For example, the federal government’s budget director David Stockman and other officials in the administration of President Reagan proposed cuts in income tax rates. Congress adopted the cuts in 1981 and 1984 as a way to reduce unemployment and make the economy grow so much that tax revenues would actually end up rising, not falling. Most economists and many politicians did not believe that would happen, but the tax cuts were politically popular.

In fact, the tax cuts resulted in very large budget deficits because the government did not collect enough taxes to cover its expenditures. The government had to borrow money, and the national debt grew very rapidly for many years. As the government borrowed large sums of money, the increased demand caused interest rates to rise. The higher interest rates made it more expensive for U.S. firms to invest in capital goods, and increased the demand for dollars on foreign exchange markets as foreigners bought U.S. bonds paying higher interest rates. That caused the value of the dollar to rise, compared with other nations’ currencies, and as a result U.S. exports became more expensive for foreigners to buy.
When that happened in the mid-1980s, most U.S. companies that exported goods and services faced very difficult times.

In addition, whenever resources are allocated through the political process, the problem of special interest groups looms large. Many policies, such as tariffs or quotas on imported goods, create very large benefits for a small group of people and firms, while the costs are spread out across a large number of people. That gives those who receive the benefits strong reasons to lobby for the policy, while those who each pay a small part of the cost are unlikely to oppose it actively. This situation can occur even if the overall costs of the program greatly exceed its overall benefits.

For instance, the United States limits sugar imports. The resulting higher U.S. price for sugar greatly benefits farmers who grow sugarcane and sugar beets in the United States. U.S. corn farmers also benefit because the higher price for sugar increases demand for corn-based sweeteners that substitute for sugar. Companies in the United States that refine sugar and corn sweeteners also benefit. But candy and beverage companies that use sweeteners pay higher prices, which they pass on to millions of consumers who buy their products. However, these higher prices are spread across so many consumers that the increased cost for any one is very small. It therefore does not pay a consumer to spend much time, money, or effort to oppose the import barriers.

For sugar growers and refiners, of course, the higher price of sugar and the greater quantity of sugar they can produce and sell makes the import barriers something they value greatly. It is clearly in their interest to hire lobbyists and write letters to elected officials supporting these programs. When these officials hear from the people who benefit from the policies, but not from those who bear the costs, they may well decide to vote for the import restrictions. This can happen despite the fact that many studies indicate the total costs to consumers and the U.S. economy for these programs are much higher than the benefits received by sugar producers.

Special interest groups and issues are facts of life in the political arena. One striking way to see that is to drive around the U.S. national capital, Washington D.C., or a state capital and notice the number of lobbying groups that have large offices near the capitol building. Or simply look at the list of trade and professional associations in the yellow pages for those cities. These lobbying groups are important and useful to the political process in many ways. They provide information on issues and legislation affecting their interests. But these special interest groups also favor legislation that often benefits their members at the expense of the overall public welfare.

E The Scope of Government in the U.S. Economy

The size of the government sector in the U.S. economy increased dramatically during the 20th century. Federal revenues totaled less than
5 percent of total GDP in the early 1930s. In 1995 they made up 22 percent. State, county, and local government revenues represent an additional 15 percent of GDP.

Although overall government revenues and spending are somewhat lower in the United States than they are in many other industrialized market economies, it is still important to consider why the size of government has increased so rapidly during the 20th century. The general answer is that the citizens of the United States have elected representatives who have voted to increase government spending on a variety of programs and to approve the taxes required to pay for these programs.

Actually, government spending has increased since the 1930s for a number of specific reasons. First, the different branches of government began to provide services that improved the economic security of individuals and families. These services include Social Security and Medicare for the elderly, as well as health care, food stamps, and subsidized housing programs for low-income families. In addition, new technology increased the cost of some government services; for example, sophisticated new weapons boosted the cost of national defense. As the economy grew, so did demand for the government to provide more and better transportation services, such as super highways and modern airports. As the population increased and became more prosperous, demand grew for government-financed universities, museums, parks, and arts programs. In other words, as incomes rose in the United States, people became more willing to be taxed to support more of the kinds of programs that government agencies provide.

Social changes have also contributed to the growing role of government.
As the structure of U.S. families changed, the government has increasingly taken over services that were once provided mainly by families. For instance, in past times, families provided housing and health care for their elderly. Today, extended families with several generations living together are rare, partly because workers move more often than they did in the past to take new jobs. Also the elderly live longer today than they once did, and often require much more sophisticated and expensive forms of medical care. Furthermore, once the government began to provide more services, people began to look to the government for more support, forming special interest groups to push their demands.

Some people and groups in the United States favor further expansion of government programs, while others favor sharp reductions in the current size and scope of government. Reliance on a market system implies a limited role for government and identifies fairly specific kinds of things for the government to do in the economy. Private households and businesses are expected to make most economic decisions. It is also true that if taxes and other government revenues take too large a share of personal income, incentives to work, save, and invest are diminished, which hurts the overall performance of the economy. But these general principles do not establish precise guidelines on how large or small a role the government should play in a market economy. Judging the effectiveness of any current or proposed government program requires a careful analysis of the additional benefits and costs of the program. And ultimately, of course, the size of government is something that U.S. citizens decide through democratic elections.

IX IMPACT OF THE WORLD ECONOMY Today, virtually every country in the world is affected by what happens in other countries. Some of these effects are a result of political events, such as the overthrow of one government in favor of another. But a great deal of the interdependence among the nations is economic in nature, based on the production and trading of goods and services.

One of the most rapidly growing and changing sectors of the U.S. economy involves trade with other nations. In recent decades, the level of goods and services imported from other countries by U.S. consumers, businesses, and government agencies has increased dramatically. But so, too, has the level of U.S. goods and services sold as exports to consumers, businesses, and government agencies in other nations. This international trade and the policies that encourage or restrict the growth of imports and exports have wide-ranging effects on the U.S. economy.

As the nation with the world’s largest economy, the United States plays a key role on the international political and economic stages. The United
States is also the largest trading nation in the world, exporting and importing more goods and services than any other country.. Some people worry that extensive levels of international trade may have hurt the U.S. economy, and U.S. workers in particular. But while some firms and workers have been hurt by international competition, in general economists view international trade like any other kind of voluntary trade: Both parties can gain, and usually do. International trade increases the total level of production and consumption in the world, lowers the costs of production and prices that consumers pay, and increases standards of living. How does that happen?

All over the world, people specialize in producing particular goods and services, then trade with others to get all of the other goods and services they can afford to buy and consume. It is far more efficient for some people to be lawyers and other people doctors, butchers, bakers, and teachers than it is for each person to try to make or do all of the things he or she consumes.

In earlier centuries, the majority of trade took place between individuals living in the same town or city. Later, as transportation and communications networks improved, individuals began to trade more frequently with people in other places. The industrial revolution that began in the 18th century greatly increased the volume of goods that could be shipped to other cities and regions, and eventually to other nations. As people became more prosperous, they also traveled more to other countries and began to demand the new products they encountered during their travels.

The basic motivation and benefits of international trade are actually no different from those that lead to trade within a nation. But international trade differs from trade within a nation in two major ways.
First, international trade involves at least two national currencies, which must usually be exchanged before goods and services can be imported or exported. Second, nations sometimes impose barriers on international trade that they do not impose on trade that occurs entirely inside their own country.

A U.S. Imports and Exports

U.S. exports are goods and services made in the United States that are sold to people or businesses in other countries. Goods and services from other countries that U.S. citizens or firms purchase are imports for the
United States. Like almost all of the other nations of the world, the
United States has seen a rapid increase in both its imports and exports over the last several decades. In 1959 the combined value of U.S. imports and exports amounted to less than 9 percent of the country’s gross domestic product (GDP); by 1997 that figure had risen to 25 percent.
Clearly, the international trade sector has grown much more rapidly than the overall economy.

Most of this trade occurs between industrialized, developed nations and involves similar kinds of products as both imports and exports. While it is true that the U.S. imports some things that are only found or grown in other parts of the world, most trade involves products that could be made in the United States or any other industrialized market economies. In fact, some products that are now imported, such as clothing and textiles, were once manufactured extensively in the United States. However, economists note that just because things were or could be made in a country does not mean that they should be made there.

Just as individuals can increase their standard of living by specializing in the production of the things they do best, nations also specialize in the products they can make most efficiently. The kinds of goods and services that the United States can produce most competitively for export are determined by its resources. The United States has a great deal of fertile land, is the most technologically advanced nation in the world, and has a highly educated and skilled labor force. That explains why U.S. companies produce and export many agricultural products as well as sophisticated machines, such as commercial jets and medical diagnostic equipment.

Many other nations have lower labor costs than the United States, which allows them to export goods that require a lot of labor, such as shoes, clothing, and textiles. But even in trading with other industrialized countries—whose workers are similarly well educated, trained, and highly paid—the United States finds it advantageous to export some high-tech products or professional services and to import others. For example, the
United States both imports and exports commercial airplanes, automobiles, and various kinds of computer products. These trading patterns arise because within these categories of goods, production is further specialized into particular kinds of airplanes, automobiles, and computer products. For example, automobile manufacturers in one nation may focus production primarily on trucks and utility vehicles, while the automobile industries in other countries may focus on sport cars or compact vehicles.

Greater specialization allows producers to take full advantage of economies of scale. Manufacturers can build large factories geared toward production of specialized inventories, rather than spending extra resources on factory equipment needed to produce a wide variety of goods.
Also, by selling more of their products to a greater number of consumers in global markets, manufacturers can produce enough to make specialization profitable.

The United States enjoyed a special advantage in the availability of factories, machinery, and other capital goods after World War II ended in
1945. During the following decade or two, many of the other industrial nations were recovering from the devastation of the war. But that situation has largely disappeared, and the quality of the U.S. labor force and the level of technological innovation in U.S. industry have become more important in determining trade patterns and other characteristics of the U.S. economy. A skilled labor force and the ability of businesses to develop or adapt new technologies are the key to high standards of living in modern global economies, particularly in highly industrialized nations. Workers with low levels of education and training will find it increasingly difficult to earn high wages and salaries in any part of the world, including the United States.

B Barriers to Trade Despite the mutual advantages of global trade, governments often adopt policies that reduce or eliminate international trade in some markets. Historically, the most important trade barriers have been tariffs (taxes on imports) and quotas (limits on the number of products that can be imported into a country). In recent decades, however, many countries have used product safety standards or legal standards controlling the production or distribution of goods and services to make it difficult for foreign businesses to sell in their markets. For example, Russia recently used health standards to limit imports of frozen chicken from the United States, and the United States has frequently charged Japan with using legal restrictions and allowing exclusive trade agreements among Japanese companies. These exclusive agreements make it very difficult for U.S. banks and other firms to operate or sell products in Japan.

While there are special reasons for limiting imports or exports of certain kinds of products—such as products that are vital to a nation’s national defense—economists generally view trade barriers as hurting both importing and exporting nations. Although the trade barriers protect workers and firms in industries competing with foreign firms, the costs of this protection to consumers and other businesses are typically much higher than the benefits to the protected workers and firms. And in the long run it usually becomes prohibitively expensive to continue this kind of protection. Instead it often makes more sense to end the trade barrier and help workers in industries that are hurt by the increased imports to relocate or retrain for jobs with firms that are competitive. In the
United States, trade adjustment assistance payments were provided to steelworkers and autoworkers in the late 1970s, instead of imposing trade barriers on imported cars. Since then, these direct cash payments have been largely phased out in favor of retraining programs.

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