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ib economics hl notes

Market-Oriented Policies And Government Intervention

UPDATED ON - 01 APR 2020

Learning Points:

  1. Strengths and weaknesses of Market-Oriented Policies

  2. Strengths And Weaknesses Of Interventionist Policies

  3. Market With Government Intervention

  4. Achieving A Balance Between Markets And Intervention

Strengths and weaknesses of Market-Oriented Policies

Market-oriented policies are based on the market mechanism.

Market mechanisms we have studied include:

  • Market‐based supply‐side policies, including:
  • Policies encouraging competition (deregulation, privatization, and anti-monopoly regulation)
  • Labour market reforms 
  • Incentive-related policies
  • Trade liberalization
  • Freely floating exchange rates
  • Liberalized capital flows, or the absence of exchange controls


  • With market‐determined prices working as signals and incentives, markets coordinate the countless independent decisions of consumers, firms and resource owners, allowing social surplus to be maximized, thus achieving allocative efficiency.
  • The pursuit of self-interest by all economic decision‐makers gives rise to incentives for hard work, risk‐taking, innovation, and investment, which lead to higher levels of output.
  • Market-oriented policies work by freeing market forces and making markets more competitive, resulting in greater efficiency in production, lower prices and improved quality, and a better allocation of resources, as well as increased levels of output.
  • Labour market reforms similarly promote free-market forces in labour markets, allowing the allocation of resources to improve.
  • Incentive-related policies (adjustments of taxes) improve the incentive to work, innovate and invest, improving the allocation of resources and giving rise to economic growth.
  • Trade liberalization – the elimination of trade barriers makes the markets much larger, which increases competition, increase efficiency in production, lower prices and improve quality, increase consumer choice, improve the allocation of resources and allow for greater economic growth.
  • Freely floating exchange rates automatically adjust to excess demand and supply of a currency, bringing about a balance in the balance of payments and offering greater flexibility to policy-makers to pursue policies needed domestically.
  • Liberalized capital flows (absence of exchange controls) are vital for attracting MNCs because it means the MNC is free to repatriate profits or to import inputs. In addition, free capital flows mean more efficient global allocation of savings, since savers are free to make financial investments anywhere in the world.


  • Market Failure 

    • Market‐oriented strategies cannot deal with the issue of market failures. This is of special importance in developing countries where market failures are more widespread, including:
      • Negative environmental externalities and problems of common access resources
      • Insufficient provision of merit goods (e.g. education, healthcare etc.)
      • Failure to provide public goods 
      • Abuse of monopoly power
      • Information asymmetries
  • Coordination failures

    • This is a reason for the failure of firms to be set up and to contribute to growth. Coordination failures arise when two or more activities that must begin simultaneously fail to do so. The inability of decision‐makers to coordinate their behaviour results in an outcome where everyone is worse off.
    • E.g. Firms will not enter a market if the skilled labour is not available, at the same time, workers will not acquire the skills if the firms that could hire them do not exist.
  • Weak or missing market institutions

    • To be able to function effectively, markets need an institutional and legal environment that is often missing in less developed countries and some transition economies.
      • These include:
        • Enforcement of property rights o Enforcement of legal contracts o Effective Legal resource
        • A stable currency
        • A well-developed banking and insurance system 
        • An effective road and utility infrastructure system o Ready available information on prices, quantities, and qualities of goods

In the absence of these conditions, markets are highly imperfect and fail to function effectively.

  • Development of dual economies
    • A dual economy is the existence of two separate economic sectors within one country, divided by different levels of development, technology, and different patterns of demand.


  • It is the outcome of market forces that do not work to the benefit of all or most people in a country due to the presence of market failures such as:
    • Weak market institutions or coordination failures
    • The persistence and growth of great income equalities and extreme poverty
    • Government policies that support one sector of the economy at the expense of another


  • Income inequalities
    • The loss of protection of workers resulting from labour-market reforms and increases in unemployment resulting from some policies to increase competition, including trade liberalization which often involves the closure of firms, often results in increases in income inequalities.
    • The inability of certain groups of people to take advantage of opportunities opened by trade and market liberalization can also lead to increasing income inequalities.


  • Insufficient credit for poor people
    • As the market working on its own does not allow poor people with no collateral and seeking very small loans to acquire credit they need – it results in lower investment possibilities, greater poverty, and poorer income distribution and an inability to escape the poverty cycle.


  • Questionable effects on economic growth and development
    • Trade and market liberalization may not lead to improved export performance and greater economic growth and development in some countries.
      • Evidence shows that countries that are better able to take advantage of opportunities offered by trade and market liberalization are those that have already developed an industrial base, and are therefore better able to withstand the competition arising from elimination or reduction of trade barriers.
      • Capital liberalization, if undertaken before countries have developed the necessary institutions may lead to capital flight, reduced ability to conduct monetary policy in accordance with domestic priorities and even financial crisis.
      • The withdrawal of government from the provision of merit goods has negative effects on economic and human development.

Strengths And Weaknesses Of Interventionist Policies

Interventionist policies are based on government intervention in markets intended to correct market deficiencies and create an environment in which markets can work more effectively.


  • Correcting market failures
    • Governments play a major role in the correction of market failures stated above in weaknesses.
  • Investment in human capital
    • Education and health have significant external benefits – therefore, government intervention is important to increase the consumption of both.
  • Provision of infrastructure
    • Infrastructure plays an important role in economic growth and economic and human development.
    • It increases productivity and makes a direct contribution to improved standards of living. 
    • Therefore, it is a strong role for governments in order to ensure the provision of the appropriate kinds of infrastructure.
  • Provision of a stable macroeconomic environment
    • Includes price stability, full employment, a reasonable budget deficit, and a reasonable balance of trade.
    • The market mechanism cannot accomplish these tasks on its own and requires government intervention through the use of appropriate policies.
    • A stable macroeconomic environment is important for ensuring that economic decision‐makers can plan their future economic activities – key condition for investment
  • Provision of a social safety net
    • The market cannot ensure that everyone can secure enough income to satisfy basic needs – the government must step in with the provision of a social safety net to ensure that people falling below a minimum income level will be able to secure their basic needs.
    • A social safety net is a system of government transfers of cash or goods to vulnerable groups
  • Redistributing income
    • The government’s policy of income redistribution is another method to deal with the market’s inability to secure everyone a minimum income.
  • Industrial policies
    • Industrial policies are interventionist supply‐side policies that include support for small and medium-sized businesses as well as protection of infant industries in order to help developing countries in the early stages of their industrialization.
    • Industrial policies include government support of appropriate technology transfer from developed countries and investment in R&D and human capital.
    • Plays an important role in helping developing countries develop their industries and higher value-added activities.



  • Excessive bureaucracy
    • There may be too many rules governing procedures, red-tape, unproductive workers, high administrative costs and inefficiency.
    • Reducing the size of the government sector through privatization and contracting out government activities, and private financing of public sector projects can reduce bureaucratic procedures and improve efficiency.
  • Poor planning
    • Planning plays a major role in government provision of merit goods and public goods, as well as numerous government policies.
    • Planning may run into difficulties because it requires technical knowledge and expertise, which they may not process, as well as a tremendous amount of detailed information, much of which is often not available.
    • Therefore, planning can become highly bureaucratic and inefficient.
  • Corruption
    • Corruption is often associated with lower growth and poorer development prospects.
    • Multinational corporations in their dealings with governments play an important role with respect to bribes.
    • Bribes for tax evasion reduce government revenues further.
    • Corruption also leads to a misallocation of resources as government officials accept bribes to pursue uneconomic projects instead of socially necessary services like education, healthcare etc.
    • Corruption may also weaken sustainable development as government officials may accept bribes to bypass environmental regulations

Market With Government Intervention

Why good governance is important

Governance is the manner in which power is exercised in the management of a country’s economic and social resources for development. (not what is done for economic growth and development, but how it is done)

Good governance consists of 6 principles:

  • Participation – the extent to which the stakeholders affected by policies are involved in making decisions.
  • Fairness – rules apply to everyone in society equally
  • Decency – the formation and implementation of rules does not harm or humiliate anyone
  • Accountability – the extent to which political figures and decision‐makers are responsible to society for the actions and their statements.
  • Transparency – the extent to which decisions made by the government are clear and open
  • Efficiency – the extent to which scarce resources are used without waste, delays or corruption

Good governance is important because better governance is related to more investment and greater economic growth and economic and human development.

Achieving A Balance Between Markets And Intervention

Neither the extreme of very strong government intervention nor the extreme of highly free-market orientation is appropriate for the conditions of developing countries. Instead, an appropriate mix of market‐based and interventionist policies should be found.

  • Very strong government intervention in the market has been mostly discredited as a strategy for economic growth and development and international trade
    • Strong government intervention leads to misallocation of resources and inefficiencies in production, which may result in lower rates of growth.
  • A market‐led economic development strategy with a minimum amount of government intervention does not take into account the special set of circumstances faced by developing countries 
    • If such a policy is pursued over an extended period of time, there will likely be persistence of increasing poverty, a likely increase in unemployment, persisting and increasing inequalities in income distribution, insufficient investments in education, health and infrastructure, unsustainable development, the continued use of inappropriate technologies and limited opportunities to expand exports.
  • The new development consensus outlines a number of areas in which governments of developing countries should intervene in order to promote growth and development

There should be government intervention in the areas: 

  • Poverty alleviation
  • Reductions in income inequalities and inequalities in economic opportunities
  • Investments in health, education, infrastructure, technology transfer and development of R&D
  • Some support for small and medium-sized businesses 
  • Protection of the environment and sustainable development
  • Some protection for domestic industries and infant industries (especially in very poor developing countries) in initial phases of their industrialization


It would be a mistake to take a uniform approach to all developing countries with regard to proposals for market-led or interventionist strategies 

  • Each country is unique and should be able to tailor its strategies to its own particular needs and conditions
  • It is likely that countries at lower levels of economic development can benefit from strategies that are more strongly interventionist ‐ the government can gradually withdraw as the country grows and develops Countries at lower levels of economic development are likely to be lacking in the necessary institutions are regulatory and legal mechanisms required for markets to work well – thus needing a greater degree of government intervention.
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