This article introduces The STEEPLE Analysis – Political Opportunities and Threats: Fiscal Policy, Monetary Policy and Supply Side Policies.
The politics and regulations of businesses have tremendous influence on firms, the spending power of customers and competitiveness between businesses on the market. Government influences usually come in a number of ways to ensure consumer safety, encourage competition, set performance standards, regulate prices, and so on.
In general, there are two types of government involvements in markets. And, different businesses will be impacted to a various degree by each approach:
- Interventionist government is similar to planned economy. The government manages the economy by using legislation and policies to oversee business behavior and to influence the level of business activity. There are strong market regulations, strict laws regulating businesses and extensive consumer protection laws. Many argue that the government should control key industries, such as transportation, energy or education, to prevent exploitation of people and resources.
- Laissez-faire government adopts a free market approach to managing the economy as it rarely intervenes in business affairs. Rules and regulations exist, but, only when absolutely necessary. The government interferes minimally in markets letting them and the country’s economy to rely on the competition to provide the best deals for consumers. Many argue that key industries such as healthcare and education should be privatized to improve quality and choices of products.
In details, the government’s decisions can be broadly categorized into three different types of policies: Fiscal Policies, Monetary Policy and Supply Side Policies.
1. FISCAL POLICY
Fiscal Policy means any change by the government in the TAX rate or public-sector Government Spending to influence business activity. The government first raises the TAX revenue in addition to other sources of government revenue (e.g. land sales, privatization of state-owned businesses), and then it spends that TAX revenue on a number of areas including social security payments, health care system, public education, public transportation systems and infrastructure such as roads, bridges or airports.
There are two types of fiscal policies: Inflationary (expansionary) used to get out of recession by speeding up the economic growth, and Deflationary (constraining) used to slow down the economy by reducing rapid price increases.
- Inflationary (expansionary) fiscal policy is used to boost business activity, perhaps to get the economy out of a recession. This is done by a combination of TAX cuts and increased public sector Government Spending, thereby creating more business opportunities.
- Deflationary (constraining) fiscal policy is used when the economy experiences high rates of economic growth and high inflation, so it needs to be slowed down via a combination of higher TAXes and reduced public sector Government Spending policies.
TAX
Direct TAXes are paid directly from incomes, e.g. Income TAX paid by employees and Corporate TAX paid by businesses.
a.) Income TAX is paid from people’s income, can be fixed or progressive. If income TAX is higher, people have lower disposable incomes, therefore will have less money to spend and save.
b.) Corporate TAX is paid by companies on Net Profit Before Interest and TAX made. Higher Corporate TAX means, first, less money to reinvest back into the business, therefore difficult for businesses to expand, and second, less money to pay back to the owners who originally invested in the business, therefore fewer people will want to invest in the business.
Indirect TAXes are added to prices of products. TAX payers pay this TAX when they purchase the goods and services, e.g. Consumption TAX, and Import Tariffs and Quotas.
c.) Consumption TAX (VAT, GST or Sales TAX) is added to prices of the products which we all buy every day. Higher VAT means prices of goods in the shops would rise, therefore demand for products will decrease. As prices rise, the workers employed by a firm can buy less, which means that their real incomes have declined, therefore businesses will be under pressure to raise salaries and wages which will increase the costs of making products.
Import Tariffs and Quotas mean putting special TAXes on imported products into the country. If the government of the country imposes import quotas, it means that local companies will benefit, if they are competing with imported goods which will be more expensive. Also, costs of bringing raw materials, components or finished goods from abroad will increase, therefore Cost of Goods Sold (COGS), or the cost of production, will increase causing Gross Profit Margin (GPM) to decrease. Finally, either countries may take the same actions which is called retaliation, therefore the local business trying to sell goods abroad will face lower demand.
Government Spending
The state will spend money on government-sponsored projects in industries owned and controlled by the government. Public-sector Government Spending will have major impact on many large businesses especially in the healthcare, transportation, military and education sectors. The government public-sector Government Spending will usually happen in the following areas:
- Engineering and construction companies will benefit from new public transportation building schemes.
- The army and military companies will benefit, if the government decides to better equips the army.
- Airlines, train, bus, subway and TAXI companies will benefit from government spending on public transportation.
- Public schools will benefit, if the government decides to build more schools, add new facilities to the current schools or purchase more resources to better equip classrooms.
- Hospitals and the healthcare providers will also see benefits.
2. MONETARY POLICY
Monetary Policy means a change in the interest rate that governments can make usually through the Central Bank in order to influence business activity. The interest rate is the price of money, both in terms of the cost of borrowing money and the return for saving money in a bank account. If the economy is believed to be growing too fast, the government or the Central Bank is likely to raise interest rates to combat the effects of inflation. If the economy is believed to be slowing down and entering into recession, the government or the Central Bank is likely to lower interest rates to stimulate businesses.
Interest Rates
The increase in interest rates will have very significant impact on the following aspects:
- New loans. Borrowing money from a bank is now less attractive because households and businesses face higher interest repayments on their loans. People’s disposable income after all interest-bearing loans have been paid is reduced. Therefore, consumers will be unwilling to borrow money to buy expensive items making companies which make luxury products to face lower demand and sales.
- Existing loans. Those households with existing credit card bills, personal loans and mortgages now face escalating interest repayments and may need to reduce their overall spending. Companies with existing corporate loans will have to pay back more interest to the banks, so their Net Profit After Interest and TAX will be reduced, therefore dividends and retained profits will decrease.
- Disposable incomes. If consumers borrowed money to buy homes, then their available incomes will be reduced, therefore demand for goods will decrease because consumers will have less money to spend. An increase in interest rates is likely to reduce consumption and investment expenditure, therefore being a threat to businesses that will face lower demand leading to lower sales revenue.
- Business expansion. Managers may delay decisions to expand their businesses using borrowed money, therefore there will be less business activity in the country. Also, because of lower retained profits, companies will have less of their own resources (equity) to invest back into the business.
- Savings & Appreciation of local currency. Higher interest rates in one country will encourage foreign banks and individuals to deposit capital in that country causing higher demand for that country’s currency, so the exchange rate will rise. An increase in interest rates tends to stimulate demand for the currency since foreign investors are attracted by better returns on their savings. If China has relatively higher interest rates than the U.S., then demand for Renminbi would tend to rise thereby increasing the price of the Chinese currency. Therefore, Renminbi will appreciate against USD.
- Price of exports. Higher interest rates causing appreciation of the domestic currency will make the price of exports to be relatively higher, therefore it will likely reduce the demand from abroad for exported products. Hence, higher exchange rates tend to be a threat for domestic export businesses in the long run.
3. SUPPLY SIDE POLICIES
Supply Side Policies include Privatization, Training & Education, Deregulation and Domestic Policy & Foreign Policy. These policies exist to increase the competitiveness of industries in an economy against those from other countries. Supply side policies are to make the economy more efficient in the longer term.
Privatization
Privatization means transferring the ownership of the business from the public sector to the private sector to improve efficiency, increase competition within the particular industry, enhance quality and increase choices for customers.
Training and education
Training and education for improving the skills of the country’s workers, e.g. computer literacy, decision-making skills or soft skills.
Deregulation
Deregulation means reduction or removal of government controls over an industry, or by acting against monopolies. The advantage of deregulation is that it is leaving businesses on their own which should stimulate healthy competition, may attract foreign direct investments, as it is easier and faster to conduct business in such countries, and eradicate political corruption which can be a major and ongoing threat for businesses as there is a strong correlation between corruption, poverty and international competitiveness.
Domestic Policy & Foreign Policy
It relates to the government’s attitude to foreign trade. The governments can provide assistance to exporters through grants, subsidies, low rent premises or TAX rebates to help newly emerging industries become as competitive as in other countries, or even establish a trading bloc where a single currency will be adopted to make trading easier. Regional assistance to domestic business in the country to encourage business location in undeveloped parts of the country can be provided too. The government can also ease planning regulations such as cancelling restrictions on building new factories or offices in an area of residential housing or in areas of natural beauty.
All in all, the political stability of a country and government policies can provide both opportunities and threats for businesses. In case there is political change in a country, it will have major impact on businesses. Any changes in the government can reverse previous concessions to businesses, can result in drastically different policies or provide either less or more government’s involvement in the markets.
