Effect of Political/national events on the economy

How does political instability affect the economy ?
What political and economic factors influence policy decisions ?
Why is political economy important ?

Introduction

The instability of government, inefficiency of political parties, and a weak political culture create the scenario for a politically instable state. Political instability has become a serious problem especially for the developing and underdeveloped countries. The problem of political instability generates more serious for a society which is multi ethnic, having people of diverse cultural attributes. In a politically stable state all sections of society get their due shares and are satisfied being a part of a multi ethnic society which ultimately leads towards the nation-building. In stable conditions people are empowered and exert their energies for the development of nation. In case of instability the case is vice versa, people feel unsatisfied and powerless, lose their trust on institutions and they prefer their own interest in front of state and ultimately society leads to split.

Economists usually stress that an unstable political system may slow down investment or speed up inflation, and in consequence reduce the GDP growth rate. Theoretically, an inverse relationship is also possible. The economic troubles of a country may constitute major factor in social tensions and political instability, which in turn may cause the fall of a government. Until the early 1990s, the world was in general characterized by two models of economic development: socialism: led by the Soviet Union, and capitalism, led by the United States.

Political events can have huge effects on the global economy. Some of the most striking examples of political decision effect the economy which are as follows:

1. The Greek financial crisis
The Greek financial crisis, which started in 2010, was arguably caused by the bad political decisions of the Greek authorities, which spent money excessively, engaged in tax avoidance and kept interest rates low for too long, leading to inflationary pressures. As a result, 50 percent of under-25 year old in Greece became unemployed, deprivation was commonplace and riots took place throughout the country.

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2. The fall of the Berlin Wall
The fall of the Berlin Wall on November 9, 1989 signified the end of Soviet and communist rule in Eastern Europe; this political decision gave rise to many economic opportunities for the USSR’s ex-satellite states. Indeed, the trade market opened up to an extra 400 million people in Eurasia; moreover, it dramatically benefitted the financial state of countries such as Poland, Hungary and Ukraine. These economies were previously controlled by Moscow, but following the collapse of the wall, they gained the freedom to trade with any country they wished, manage their own finances and adopt capitalism.

3. The formation of the European Union
The formation of the European Union (EU) on November 1, 1993 in the Netherlands, was an extremely significant political decision that is still felt today. The euro, which many EU member states use as their currency, better facilitates the freedom of movement and goods across the Union, while providing the benefits of integrated financial markets. It also gives the EU a stronger presence in the global economy. Since it was conceived, the single market is said to have added 2.2 percent to EU gross domestic product, as well as boosting employment by 2.8 million.

4. World War Two
The end of World War Two in August 1945 came with countless economic effects. In the Soviet Union, around 15 million people were killed as a result of the war; productivity in the USSR slowed as a result, which in turn led to huge economic difficulties. In Germany, low industrial output led to a downturn, further worsened by the cost of $320bn in compensations. The UK was forced to borrow $4.33bn from the US, which it could not pay back until 2006, showing just how much the economy was dependent on the US after the war.

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What impact does Economics have on Government policy?

Governments may make policy changes in response to economic conditions. Government regulation of the economy is frequently used to engineer economic growth or prevent negative economic consequences. During periods of weak growth, Keynesian economists recommend lowering interest rates to encourage borrowing and restore economic growth. In response to inflation concerns, governments may decide to increase interest rates. Government policies may use tax incentives to direct economic conditions also. The active use of these strategies demonstrates government interest in preserving particular economic circumstances to further the economic well-being of important stakeholders and the public.

Generally speaking, economic growth is beneficial to those in political power, which may also be seeking re-election. Strong growth typically translates into more hiring and higher wages for some workers, although not always. Strong economic growth can also lead to higher corporate profits, which is a positive for the stock market.

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Can Political stability Hurt Economic Growth?

Economic growth and political stability are deeply interconnected. On the one hand, the uncertainty associated with an unstable political environment may reduce investment and the pace of economic development. On the other hand, poor economic performance may lead to government collapse and political unrest. However, political stability can be achieved through oppression or through having a political party in place that does not have to compete to be re-elected. In these cases, political stability is a double-edged sword. While the peaceful environment that political stability may offer is a desideratum, it could easily become a breeding ground for cronyism with impunity. Such is the dilemma that many countries with a fragile political order have to face.  

Political stability is by no means the norm in human history. Democratic regimes, like all political regimes, are fragile. Irrespective of political regimes, if a country does not need to worry about conflicts and radical changes of regimes, the people can concentrate on working, saving, and investing. The recent empirical literature on corruption has identified a long list of variables that correlate significantly with corruption. Among the factors found to reduce corruption are decades-long tradition of democracy and political stability. In today’s world, however, there are many countries that combine one of these two robust determinants of corruption with the opposite of the other: politically stable autocracies or newly formed and unstable democracies.

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When political stability comes with having one party or a coalition of parties in office for a long time, it may eventually be detrimental. The economy may do well in terms of attracting foreign direct investment because stability means a predictable political environment. However, other aspects of the society might suffer because of satisfaction, lack of competition, and opaqueness. The economy eventually suffers because of these. Consequently, stable governments do not necessarily lead to higher economic growth. India is another case in point. India’s performance on the economic front in the first 30 years of post-independence era, which symbolized political stability, exhibited 3 to 3.5 percent level of economic growth, lowest in the last sixty years. In contrast, in the last 20 years when India saw as many as four Prime Ministers, industrial growth rates jumped to double digits, something that had not happened before.

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