I've been trying to explain to a friend why practically it is a bad idea for the government to tax/print money and then invest it into businesses. I.e., why this is really not the same thing as a bank investing money.
I said that the problems are (and I am talking only about practical, not ethical, problems):
1. Capital is already malinvested in the businesses to which the government wants to help. Giving them more money is malinvesting even more capital.
2. By taxing other businesses or printing money, the government (which doesn't have its own money) is really just reshuffling money from the businesses that have been proven to work to businesses that have failed.
3. The government is not a good entrepreneur. It does not have knowledge/experience necessary to make calls where to invest, and it does not invest money in a competitive way (unlike private businesses which compete with each other, and thus we can figure out which of the strategies/targets for investment are the best).
That's what I came up with so far. I have an intuitive feeling that there is something else. I.e., even if the government did not invest in bad businesses, and even if it had perfect foreknowledge of where to invest the money best, we still could not treat the taxed/printed money the same as the money that a bank invests. Is there another reason besides the ones I listed above?
If you have $100 you're saving for something important, and someone steals it and buys you something else, are you any richer?
I think you have to dumb this one way down. The core point here should be that money is not wealth; stuff is wealth. Wealth is houses and cars and meals and haircuts. In short, things that we have a use for that require scarce resources to be produced, such as iron and human labor. Money is just an allocation mechanism. Your friend thinks that scarcity exists because we lack money, and therefore when the government creates money it eliminated scarcity. But you know that the real cost of anything is the resources it uses up, not the money it costs. If a business is failing it must be using resources that have more valuable alternative uses, since somebody else is willing to bid more for those same resources. If this business fails it is not a loss to society, but a valuable mechanism to free up resources for more valuable uses. Inefficient uses of resources should cease, that is the whole point of having a monetary system. And the reason there is economic growth in the first place. When the government creates money, it does not also create resources, therefore it enables failing businesses to bid away resources from other purposes that necessarily were more valuable. In other words, resources are by necessity shifted towards less valuable uses and therefore society is poorer.
My friends' response to what I wrote to him:
The libertarian criticism [...] is that the government cannot create wealth. The Keynsian response is that the government is not creating wealth, it is ACTIVATING the wealth that already exists. Say there are $100 billion worth of auto manufacturing equipment, and $100 billion of worker training invested in auto workers. Given that the auto companies are poorly invested, the US economy may only be getting a $150 billion yield from that $200 billion in wealth. But, if the auto companies go bankrupt, and their machines are sold for scrap, and their workers get jobs in other sectors, then you will only be getting say a $50 billion yield from that $200 billion in wealth. The government can print say $20 billion, use that money to prop up the economy and get people buying American cars, and voila, a $20 billion money printing nets an $80 billion boost to the economy. How did that happen? How do you "inject yourself with your own blood?" Because the wealth was already there, its just that the slumping economy renders that wealth inactive, and Keynsian borrowing activates it. This point is the refuation of the libertarian whine that "Government cannot create wealth." There are many caveats to this rule: 1) It only works when there is inactive wealth lying around. 2) It is very hard for government to properly target spending to have the desired effect. 3) this may be "feeding the tumor" Which is why this tool should be used very, very carefully. But, the extremist position that government stimulus is like draining a pint of blood from a patient in order to give that patient a transfusion is definitely refuted by the above argument.
The libertarian criticism [...] is that the government cannot create wealth.
The Keynsian response is that the government is not creating wealth, it is ACTIVATING the wealth that already exists.
Say there are $100 billion worth of auto manufacturing equipment, and $100 billion of worker training invested in auto workers.
Given that the auto companies are poorly invested, the US economy may only be getting a $150 billion yield from that $200 billion in wealth.
But, if the auto companies go bankrupt, and their machines are sold for scrap, and their workers get jobs in other sectors, then you will only be getting say a $50 billion yield from that $200 billion in wealth.
The government can print say $20 billion, use that money to prop up the economy and get people buying American cars, and voila, a $20 billion money printing nets an $80 billion boost to the economy.
How did that happen? How do you "inject yourself with your own blood?"
Because the wealth was already there, its just that the slumping economy renders that wealth inactive, and Keynsian borrowing activates it. This point is the refuation of the libertarian whine that "Government cannot create wealth." There are many caveats to this rule:
1) It only works when there is inactive wealth lying around. 2) It is very hard for government to properly target spending to have the desired effect. 3) this may be "feeding the tumor" Which is why this tool should be used very, very carefully. But, the extremist position that government stimulus is like draining a pint of blood from a patient in order to give that patient a transfusion is definitely refuted by the above argument.
You pretty much covered it. The main thing is, as you said, politicians in Washington have no idea how to be entrepreneurs...if they did, they would be creating jobs, and wouldn't be politicians in Washington. But more so than that, you have to bear in mind the incentives. Politicians (like...or some might even say more so than everyone else) are looking out for their own interests. They are going to do things to further their own personal goals. That means doing things that are politically and financially and otherwise expedient to them...and of course, this often does not align with what is best for everyone else. In other words, not only do the politicians not know what to invest in in the first place, the money they are playing with isn't even their own...so the incentive isn't necessarily to invest it wisely and make a profit.
And this is exactly what we see...politicians using other people's money (that was taken by force, i.e. taxation) to further their own agenda...whether that's an overall ideology, or something as simple as a power grab and furthering their political career. The "corn husker kickback", the "louisiana purchase", all these shady political deals done as quid pro quos using taxpayer's money...no one can seriously say these were "investments" made for the benefit of everyone.
Again, a company never gets taxpayer money from government because it "deserves it" because it's a good business and provides the best service at the best price. If that were the case, it wouldn't need government to take poeple's money by force and hand it over to it. No, a company gets taxpayer money because it is politically connected, has the lobbying power, has a strong influence in a large voter base, or something else a politician wants. Jimmy Hoffa, the president of the International Brotherhood of Teamsters had 8 years left on a prison sentence when he was pardoned by President Nixon...and his union of over 1.5 million members, who consistently endorsed Democrats, endorsed the Republican. And this was just a coincidence?
Saying government "investing money" is a good thing is the equivalent of saying me putting a gun to your head, taking your money, and spending it on what I think you should spend it on, is a good thing. That's literally what it is. Literally.
So, what's wrong with this argument:
OF course, if a) Americans don't want cars anymore, or b) they want cars but they don't want this company's cars, they want another company's cars, this doesn't work. But, in the limited case where Americans want cars, they just can't buy them because of the economic slump, government spending CAN ACTIVATE wealth that is already latent in the economy.
To me, it sounds wrong intuitively, but I can't put it down succintly.
FlyingAxe: So, what's wrong with this argument: OF course, if a) Americans don't want cars anymore, or b) they want cars but they don't want this company's cars, they want another company's cars, this doesn't work. But, in the limited case where Americans want cars, they just can't buy them because of the economic slump, government spending CAN ACTIVATE wealth that is already latent in the economy. To me, it sounds wrong intuitively, but I can't put it down succintly.
Surprisingly, he's actually talking sense in the first part. He's exactly right. It's all about individual preferences. And that's why it doesn't work. Obviously people don't want those cars (at least not at the price they're currently marked). If they did want those cars, people would be buying them and those companies wouldn't be bankrupt. His argument is "well, maybe people do want those cars, but they just can't afford them."
Uh...okay,
a) Then why are American purchases of other automobiles doing just fine? And why aren't American cars selling in other countries where people can afford cars? Obviously plenty of people can buy cars. They just don't want the cars made by the companies that are failing (which is exactly why the companies are failing...derr.)
b) So you see the problem as "these people want cars but can't afford them" and your solution is "let's take money from other people and hand it over to these people so that they can buy the stuff they want."
Kind of like how we said "if Jack wants a house, but just can't afford one, we should take money from everyone else and buy the house for him." Yeah. That worked wonders for us over the past decade when we tried that. Again, I put a gun to your head, take your money and spend it on something I think you should be spending it on (in this case, cars and houses for other people who can't afford them). I'm not stealing from you. I'm "activating wealth that is latent in the economy".
Thanks, guys.
What rationalizes the decision-making of entrepreneurs is the potential for both profit and loss. Without the goad of the potential for losses, investing is no longer rational and becomes unshackled from the constraints of reality. This is precisely what happened with Fannie Mae and Freddie Mac. More generally, this is what is happening across the board to the economies of the entire developed world as the Establishment's Evil Giant Squid Military Industrial Complex is staging a hostile takeover of all peacetime economic activity and strangling the economy through stifling regulations and gold-plated investment into a tiny handful of mega-corporations.
The fact that the government "cannot lose money" is precisely why the government is a horrid investor. Anything can look like a good idea on paper and when it's not your money that's on the line, the voice-in-your-head that says "Well, wait a minute, what if this thing flops?" has been smothered in its sleep. Reckless misallocation of resources is the inevitable result.
Clayton -
My friend's response (I am summarizing from myself for brevity):
Imagine you have a village in which there are two products: apples and gadgets. There is a factory that produces gadgets. People buy them. Then, one year, the apple harvest fails, driving apple prices higher. This results in people not being able to afford the gadgets. As a result, the gadget factory owner has to sell the machinery for scrap, and the society loses the capital that was invested in the machinery. Instead, the government can subsidize the gadgets to make them more affordable, to make sure that the people still buy them, keeping the gadget business going. Then, next year, hopefully the apple harvest will not fail, the apples prices will go down, and people will be able to afford buying gadgets again. This way, through its actions, the government will save the capital that the society invested in the gadget machines, as opposed to allowing it to go to waste. As a result, the society still has gadgets produced next year, as opposed to losing ability to do that for a long time (until it comes up with the capital to invest in the gadgets again).
Imagine you have a village in which there are two products: apples and gadgets. There is a factory that produces gadgets. People buy them. Then, one year, the apple harvest fails, driving apple prices higher. This results in people not being able to afford the gadgets. As a result, the gadget factory owner has to sell the machinery for scrap, and the society loses the capital that was invested in the machinery.
Instead, the government can subsidize the gadgets to make them more affordable, to make sure that the people still buy them, keeping the gadget business going. Then, next year, hopefully the apple harvest will not fail, the apples prices will go down, and people will be able to afford buying gadgets again.
This way, through its actions, the government will save the capital that the society invested in the gadget machines, as opposed to allowing it to go to waste. As a result, the society still has gadgets produced next year, as opposed to losing ability to do that for a long time (until it comes up with the capital to invest in the gadgets again).
My answer:
In your example, the reason why the people can't afford to buy the gadgets is because they have to spend so much money on the (more expensive) apples that they have no money left for the gadgets. So, when the government prints money to subsidize the gadgets, a lot of people buy gadgets, and this keeps the gadget business afloat. But then, within next couple months, the wave of inflation spreads through the economy and... guess what?.. people cannot afford to buy apples anymore. People starve and most of the population dies. Or, people have to spend even more money to buy apples, which means they cannot afford to buy gadgets anyway... and now the money they had in savings/salary is devalued. So, the government has to subsidize the gadgets again... And the story repeats again, with each cycle, society becoming more and more poor.
Anything else I should add?
This is just saying that the government can do a better job insuring against catastrophe than insurers, futures and other kinds of speculators can. For the reasons I've already given above (the government cannot be a rational investor no matter how hard it tries), this is simply not true. The zeitgeist simply takes this as a self-evident fact. Read any article about the famine in East Africa and you will see innumerable references to how "lack of government" is what has made the famine so bad. The assumption is that governments can magically make things better. But this is really magical thinking. During the Republican debates, the moderators have tried to make hay against Ron Paul for opposing FEMA. "Federal" magically means "strong, better, richer" but there is no thought put to the fact that the Federal government has nothing but what it appropriates from the several States. If the Federal government didn't exist, the State governments and Americans would simply have that much more money at their disposal with which to insure themselves.
This is a particularly laughable talking point for the Republican mainstream since the obvious conclusion is that if Federal disaster protection is better than State disaster protection, then disaster protection by a global government is the best possible. Therefore, we obviously ought to have a global government. Screw FEMA, UNEMA to the rescue!
First off, it may actually be easier to explain things in the same island economy...without money. What if there was no money? What if everyone either made apples or gadgets...and just traded? How would that look? Also, here's another island example you might use:
You have to remember...why are the prices going up? You have to think of dollars as a commodity, just like anything else. Because that's what they are. The only difference is, we don't consume them...we just trade them. When you recognize this, you realize that prices are nothing more than a ratio...the ratio of the value of the dollar, to the value of whatever you're looking at. Let's say we're on an island economy where there is only 1,000 dollar bills, and the people trade using those dollars. That is their entire money supply. Let's also say there are 100 widgets on the island and the price of a widget is $4. This means that with the current number of dollars, and the current number of widgets, the value of dollars to widgets is 4:1. Each widget is worth $4, and each dollar is worth one-fourth of a widget. Now suppose someone finds a genie lamp and the magical creature grants him one wish...and he wishes for a box of widgets. (Not a very imaginative fellow). The box that appears is filled with 100 widgets. Now the economy has 200 widgets. But the number of dollars has not changed. This means, as the widgets make their way into the economy, they will begin to trade at half the price...in essence, they are more plentiful...so their value is decreased. By the same token, let's say the man wished for a case of dollars instead. And it had $1000 in it. In the same way, the dollar is worth less...because there is more of it. With $2,000 in the economy and still only 100 widgets, this means that widgets will eventually trade at $8. See? The price went up...because the value of the dollar went down. Before, when the dollar was more rare (and therefore more valuable), it only took $4 to buy a widget. Now, each dollar is worth half as much. So it takes double the number of dollars to buy the same thing. Now here's where the tax comes in... The guy who wishes for the case of dollars...Let's call him "Ben". By being granted a case of dollars without really doing anything, Ben has basically created dollars out of nothing. He has inflated the money supply. Those dollars do not represent any sort of work or effort on the part of anyone in the economy. It didn't take Ben any time or labor or resources to get those dollars...so there is no real-world value there..that is, those dollars do not represent any work that took place in the real world. They came out of nowhere. So Ben is able to go into the economy and buy things...things that did take real-world effort, time, and resources...but he didn't produce anything of his own to trade. He got the dollars out of nothing. So Ben goes into the economy and buys some widgets. The problem is, those widgets didn't come from nowhere. They actually did take time, effort and resources. In effect, Ben is getting something for nothing. Some people call this "stealing." But he's not really stealing, is he? After all, he paid the price those sellers were asking for. They had an item, they offered to sell it at a certain price and Ben accepted. Voluntary exchange. That's free market capitalism, right? How is he stealing? He got something, they got something. Not at all. Remember the price increase we mentioned earlier? The minute the genie conjured the case of dollars, the real value of each dollar went down. There were now twice as many dollars. But of course, when Ben "created" the new dollars, prices hadn't changed to reflect that yet. He was able to buy anything in the economy at it's original price. He was able to take real goods, that took real-world effort, at a price that was much lower than it should have been...by creating dollars out of nothing. In effect, he "stole" half the wealth of everyone else who had dollars. This is exactly what happens when America's Ben (Bernanke) pushes a button and cranks up the printing press. Everyone who gets the newly printed dollars first gets the benefit of essentially getting something, created out of nothing. They are able to go into the real world economy and buy anything they want, at prices that are much lower than the real value...prices that do not yet reflect the devalued dollar. And who gets those newly printed dollars first? The government. Big corporate banks. And their big corporate friends. They benefit at the expense of everyone else in the economy. Don't forget these are all the same cartel of guys.[1] Imagine if an old man on the island economy decided to save some of his money for a rainy day. He saved up $16. As the new genie money was spent into the system, the prices of everything in the economy would eventually double. Now, when the old man tries to go and spend his savings, he finds it only buys half as much stuff. Before, he could buy four widgets with his savings...now he can only buy two. Where did his money go? Well, his dollars are all still there. But his purchasing power has been stolen. And purchasing power is everything. It doesn't matter how many dollars you have...what matters is how much you can buy with them. Inflation (i.e. money printing) steals the purchasing power of everyday citizens and transfers it to the elites in banking and government. It is a hidden tax that is not voted on, not ratified, and not even recognized by the majority of the public. The picture of pickpocket-Uncle Sam is no joke. That's quite accurately what inflation is...
[1] What did Hank Paulson do before he was made Secretary of the Treasury? Oh nothing...he was just CEO of a little company called Goldman Sachs. How about the current Treasury Secretary, Tim Geithner. Oh he was just the president of the Federal Reserve Bank of New York (yes, a private (read, non-governmental)) bank. Joshua B. Bolten, was a former Goldman executive before he was made President Bush’s chief of staff. Stephen Friedman, a former chairman of Goldman was chairman of the New York Fed until he resigned last year--He remained on the board of Goldman even as he was supposedly regulating Goldman. In 2008, as part of its bailout, the government put Edward M. Liddy, then a Goldman director, in charge of A.I.G. (a company that owed Goldman a shitload of money). Who is president of the New York Fed now? William C. Dudley...the chief economist for Goldman Sachs since 1986, William C. Dudley. The list goes on and on.
FlyingAxe:I've been trying to explain to a friend why practically it is a bad idea for the government to tax/print money and then invest it into businesses. I.e., why this is really not the same thing as a bank investing money.
The problem with a government investing money is severalfold, from practical considerations of incentive structures and consequences of the investment, to economic considerations of what investment really is and means, as well as where the money itself is coming from.
1. Incentive structures:
Probably the biggest reason why the government investing money is a poor investment strategy is that governments do not own the money they are spending, and will not receive back any money that is earned. This is to say, that the bureacrat spending the "public money" draws a wage solely, and the cash did not come from his pocket; and any money returned from the investment also does not go into his pocket. Thus, whether he makes a good investment or a bad investment, there are no consequences to him personally--he cannot be fired, nor gain any profit from the investment, and thus no incentive to weigh all the options, do due diligence, and make an informed choice.
Just look at the Obama administration's $500m investment in some energy company. The only gain the administration received from that was political gain, some talking points, some press coverage. They had no idea if that investment would actually help the economy, they just wanted to help a political ally (green energy).
2. Economic considerations:
All investment done by private citizens is surplus wealth reinvested. This means that a multitude of minds are involved in looking into investments, putting money where they each think it would best be invested.
How many people were taxed to garner $500m? Probably something like 100,000 people or more. The ability of those 100k people to hear about new investments, to network, to hear of problems with existing investments, or to stumble into a good investment dwarfs any government body of 10 or so appointed people, no matter how expert they are. And they are each investing their own money and directly receiving the pain of loss or joy of gain depending on how well they invested, which recalls incentive structures.
And if each thinks the investment they put it into isn't doing well, they can pull it and move it elsewhere. While the Obama admin was tossing around hundreds of millions at a time (into a single company!) 100,000 investors would've invested in stocks, bonds, entire portfolios of companies, resulting into hundreds and thousands of companies receiving funds to further their productive action. Which would've prevented the total loss of the investment as in the Obama-green energy case.
And who in the Obama admin got fired for losing $500m? No one. It's play money to them, because they didn't earn it:
3. Where the money came from:
The reason the Obama admin could spend $500m of other people's money is because of statements like, "wouldn't it be a good thing if...?" It could be "wouldn't it be a good thing if retirees had free medicine," or "wouldn't it be a good thing if everyone had free education"--and the problem with such statements is that they obscure the consequences of implementation. Wouldn't it be a good thing... for who? and from who? Because every act of the government is done at the cost of human man hours of productivity, turned into a wage, and then confiscated. Wouldn't be a good thing if we had renewable energy? Sure, but who will pay for it.
To tax someone's wage to invest in a company is akin to saying that their income and effort must be sacrificed to the whim of politicians and their political goals. This money was taken from people who individually could've put it to much better use.
If a company is a good investment, let the free market invest in it, where the actions of many, based on their own judgment, and to their own gain or detriment, will make a choice free of political considerations, ensuring that it will not be the politically connected that get funding but rather those actually being productive.
FlyingAxe:Is there another reason besides the ones I listed above?
The main problem is centralization. When you take money from dozens or hundreds of thousands of people, you cannot invest it better than they could have. This creates natural inefficiencies. Smaller amounts of money invested in more companies with more eyes watching the outcome of the investment, tracking it, and with the incentive to make sure it does well will always outperform a fiat decision by government.
I suggest Thomas Sowell's "Knowledge and Decisions" for a closeup look at the inefficiencies between centralized decision-making and decentralized decision-making and why that means communism and it's variants can -never- be as economically efficient in any field as free capitalist economies are.
So, I had a phone conversation with my friend, and he says I misunderstood his point.
His point was that the critique of the concept of a Keynesian stimulus that "government cannot generate wealth" is not fair, because the goal of a Keynesian stimulus is not to generate wealth, but to activate existing wealth by investing money into a business that has idle capital (e.g., machines that would be better used at producing cars than being sold for scrap).
Now, says my friend, it may be the case that the government doing that is a bad idea in and of itself, because a) the government is a bad investor (bad at picking businesses in which to invest) for all the above-said reasons, b) the government takes the wealth from already healthy businesses in order to invest into failing ones. That's the fair critique. But to criticize the government for wanting to generate wealth with a stimulus is building a strawman.
My answer to the point would be that by investing money into already failing businesses, the government doesn't even activates wealth; it activates garbage. Robert Murphy in a couple articles explains why idle human capital should not be "activated"; that the people, while being unemployed, reassess their chances of being hired at a certain industry, and that period is important to redirect human resources to the industries that are healthy.
With the material capital, it's the same. If American car industry sucks, and this is why it came close to bankruptcy — since Americans think that American cars are garbage — then giving the industry more money is enabling it to continue producing garbage. And giving Americans rebates for buying American cars is really the same thing. (This is all besides all the other problems of doing so.)
Real "activation of wealth" would be to allow the workers to be rehired by other, healthy, industries, and the machinery that made American cars to be rebought by those who know better what to do with it.
Anything else one could add?
The source of all wealth is the human mind. This is why laissez faire results in more wealth.
A stimulus is just a waste of other people's money, inevitably spent poorly and politically by politicians. Much of the original stimulus went to unions in the guise of spending on schools.