a) Minimizing government borrowing requirements
i. A lower public sector borrowing requirement (PSBR) will reduce the total market demand for long
term funds, since the government's demand for funds will be lower. This could result (through
supply and demand) in lower long term interest rates, and so make it cheaper for businesses to raise
long term debt capital.
ii. In theory, if long term debt capital is cheaper, a company's overall cost of capital should fall, and so companies might be encouraged to invest in more marginal capital expenditure projects.
iii. Since investors, particularly institutional investors, might be unable to invest as much as before in gilts, more investment capital might be diverted into shares, thus pushing share prices up.
iv. The purpose of reducing the PSBR might be to control the growth in the money supply, as a means
towards keeping inflation under control. If such a policy is successful, lower inflation would affect
companies' costs and prices, as well as the general state of the economy.
v. If the PSBR is reduced to zero, and if the country has a balance of payments deficit on current
account, the deficit would have to be financed by private sector borrowing from abroad, or by the
sale of assets by the private sector. This would have implications for the ownership of some firms in
the country and for divestments of foreign subsidiaries.
Reducing tax on incomes
- Lower income tax is thought by some economists to provide greater incentives to entrepreneurs and
employees to work harder. If so, the consequences of lower taxes would include more new
businesses, greater productivity and stronger industrial growth.
- Lower income taxes would leave consumers with more income after tax. This could be saved, or
invested in the stock market. Alternatively, the extra income might be spent, leading to a growth in
consumer spending. Higher consumer spending will increase market demand for firms' goods and
services. If a consumer-spending boom is too fast, the rate of inflation will increase.
- It is possible that if employees have more after-tax income because of lower taxation, annual wage
settlements will be lower than they otherwise would be, because employees are already better off.
- Lower taxes on the profits of companies will leave companies with bigger after-tax profits which they
can either re-invest or pay out as dividends.
(b) Reductions in public expenditure
1. If the government spends less, the firms that supply the government will suffer a loss of business; for example, a firm of defense equipment manufacturers might suffer a loss of orders. Firms suffering a
loss of business will need to look to other markets for sales growth, perhaps by exporting more. If
they fail to do this, their sales turnover and profits will fall.
2. A consequence of lower public expenditure is likely to be a reduction of government assistance for
industry. Grants and subsidies might be cut, and government offices that provide specialist advice to
industries might be closed.
3. It is conceivable that the cuts in public expenditure might persuade firms to pay for services or
benefits that have been lost. This would increase firms' costs. (For example, a cut in public health
services might persuade a firm to spend more on in- house medical services for its employees.)
4. Lower government spending will probably create new competitive opportunities for firms in the
private sector. For example, lower government spending on schools and hospitals will create more
market opportunities for private schools, private hospitals, private education funding schemes,
medical insurance schemes and so on.
Increases in nationalized industries prices
1. While government finances will benefit from the increased revenue, for companies that buy the goods
and services of nationalized industries, higher prices will result in higher production costs. Higher
costs in turn mean lower profits, unless they put their own prices up.
2. Employees are likely to suffer from the higher prices of the nationalized industries, and there will be higher annual wage demands.
3. (If demand for the goods and services of the nationalized industries falls, because of higher prices,
suppliers of materials and services to the nationalized industries will suffer a loss of business.
However, they might be able to raise their own unit prices.
4. Higher prices from nationalized industries will, in industries where there is private sector competition, make the goods of the private sector firms more competitive.
Selling nationalized assets
1. The sale of nationalized assets could result in the creation of a competitive private sector market
2. The opportunity might arise for firms to purchase some of the assets that are being sold off, or to buy shares in the privatized business.
3. The government will benefit from the revenue generated by asset sales. With large privatizations,
there might be an effect on the general level of share prices, since the stock market will be flooded
with new shares for sale.
4. One consequence of privatization might be higher prices for customers. The nationalized industry,
just before or just after privatization, is likely to put up its prices, in order to become more profitable and so be more attractive to investors. This would result in higher costs for firms that buy goods and services from these industries.
5. A further consequence of privatization might be a change in buying policy by the privatized company,
to a more commercial footing. There might, for example, be a greater willingness to buy from abroad.
This would have implications for supplier firms.
Kavungya answered the question on April 14, 2021 at 18:58