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Role of Government

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What role does the government play in the financial markets? First of all, let's think about what is the government. Charles T. Bo, studied why cities are successful. His idea is that cities compete with one another for taxpayers in government services. So governments that have more government programs that rent seekers wants will attract more taxpayers. If they provide better public goods, and taxpayers are willing to pay more for them, the government's can then attract higher paying taxpayers and get more taxpayers.

On the other hand, if the government is giving subsidies to the wrong people, and services suck, then the taxpayers will leave and go to another city. It's an interesting idea. And we might be able to find examples to support that. But let's look at another way. What if the government wasn't competing for services? What would that look like?

Well, this has happened for many years. And this is where we have this term called mentalism. This is where one government would capture another country. And they would form a government there where the government's purpose was just to extract resources and benefits for the home country. We now need to introduce another term called rent seeking. Rent seeking is where individuals will use organizations or the government resources to obtain some kind of economic benefit for themselves without actually making any value to the rest of the society.

An example of rent seeking is when you have a company that lobbies for a government loan, or grants or tariff protection, any of these things, they create benefit for the individual, but they don't create any benefit for the society. They've just merely redistributed resources to themselves. Came back this Colbert, a French politician is often known as the father of mercantilism. And he pointed out that a most centralism society tends to have a few distinct quality Since the purpose of that government that's been colonized is solely to benefit the home country, there's going to be a few factors that tend to pop up such as complicated cash tax structures, government subsidies, there's a benefit for the home country elite, and any politicians that they install in this colonized government are now entrenched. They don't want those people to be removed. They want them to stay there.

There's often a large number of monopolies that are state owned. A monopoly is just a firm that doesn't have any competitors. So with no competition, they're able to charge whatever they want. And the services will be taken by consumers because there's no one else to buy from. There's incentives to create monopoly profits because you already have a monopoly. You want to milk that.

So there's a lot of exports, but not too many imports. Often, the elite create laws that favor them And you can then purchase government positions for yourself and the family who or anyone else who has loyal ties to you. So this government then, in the summer centralism structure is organized specifically to maximize political rent seeking. So your government is revolve all around that. Now, Scottish university professor Adam Smith, he didn't like that he hated mercantilism. He thought that rent seeking in general slows down the economy.

It involves a large number of experience and contacts with specific firms to make lobbying easier, and this makes firms grow extremely large and bureaucratic. And it's very hard to stop rent seeking economies once they start. But Williams, an American economist, agrees and says that if rent seeking slows down the economy, and perhaps the reason the West was able to get rich so fast, is that they were able to abandon mercantilism faster than other colonies around the world. Alton macker is an American economist and he asks the question then why are this still so many rent seeking countries? It's easier for small rich groups to get together than a large working class and try to lobby the government. Small, rich, organized classes are able to lobby better to get what they want rent seeking trade barriers.

They end corruption harm the economy, but they benefit individuals. So how does rent seeking begin anyways? How do you get rent seeking economy? George Stigler, an American economist looked at the lifecycle of a bureaucracy, specifically a regulator bureaucracy. So in regulation, and this forms is this large, massive bureaucracy that nothing seems to get done. How does this starting beginning?

Well, it starts off with a regulator who's actually honest and committed They want to benefit society and that's what they wanted to install some kind of regulation that would be good for the society. After a while bureaucrats notice that they can advance their own personal careers if they can regulate a large industry. They then develop close ties and relationships of trust with the firms that they're regulating. The bureaucrats seek to protect and raise the profits of firms in their industry. And over time, a bureaucrat who started off as a government representative trying to influence the industry. They end up as a representative of the industry trying to influence the government.

Raghu ram Rajan and we decent galleys notices how entrepreneurs they start building businesses, and these are often very innovative, but when they get old, the children tend to take over the businesses, but the children are not entrepreneurs. However, they are now a part of the elite class and the elite class. can use their lobbying power to capture government. So rather than trying to come up with innovative new businesses, what these children do is they focus more on being more politically connected. Myra facha notices how firms that are more politically connected now have a few interesting characteristics. That tends to be more corruption, more barriers to entry, more regulation, less press freedom.

But here are the benefits for those. There's often a higher stock share price is often higher subsidies are more likely, there's more likely the probability of a bailout during crises and probability of being bailed out multiple times. And they often have access to higher leverage and firm funding. So it's easy to see how being politically connected has lots of benefits. So rent seekers then will lobby for subsidies that lobby for free land for tax and polls and exemptions. They want favorable regulation or favor Quality regulation.

And they often ask for more trade barriers. And so this is where you can see why does the government often create all of these subsidies and tax loopholes and odd regulation and trade barriers? It's probably because some politically connected firms are lobbying for these things. Also, manager now made an interesting observation. What does the mafia the mafia collects protection money? It keeps public order in forces contract deals, they provide protection from the criminals.

They run gambling joints and sell drugs. They help the needy and they support the needy. What does the government do? The government collects taxes. They keep public order. They enforce rules of law.

They provide protection from criminals. They run lotteries and sell liquor. They help the needy and they support the knee hmm interesting comparison theory then comes this. The government evolved from bandits or from the mafia, or something similar like they used to be lots of roving bandits. And these roving bandits would go all over the place and steal from everyone. And so people didn't bother to collect too much wealth, because they might get stolen from.

However, stationary bandits they don't take everything. rather a stationary bandit is a roving band who's collected so much wealth, that they now need to stay in one place. They can't carry it with them, so they stay in one spot. And once you're staying there, the people around you who's stealing from, they now have different incentives. He actually wants the people around him to collect wealth, become wealthy themselves, and then steal it from them, rather than having to constantly chase all over the place. In return, he offers protection against other bandits.

And slowly the government forms out of this. So station a bandits will then coordinate to leave an optimal amount. So that the Farmers with people he's stealing from will get rich. But they will allow them to get rich just and steal just the right amount so that this can be sustainable. If you look back historically, you can see that many Dukes and rich monarchs, their ancestors, they date back to Castle cattle rustlers emerging after the Middle Ages. Often you can even see that a lot of knights often they got their wealth in the very beginning by stealing it from farmers of these going back through their ancestors, so they were essentially roving bandits.

There's another definition of what a government might be. Douglas Dorf has a definition of what an institution is. It goes like this, an institution is anything that constrains self interest, such as laws, regulations, contract obligations, cultural taboos, customs and religion. The purpose of institutions is to make sure that by people acting in their self interest, they're not causing harm to a larger part of society, also known as an undesirable Nash equilibrium. The West then developed institutions faster than other countries, such as accounting standards, financial regulations, market efficiencies, laws, courts, police, prisons, and so on. The West was able to develop these, or at least more efficient institutions than other parts of the world.

And so these economies thrived faster. He can then point at historical points how British colonies tended to do better than Spanish, French and Turkish colonies, because they had better institutions. So here we are with several different ideas of how the government might have been structured. Is it structured to compete with other governments for taxpayers, or rather, is it structured To encourage rent seeking, so certain individuals will benefit from the government. What kind of regulations are involved? And what are the incentives behind regulation or deregulation?

Also what institutions are being created to what kind of self interests are being constrained to benefit the public. And so whose interest is the government acting for isn't always so simple, because it changes over time as different groups gain political influence.

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