double-digit.

Read More