Friday, 17 December 2010

Bastiat and the bailouts

Bastiat provides a simple distinction between a bad and good economist: “The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” The bad economist focuses only on what is easily discernible – the immediate; that which requires foresight is beyond him. If we can draw insight from another dictum about things seen and unseen – “Now faith is the assurance of things hoped for, the conviction of things not seen” – it becomes much clearer why bad economists rely on twisted logic and the instantly visible. This is because their economic understanding is founded on faith; they remain unaware that things unseen need to be foreseen to make good economic policy. This essay will briefly look at three actions the American government has made within the past two years that have had and will have a tremendous impact on the lives of its citizens. The bank bailout bill, the automotive industry takeover and the stimulus package are examples of the government performing the role of a bad economist.
Two years ago, the financial system in the United States was rescued by the government which had obtained a credit line of $700 million. The bailout, which was entitled “Emergency Economic Stabilization Act of 2008” authorized the government to restore “liquidity and stability to the financial system of the United States;” to protect “home values, college funds, retirement accounts, and life savings,” preserve homeownership and promote jobs and economic growth and to increase “overall returns to the taxpayers of the United States.1” To protect the economy and safeguard jobs, the government used part of its funds to buy off “illiquid mortgage-related assets” that were choking the flow of credit in the economy. One can already see the thinking at work here. Secretary of the Treasury Henry Paulson, speaking before the Senate, maintained that the relief program had “to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence.2” The response needed to be immediately implemented and had to have maximum impact; in other words, it rested on what was seen.
On the other hand, what was unseen? For one, the cost of buying these assets was borne by the tax payers. Whatever funds the government used came from taxes collected from its citizens who are better placed to determine what to do with their wealth. Now let us suppose the cost on every American was $2500; if he can be personified by everyman James Stewart, it means $2500 was taken from James to prop up the banks. That is what is seen. What is unseen is that $2500 might have been used to buy James’s daughter a used car. This slight infusion of cash might have kept the car salesman in business or provided more money to advertise his merchandise. What is not accounted for in the bailout is the loss to the car salesman. Now if it can be argued that the government was investing on behalf of James, then it behooves the government to show that transferring James’s wealth to the banks was a worthy investment. This is because, even if James’s daughter got the car and the company collapsed, there is at least the utility derived from driving to school instead of taking the bus. How successful was the bailout? We can consider government’s intervention a failure by the fact that 36 banks closed between October 2000 and September 2008. But since then, 228 have hung shop3. Even with the lifeline obtained from government, more banks have gone under. We should note the claim is not that the government made the banks fail, rather it is to show that James was better off buying the car (if the government had not taken his money.)
Furthermore, the government can do a terrible job with the services it provides without facing adverse repercussions. James could exhibit his displeasure with a firm that performed below his expectations by refusing to patronize the company. On the other hand, if we look at the bank bailout again, we see that the banks which gave out loans indiscriminately were maintained on life-support by the government. Where is the reward for taking calculated risks? When government acts as it did – by either bailing out failing financial institutions or taking over the automobile industry 4 in 2009 – it distorts the economic playing-field and makes it harder for individuals to distinguish between those companies that should survive and those that should die out.
The next example proves the same point. A year ago, the government passed a stimulus package entitled “The American Recovery and Reinvestment Act of 2009.” Like the previous act, this one aimed to “preserve and create jobs and promote economic recovery,” “to provide investments needed to increase economic efficiency by spurring technological advances in science and health,” and “to invest in transportation, environmental protection, and other infrastructure that will provide long-term economic benefits.5” These are all laudable goals. Nevertheless, the government only focused on what was seen: It was required to “expend the funds made available in this Act so as to achieve the purposes including commencing expenditures and activities as quickly as possible consistent with prudent management.” What was seen was how fast the money was been spent.
To give an example of how the funds were supposed to be disbursed, $50 million was provided “for the purpose of maintaining and modernizing the information technology system.” A rationale for the disbursement was that such a construction would provide jobs for the citizens, as well as maintain and if possible modernize the information technology system of the country. People were employed and some modernization did take place. This is what is seen. Let us suppose the cost of the stimulus per head is $1500. What is unseen can be exemplified again by the government’s interaction with James. The government obtained $50 million from taxes and forcibly decided to prioritize it. Though James owns his own music firm, music was not high on the government’s scale of preference. Hence, instead of upgrading his stock of sound equipment, James’s store still displays an older model. This was definitely not great for his business.
The government is not a profit-making entity and as such its primary objective is not efficiency. Government directs spending to satisfy constituencies. The incentives are different for individuals and businesses. A politician is within his rights to drum up electoral support by any means necessary, but as has been stated earlier government funds come from taxpayers. Consider again: the stimulus provides up to $7.2 billion to improve broadband service6. But to do so, it takes money from James, who needs to repair his roof, and transfers it to the receiving district. If James lives in that district, it could be argued he is a beneficiary of the government’s largesse. That is what is seen. What is unseen is that James might never have used a computer before and does not intend to. Or even if there is a computer at home – the son is a computer scientist – the government might not provide the necessary bandwidth. In either case, the consumer is unsatisfied.
This is not an anti-tax paean. There are roles the government can play and instances when it requires the money to perform its tasks. This essay is an apologia for choice, for letting the individual make his own mistakes or achieve his own successes. Whatever decisions are made by government are paid from the revenue gotten through taxation. In closing, a fast-food company has an ad on television where a man is told that if he paid $2 he would get any three items on the menu free. Governments engage in a similar hoax: the items on the menu and the satisfaction derived from them are what are seen; what is unseen is the hidden cost to the individual, who lacked the appetite, but is now required to eat.
What Bastiat realized was that being a good economist or a bad one has nothing to do with having an economics degree. Every decision involving two or more choices is an economic decision; it involves an individual weighing the opportunity cost. Unfortunately, the skills required to be a good politician are what make the same person a bad economist. The politician emphasizes what is immediately seen, while banishing what is unseen to the sidelines. Bastiat recognized “that not to know political economy is to allow oneself to be dazzled by the immediate effect of a phenomenon; to know political economy is to take into account the sum total of all effects, both immediate and future.” Therefore, we should beware of linguistic manipulations – what Bastiat considered sophism – employed to deceive the citizenry. Free healthcare is not free, neither is protectionism a form of protection – there are hidden costs attached.
Ndifreke Ette
Graduate Student (from Nigeria)
Department of Political Science
Louisiana State University, Baton Rouge

1. Text of bailout bill.
2. Henry Paulson appears before a Senate Committee.
3. Failed bank list.
4. Automotive Industry Crisis.

5. Text of Stimulus bill <>
6. Stimulus bill includes $7.2 billion for broadband. <>

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