Any country’s the prosperity and obstacles of economic growth results from activities of government. That means, government plays important role in economic activities. In free market economies government plays important activities. It has to perform role to prevent market failure. As we know that market does not yield economically efficient outcome every time as the result market fails to operate. In free market economy government has designed activities to stimulate and assist private enterprise and to regulate or control business practices so that their operations are consistent with the public interest. There are various forms of government regulation especially to regulate the activities of private firms.
- Industrial products are subject to Operating Regulations, governing plant and pollutant emission, product packaging and labeling, worker safety and health etc.
- Banks and Financial Institutions are subject to Financial Regulations, both the government as well as the control made by the Central Bank for financial soundness.
Rationale for Regulation
1. Economic Consideration
Economic consideration is related to the cost and efficiency implications of various regulatory methods. From economic view point a given mode of regulation or change in regulatory policy is desirable to the extent that benefit exceeds the cost. Political consideration relate to equity rather than efficiency. Economic consideration has an important role in formulating regulatory policy. In fact, it is due to market imperfection that need of regulation in production and marketing activities was felt. If unregulated, the market activities itself creates inefficiency or waste and market failure. Market failure is mainly two types
- Failure by market structure: In order to achieve the economically efficient outcome there must be many producers and consumers within each market. This condition is unfulfilled in some market such as water power, telecommunication etc. If these sectors are allowed for private sectors natural monopoly situation come to exist. They may exploit the consumers by charging higher prices and reduces the volume of output and earn excessive profit. Under such situation market does not yield economically efficient outcomes and creates the situation of market failure.
- Failure by incentive: Second kind of market failure is due to lack of incentive. The market failure due to presence of externalities is known as incentive failure. Production of the firms and consumption of individuals are interdependent of each other. Differences between social and private costs or benefit are called externality. Pollution caused in the water supply in the lower part of the city by the carpet factory situated in the upper part of the city and Plantation of trees in the certain part of the community benefits the community as a whole are the examples of negative and positive externalities.
2. Political Consideration
In formulating regulatory policy, political manifesto of the ruling party and the opposition parties needs to be taken into consideration for political consensus and commitments. From political viewpoint there are two reasons for regulation:
- Preservation of consumer sovereignty: The preservation of consumer’s choice or consumer sovereignty is an inherent aspect of democracy. Consumers have free to decision regarding to their consumption. This is possible only in the competitive market. In competitive market price is set at minimum point of LAC curve in the long run. Therefore monopoly market regulatory policy can be valuable tool to restore control over the price and quality decision making process to the public.
- Limit concentration of economic and political power: In a democratic society it is not desirable to have economic and political power concentrated in limited group. It is regarded that the economic and political power remains linked with one another. Economically active power oriented persons usually are seen interfering in political activities as well. Therefore, the development of large structures is prevented through regulatory policy. The aim of the government is equitable distribution of wealth and income. For the purpose government should interfere in the market.
In the free enterprises economy, the major role of government is to promote private sector participation. To promote private sector, government has to develop physical infrastructure such as transport, energy, development of irrigation, telecom networking. The social and economic overheads created by the government help private business at least in two ways:
- Economic growth: The building of economic and social overhead accelerates the pace of economic growth. Economic growth enlarges the size of market to the advantage of private business through a sustained increase aggregate demand.
- External economies: The adequate supply of economic and social overhead creates external economies which reduces the private cost of production. The social, economic overhead created by the government helps the growth of private business, facilitating acquisition of inputs such as labor, raw material, skilled labor.