In this article, I argued that a useful measure of GDP needs to extract the government sector, as all it represents is a movement of wealth from the productive private sector to the productive and not so productive government sector. The private sector is the well spring of wealth creation and the government sector can in itself create no wealth, it can only redistribute it to achieve outcomes that it determines to be more desirable.
One of our regular readers commented as follows:
I have trouble with the suggestion that government spending cannot — at least in theory — result in wealth creation.
The commentator goes on to give an example of taxes creating a useful service, that of a national railyway that creates wealth and an example of printing money that, given to the right projects, will create wealth. They are as follows;
Suppose FooCorp sends their packages by carrier pigeon. This is slow and expensive (pigeons need to be trained and fed, and packages go missing when they fly past hunting grounds). FooCorp realises that they can increase efficiency by investing in a private rail network. The cost savings delivered by the network are greater than the cost of the investment, and FooCorp reaps the rewards. This, presumably, is wealth creation. If so, why is wealth not created if a taxpayer-funded rail network benefits the taxpayers more than it costs them?
Suppose that rather than confiscating our wealth directly through taxes, the government confiscates it indirectly by printing money. The government spends its new money not on bank bailouts or welfare programs, but instead on the fusion researchers, who eventually deliver cheap power for all UK citizens. Again, it would seem that though the original funds were ill-gotten, the result has been genuine wealth creation.
I do not deny the possibility that in these specific individual, stylised examples a government can create wealth. However, in the round, they can never create more wealth than a freely functioning economy.
Economic Calculation in the Socialist Commonwealth
This is the title of a very famous essay – for the full downloadable PDF, see here.
Ludwig von Mises masterfully shows us how rational economic calculation in a socialist system is impossible. Only a half-baked system of production is possible under socialism. Empirically, we saw this in Eastern Europe and the Soviet system. The message is very simple;
- In the free market, people transact for goods and services via voluntary exchange, facilitated by the use of money.
- Money is the price you pay for the goods.
- The price mechanism tells us all sorts of information as to the scarcity of those goods and services (higher prices) or their abundance (lower prices). They also indicate the need or wants of consumers as they will pay more for more wanted goods and services and less for less wanted goods and services.
- Entrepreneurs look out for these price signals so they can direct the factors of production in better ways and combinations to satisfy those most urgent needs of the consumer.
- If government owns the means of production, there is no price for capital goods.
- The central planner has to make up a price to get a capital input.
- How is this done?
- It can only be done at best by educated guesswork.
The Pretence of Knowledge
This is the tile of a very famous speech by Hayek: see here
Also see Hayek FA 1937 Economics and Knowledge, Economica V4 N13 33-54 and 1945 The Use of Knowledge in Society, The American Economic Review .
Hayek built on the work of his teacher Mises by adding the following;
- Planning the production process in the free market economy is done by billions of people exchanging goods and services, facilitated by the medium of money.
- Prices to entrepreneurs are indispensible communication points in their planning process, showing the entrepreneur what factors of production and being demanded to produce what goods and services.
- This knowledge is dispersed and comes from a multiplicity of sources.
- Central planners cannot possible have brains big enough to take over the role and plans of all the entrepreneurs in society and all the spending individuals, thus they have a “knowledge problem.”
Although this was all debated well before the advent of super calculating computers, no program can ever take into account the changing needs and preferences of individuals. Also getting into the computer all of the combined information all the time in all circumstances for all times and places to replicate the market place cannot as of yet be done and I suspect never will be done.
So in answer to our commentator, I would advise a quick reading of the above mentioned classics as I think they are unbeatable in their logic. A government may get lucky with a plan and subsequent taxation of wealth to spend on that plan but, overwhelmingly more so than not, they will fail for the given reasons.
In the mixed economy we exist in today, Lord Andrew Adonis, the current Secretary of State for Transport, is doing just as our commentator suggests and is planning to build a high speed rail network that will undoubtedly bring benefits by moving the great cities of our nations closer together. More trade will take place than before, that is for sure. This I hope will be one of those lucky central planning projects.
The reported £34 billion is a lot of money to spend. Would the private sector have undertaken this? We do not know the answer to the latter for sure, but I would note the following pre big government;
- All the great roads until the 40’s, but now only toll roads as the road system has been nationalised, were built by the private sector;
- This is the same for all the railways, the canals and other infrastructure systems;
- And all the bridges;
- All the health care provision;
- All the education provision;
- Power supply;
- The tunnels;
- And the sewers.
I could go on and on…
If we consider food retail, we find Tesco created with £34 billion of private money invested in its capital. Do we really think that the government could provide for this in a better way?
When governments issue debt, it crowds out private sector bond issuance and fewer big capital projects are provided for by the market system. To create a better functioning market place, governments should be forbidden from raising bonds, then the needs of the market could be met as people will still want to save and they would look more favourably on corporate issuance.
Indeed, we should look once again at how bonds could be the basis of all welfare provision, as I discussedhere, from “How do we fund a Deficit” onwards.
Our commentator gives the second example of using QE or creating money out of nothing to give to some scientists who develop a superior technology that drives masses of benefit. Again, I would say this is possible and more down to luck than having the many millions, if not billions, of economic actors, working through the price mechanism solving problems and allocating resources in the most efficient way, as only entrepreneurs can.
I would back the market, comprising all of us cooperating, over any central planning agent any day of the week!
Government can create the climate for lasting wealth generation by:
- Upholding the rule of law;
- Upholding the sanctity of contract;
- Avoiding war unless attacked;
- Removing legislation that obstructs the market.
There is much more but these are some key areas. I would like to refocus our commentator on thinking of ways the government can create the climate of wealth creation, rather than attempting to be the wealth creator itself.
- The kindness of geniuses
- Socialism, Ludwig von Mises
- Economic Interventionism, Banks and the Crisis, which summarises Socialism
- The Pretence of Knowledge, Friedrich Hayek
On government spending, I also recommend Bastiat’s broken window fallacy. The first paragraph will give you the taste of it. An easy and indispensable text :
Your correspondent’s example of a successful government-built railway as wealth-creator is a very good one. But the proper question would be, should a government create wealth?
To that, the answer must be no. Creating wealth entails risk and should only be undertaken by people using their own money or that of others offered voluntarily because, after all, they might lose it.
Since the government is entrusted with money that has been taken by force from its citizens, it must only be used for tasks commonly-agreed upon. My own state government (New York) has spent hundreds of millions of dollars to foster the development of bio-informatics, optics and micro-chips in the state to attempt to counter the effects of high taxes which have chased industry away.
One or more of these ventures may prove profitable some day, but it was wrong that I was forced to invest in businesses I knew nothing about and couldn’t afford to have risked my meager income on in the first place.
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