how government might intervene to help businesses and encourage enterprise

6.1 External Influences – Economic

Objective

To understand how government can intervene in the economy to help existing businesses and to encourage new enterprise, as well as how it can constrain business activity when required.

Why Governments Intervene

Governments intervene for four broad reasons. Each reason is normally addressed with a specific type of policy tool.

• Correct market failures – e.g. information asymmetry, externalities, public‑goods problems.
• Stabilise the macro‑economy – control inflation, reduce unemployment, avoid recession.
• Promote long‑term growth and competitiveness – raise productivity, attract investment.
• Achieve social objectives – regional development, environmental sustainability, health & safety.

Market‑failure categories (with a brief example)

• Information asymmetry – consumers cannot judge product quality → consumer‑protection legislation.
• Negative externalities – factory pollution → environmental regulations, carbon taxes.
• Positive externalities – R&D spill‑overs → R&D tax credits.
• Public goods – street lighting, national defence → government provision.
• Merit / Demerit goods – education (merit) or tobacco (demerit) → subsidies or excise duties.
• Regional inequality – under‑investment in deprived areas → Enterprise Zones, regional grants.

Macro‑Economic Objectives

The government’s overall goals shape the choice of policy tools.

• Low and stable inflation
• Low unemployment
• Sustainable economic growth
• Balanced balance of payments (external stability)

Economic Policy Tools

1. Fiscal Policy

Uses government spending and taxation to influence aggregate demand.

• Expansionary – increase spending or cut taxes → boosts demand.
• Contractionary – reduce spending or raise taxes → cools demand.

Typical impact on business decisions

Policy change	Effect on costs	Effect on demand	Effect on investment	Effect on competitiveness
Tax cut for firms	Lower operating cost	Higher disposable income → higher consumer demand	More retained profit → greater capacity to invest	Improves price competitiveness
Increased public spending on infrastructure	Neutral for most firms	Stimulates demand in construction‑related sectors	Creates new market opportunities (contracts)	Better transport links raise overall competitiveness

2. Monetary Policy

Managed by the central bank (e.g., the Bank of England) through interest rates and the money supply.

• Lower interest rates – cheaper borrowing → encourages investment and expansion.
• Higher interest rates – raises financing costs → dampens investment, helps curb inflation.

Typical relationship: Investment = f(Interest Rate)

3. Supply‑Side Policies

Aim to increase the productive capacity of the economy without directly managing demand.

• Tax incentives for R&D and capital investment.
• Apprenticeship schemes and vocational training.
• Deregulation and simplification of licensing.
• Investment in infrastructure (roads, broadband, ports).
• Labour‑market reforms (flexible working hours, minimum‑wage adjustments).

Impact on business: lower unit costs, higher productivity, better skill base, faster market entry.

4. Exchange‑Rate Policy

Government (often via the Treasury) can influence the value of the national currency.

• Devaluation – makes exports cheaper, imports more expensive → supports export‑oriented firms.
• Managed float / intervention – stabilises exchange‑rate volatility, reduces uncertainty for importers.

Business implications: export profitability, cost of imported inputs, competitive positioning in global markets.

5. Regulatory Measures

Rules and standards that shape the operating environment.

• Health & safety legislation – protects workers, can raise compliance costs.
• Environmental regulations – may require investment in cleaner technology.
• Competition law – prevents monopolistic behaviour, encourages market entry.
• Consumer‑protection law – addresses information asymmetry.

6. Constraining Measures (How Government Can Restrict Business Activity)

These policies are deliberately used to curb excesses, protect the environment or achieve social goals.

• Higher corporate tax rates – increase the cost of profit, may discourage expansion.
• Minimum‑wage legislation – raises labour costs, can affect hiring decisions.
• Anti‑trust / competition law – blocks mergers that would create dominant market positions.
• Environmental caps (e.g., carbon emission limits) – force firms to invest in greener processes or purchase allowances.

Direct Support to Business

Targeted assistance designed to improve competitiveness and sustainability.

Support type	Purpose	Typical beneficiaries
Grants & subsidies	Reduce capital costs for specific projects (e.g., R&D, renewable energy)	SMEs, start‑ups, firms in strategic sectors
Tax reliefs (e.g., R&D tax credit)	Encourage innovation and investment	Innovative firms, high‑tech industries
Export assistance	Help firms enter overseas markets	Manufacturers, service exporters
Business advisory services	Improve management skills and strategic planning	All business sizes, especially start‑ups

Enterprise‑Encouraging Initiatives

Policies specifically aimed at fostering new business creation.

• Enterprise Zones – tax incentives, simplified planning, and dedicated infrastructure in designated areas.
• Start‑up loans and guarantees – reduce risk for banks, making finance more accessible.
• Education & training – business studies in schools, apprenticeships, entrepreneurship programmes.
• Regulatory simplification – one‑stop shops for licences, reduced bureaucracy.
• Innovation hubs – co‑working spaces, incubators, and access to research facilities.

Case Studies

1. United Kingdom – Enterprise Investment Scheme (EIS)

The EIS offers income‑tax relief of 30 % on investments up to £1 million per year in qualifying small companies. It also provides capital‑gains tax deferral and loss relief.

• Encourages private investors to fund start‑ups.
• Reduces the cost of equity finance for high‑growth firms.
• Has contributed to a measurable increase in venture‑capital activity.

2. Singapore – Tax Incentives for Start‑ups & R&D

Singapore’s Economic Development Board (EDB) runs the Startup Tax Exemption and a 250 % tax deduction for qualifying R&D expenditure.

• Start‑ups can enjoy a 75 % exemption on the first S$100,000 of chargeable income.
• The enhanced R&D deduction lowers the effective tax rate on innovation spending, attracting high‑tech firms.
• Result: Singapore ranks among the world’s most active start‑up ecosystems despite its small domestic market.

Impact of Policy Changes on Business Decisions

Policy tool	Cost implications	Demand implications	Investment implications	Competitiveness implications
Expansionary fiscal policy (tax cut)	Lower operating cost	Higher consumer spending	More retained profit → greater capital expenditure	Improved price competitiveness
Contractionary monetary policy (rate rise)	Higher borrowing cost	Reduced consumer credit → lower demand	Deferral of new projects	Potential loss of market share to lower‑cost rivals
Supply‑side tax incentive for R&D	Reduced tax outlay on R&D spend	Neutral (direct demand effect small)	Stimulates innovation‑led investment	Long‑term productivity and export potential rise
Currency devaluation	Import costs rise → higher production cost for import‑dependent firms	Domestic demand may fall if inflation rises	Exporters more likely to expand capacity	Export competitiveness improves; import‑competing firms gain
Higher corporate tax rate (constraining)	Increased profit‑tax burden	Little direct effect on consumer demand	May postpone expansion or R&D projects	Reduces price competitiveness relative to lower‑tax jurisdictions
Minimum‑wage increase (constraining)	Higher labour cost per employee	Potentially higher prices for consumers	Firms may automate or reduce staff	Can affect competitiveness, especially for low‑margin sectors

Summary

• Government influences the economic environment through fiscal, monetary, supply‑side, exchange‑rate, regulatory, constraining, and direct‑support measures.
• Each tool affects business costs, consumer demand, investment decisions and overall competitiveness.
• Effective intervention balances macro‑economic stability (low inflation, low unemployment, growth) with the need to correct market failures, achieve social objectives, and stimulate entrepreneurship.

Key Points to Remember

1. Fiscal policy changes aggregate demand via government spending and taxation.
2. Monetary policy alters borrowing costs and therefore investment.
3. Supply‑side policies raise productive capacity without directly changing demand.
4. Exchange‑rate policy influences export/import profitability.
5. Regulations protect markets but can also raise operating costs.
6. Constraining measures (higher taxes, minimum wage, anti‑trust, environmental caps) deliberately limit certain business activities.
7. Direct support (grants, tax reliefs, advisory services) targets specific needs of firms.
8. Enterprise‑encouraging initiatives lower barriers to entry and stimulate start‑ups.