In a mixed economy like Malaysia, the government plays an important role alongside the private sector. The government intervenes because a free market does not always allocate resources efficiently or fairly. This situation is called market failure, and it is the main reason for government action.
Why does the government intervene?
The government intervenes to correct market failure, to provide public goods, to control monopolies, to narrow the income gap, and to ensure economic stability and social justice. Without intervention, goods such as national defence and street lighting might not be produced, because no private firm is willing to supply them for free. Public goods have two important features: their use cannot be withheld (they are non-excludable) and one person's use does not reduce the benefit available to others. Since private firms cannot easily charge users, they have no incentive to supply them, so the government provides them using tax revenue.
The government also intervenes to stabilise the economy during periods of high inflation or widespread unemployment, and to protect consumers from unfair prices and dishonest business practices.
The main roles of government
- Producer — the government produces public goods and services such as education, government hospitals, roads and water supply.
- Regulator — the government makes laws and regulations, for example controlling the prices of controlled items and enforcing anti-pollution laws.
- Consumer — the government buys goods and services and pays salaries to millions of civil servants.
The tools the government uses
Tax is a compulsory payment to the government. A direct tax is levied directly on income or profit, for example personal income tax and company tax. An indirect tax is levied on spending, for example the Sales and Service Tax (SST). A subsidy is government financial aid that lowers the price of essential goods such as fuel and rice so that lower-income people can afford them.
Example
A factory that dumps waste into a river imposes a cost on society (a negative externality). The government can impose a tax or fine on the factory so that it bears the true cost — this corrects the market failure.
Redistribution of income
The government redistributes income by collecting progressive taxes from high-income groups and channelling the money back through cash aid, subsidies and free public services to the poor. The aim is to narrow the wealth gap and raise the welfare of the people.
Remember
Direct tax = on income/profit. Indirect tax = on spending/goods. A subsidy lowers a price; an indirect tax raises a price.