G&S - III
PART III
Economic Progress and the Role of
Government
Gwartney and Stroup # 3 – Part III – “Economic Progress and the Role of Government,”
68-112.
“Ten Elements of Clear Thinking about Economic Progress and the Role of
Government” (p. 69)
Element # 1 – When Government Protects the Rights of Individuals and Supplies Goods
that Cannot be Provided Through Markets, It Helps Promote Economic Progress.
The August 2005 issue of the Free Market contains the article, “Anticapitalism Unleashed,” written by William Anderson. In this paper, Anderson raises some thorny issues that relate directly to Element # 1 and contradicts some of the misinformation peddled by the mainstream media. Anderson opens his article with the following statement, largely ignored by journalists:
The U.S. Supreme Court’s 9-0 decision overturning the obstruction of justice
verdict against Arthur Andersen Company comes too late to save the firm or
the jobs of thousands of employees who found themselves out of work when
the government destroyed the firm three years ago.
This can be hardly construed as ‘Government Protecting the Rights of Individuals’!
… the decision …in itself is a verification of a larger truth, that being, that
there is almost nothing individuals can do in order to check the devastating
power wielded today by the American political classes….
Most commentators have missed the larger story. U.S. attorneys have been
Busy since the fall of Enron in 2001prosecuting numerous individuals for
what essentially are business failures,…. (1, emphasis added)
Anderson goes on to explain how the collapse of Enron and the collateral damage to Arthur Andersen were ‘market failures’, precipitated by ‘prior government actions’ or ‘government failures’.
In the aftermath both of the 2001 recession and the September 11 attacks, it was
clear that many large businesses were overextended, having predicted a much
more rosy future than what actually came to pass. Furthermore, the previous
business boom had followed the classic pattern as explained by the Austrian
theory of the business cycle (ATBC), with the Federal Reserve aggressively
pumping up bank reserves, something that ultimately led to speculative bubbles, malinvestments, and the near-collapse of some business sectors most influenced
by this artificial boom. (1, emphasis added)
Just as Alan Greenspan pointed out in his article, “Antitrust,” with regard to the railroad industry in the post-Civil War period, the government’s actions with respect to Enron, Arthur Andersen and other business failures in the post-2001 recession and 9/11 period were
…an attempt to remedy the economic distortions which prior government
interventions had created, but which were blamed on the free market. (in:
Ayn Rand. 1967. Capitalism: The Unknown Ideal, 65)
Many years ago Ludwig von Mises pointed out that
… in injecting more and more fiduciary media [money] into the market they
are in fact kindling the boom. It is the continuous increase in the supply of
the fiduciary media that produces, feeds, and accelerates the boom.…If one
wants to know whether or not there is credit expansion, one must look at the
supply of fiduciary media, not at the arithmetical state of interest rates.
It is customary to describe the boom as overinvestment….The essence of the
credit-expansion boom is not overinvestment, but investment in wrong lines,
i.e., malinvestment. (von Mises. Human Action: A Treatise on Economics,
556, emphasis added
Somewhat later Mises explains the ramifications of such government induced booms:
The erroneous belief that the essential feature of the boom is overinvestment
and not malinvestment is due to the habit of judging conditions merely
according to what is perceptible and tangible… (556, emphasis added)
It is well to remember Frédéric Bastiat’s comment on ‘things seen and things unseen’ – here we have attention being paid to things that are ‘perceptible (seen) and tangible’, while things unseen are ignored.
What induces an entrepreneur to embark upon definite projects is neither
high prices nor low prices as such, but a discrepancy between the costs of
production, inclusive of interest on the capital required, and the anticipated
prices of the products. Lowering of the gross market rate of interest as
brought about by credit expansion always has the effect of making some
projects appear profitable which did not appear so before….It necessarily
brings about a structure of investment and production activities which is at
variance with the real supply of capital goods and must finally collapse.
(558-9)
The boom is built on the sands of banknotes and deposits. It must
collapse. (559, emphasis added)
Mises continues his explanation by describing the process by which the ‘boom’ must lead to ‘bust’:
The breakdown appears as soon as the banks become frightened by the
accelerated pace of the boom and begin to abstain from further expansion
of credit. The boom could continue only as long as the banks were
ready to grant freely all those credits which business needed for the
execution of its excessive projects, utterly disagreeing with the real
state of supply of factors of production and the valuations of consumers.
These illusory plans, suggested by the falsification of business
calculation as brought about by the cheap money policy, can be pushed
forward only if new credits can be obtained at gross market rates which
are artificially lowered below the height they would reach at an
unhampered loan market. It is this margin that gives them the deceptive
assurance of profitability. The change in the banks’ conduct does not
create the crisis. It merely makes visible the havoc spread by the faults
which business has committed in the boom period. (559, emphasis
added)
Compare this with what Anderson has written:
The vaunted “New Economy” was little more than the same Fed-
induced, boom-fed delusion that ultimately brought us the gloomy
economic climate of the 1970s and the disastrous Great Depression
of the 1930s. (emphasis added)
It is not surprising that many firms became highly-leveraged during
the boom; indeed, it makes perfect sense for companies to increase their
indebtedness during a time of easy money, since it permits them to pay
back the debt in the future with cheaper dollars.
Anderson continues by noting the distorting influence of other government policies, e.g., legislating a cap on executive salaries at $ 1 million through tax laws, thereby encouraging alternative means of compensation – including stock options. He then continues:
Federal Reserve policies ultimately created the stock market bubble
[“dotcom”], giving a false financial picture for these companies. When
many firm collapsed earlier this decade, it gave federal prosecutors an
opening to pin securities fraud charges upon executives….
Many of the prosecutions – this especially is true with regard to Enron –
that have been conducted in the wake of the business collapses were
instituted for political reasons….the prosecutions served as a means to
further extend state power over the actions of business owners and
managers. That these actions have dampened investment opportunities
in the country – and have helped to drive US investors to look overseas –
also works to the advantage of the political classes, as they claim that
investors and business owners are unpatriotic and should be even further
regulated and prosecuted.
The unintended consequences of Fed policy – driving U.S. investors overseas – is the blamed on ‘greedy’ businesses by the political classes who chose to totally ignore the government’s responsibility for market distortions. All of this should sound familiar, since the blame-shifting game was pointed out by Alan Greenspan himself in his article “Antitrust,” and by James M. Buchanan with his identification of bureaucrats’ pursuit of their own self-interest, even at the expense of public welfare, the idea of ‘government-failure,’ and the result of the processes of ‘rent-seeking’ behavior. This represents an attempt by the political classes to extend their power over the economy still further.
Element # 2 – Government is Not a Corrective Device.
Given the materials developed above, one has to question seriously the notion that government can provide corrections for the free market, given the incentive structures and the political classes’ tendency to pursue their own self-interest. Gwartney and Stroup, as well as, Frédéric Bastiat, have noted that unintended consequences arising from “Ignoring Secondary Effects and Long-term Consequences is the Most Common Sources of Error in Economics.” Additionally, the political classes are peculiarly susceptible to the demands of special interest groups that contribute money or other favors (bribes?) to politicians’ election campaigns, usually at the expense of the consumer and general public. These same special interests are well known for their ‘rent-seeking behaviors’ (going to government to obtain favors, usually subsidies or special tax treatment at the expense of consumers) – sugar and hops growers, milk producers, mining interests, environmental movement, labor unions, textile manufacturers, steel producers, etc.
Just remember what Alan Greenspan’s article, “Antitrust,” had to say in this regard:
As might be expected, the subsidies [land grants to railroads in the western U.S.]
attracted the kind of promoters who always exist on the fringe of the business
community and who are constantly seeking and ‘easy deal.’ Many of the western
railroads were shabbily built: they were not constructed to carry traffic, but to
acquire land grants.
The western railroads were true monopolies in the textbook sense of the word.
They could, and did, behave with an aura of arbitrary power. But that power
was not derived from a free market. It stemmed from governmental subsidies
and governmental restrictions. (64-5, emphasis added)
One need not look to the free market or to the railroads for the ultimate cause of the monopoly power of these western railroads, it is only necessary to look at perverse incentives and government’s actions for their sources to be clearly unveiled. Greenspan continues:
When ultimately, western traffic increased to levels which could support other
profit-making transportation carriers, the railroads’ monopolistic power was soon
undercut. In spite of their initial privileges, they were unable to withstand the
pressure of free competition.
In the meantime, however, an ominous turning point had taken place in our economic
history: the Interstate Commerce Act of 1887.
That Act was not necessitated by the ‘evils’ of the free market. Like subsequent
legislation controlling business, the Act was an attempt to remedy the economic distortions which prior governmental interventions had created, but which were
blamed on the free market. The Interstate Commerce Act, in turn, produced new distortions in the structure and finances of the railroads. Today, it is proposed that
these distortions be corrected by means of further subsidies.
To interpret the railroad history of the nineteenth century as ‘proof’ of the failure
of a free market, is a disastrous error. (65, emphasis added)
An additional example of the ‘unintended (?) consequences’ of government’s inter-vention into the free market has been chronicled in an editorial in Investor’s Business Daily (10/06/99, A-24), entitled, “Here We Go Again”:
You’ve got to hand it to this administration. Its willingness to revise history to
suit its political ends has no limit. The latest example is President Clinton’s
remarks on health-care reform.
When the Census Bureau reported Monday the number of American without health
insurance has risen by 1 million to more than 44.3 million, the White House reaction
was swift and predictable.
“(The new statistics) mean that the first lady and I and all the rest of us were right in
1994,”said Clinton.
“We told you in 1994 that if this were voted down [Hillary Care], the insurance
companies would continue to drop people, or employers, because of the system
we had,” Clinton added. To make sure the ‘I told you so’ was complete.
Well, we’d like to indulge in a little of the same.
First, a little background. The Clinton administration proposed to take over health
care – one-seventh of the economy – because millions of people didn’t have health
insurance. The health care crisis, it was called.
Higher insurance costs were responsible, then and now. And the reasons for those
higher costs is the same today as then, as well. Too much government and not
enough market forces.
The government’s two biggest health programs, Medicare and Medicaid, account
for more than a fifth of all spending on health care. Yet despite this apparent
generosity, neither program covers the costs of the people it is supposedly serves.
In 1990, for instance, Medicare covered 89.6% of enrollee charges due to a complex
set of price controls. In contrast, private payers paid 128% of charges. In other words,
the private sector was being forced then to make up the difference.
This cost-shifting had a predictable effect on programs. From 1984 to 1991, the cost
for the average annual health plan per employee more than doubled. After adjusting
for inflation, health-insurance cost for employees over the time period rose 67%.
Price controls haven’t come off in Medicare and Medicaid since then. They’ve become
tighter, and premium cost have jumped again. (And Clinton wants to expand Medicare
programs to include prescription drugs’) It’s no wonder employers have a hard time
affording health insurance for their workers.
Of course, the president and his team don’t acknowledge these simple economic facts
of life. Instead, they blame Republicans, saying they didn’t go far enough.
But, as Clinton likes to brag, many of the components of Hillarycare have been enacted
piecemeal. And they too have boosted premium costs.
In 1996, Congress passed the Kennedy-Kassebaum health-insurance package and a bill to
boost mental-health coverage. These new mandates made health insurance more costly.
In 1997, Washington created a new program to cover more uninsured children. Last
year, Congress made insurers cover longer maternity stays.
Last year, the average per-employee health care cost jumped 6.1%, according to an
annual survey of employer health plans by the consultancy William H. Mercer. That’s
about three times the rate of inflation. Plus, analysts are looking for an increase in