Thursday, November 3, 2016

Diverting Production

I’m finding Henry Hazlitt’s Economics in One Lesson rich in application for our day. Here’s the beginning of Chapter VI, “Credit Diverts Production”:

Government “encouragement” to business is sometimes as much to be feared as government hostility. This supposed encouragement often takes the form of a direct grant of government credit or a guarantee of private loans.
Hazlitt spends most of this chapter talking about loans to farmers. But we can extrapolate this example to similar good-intentions-with-bad-outcomes that government proposes. I’m thinking about home loans to people whose incomes didn’t qualify, which led to the housing bubble of nearly a decade ago. And it probably applies to government school loans, or any other scheme to make college available (and supposedly affordable, or maybe even free) to everyone. And of course the Affordable Care Act and any other interference in the health care industry.

The overarching principle is that government only gets money from taxpayers, and then government uses money as if they have a right to it, but no responsibility for wasting it.

Whenever government attempts something beyond the proper role of government (protection of life, liberty, and property), it causes unintended consequences—usually exactly opposite to the stated goals of the interference.
So, here is a good chunk of chapter VI, with Hazlitt explaining what happens:

At first glance the case for this type of loan may seem a strong one. Here is a poor family, it will be said, with no means of livelihood. It is cruel and wasteful to put them on relief. Buy a farm for them; set them up in business; make productive and self-respective citizens of them; let them add to the total national product and pay the loan off out of what they produce. Or here is a farmer struggling along with primitive methods of production because he has not the capital to buy himself a tractor. Lend him the money for one; let him increase productivity; he can repay the loan out of the proceeds of his increased crops. In that way you not only enrich him and put him of his fee; you enrich the whole community by that much added output. And the loan, concludes the argument costs the government and the taxpayers less than nothing, because it is “self-liquidating.”
Now as a matter of fact that is what happens every day under the institution of private credit. If a man wishes to buy a farm, had has, let us say, only half or a third as much money as the farm costs, a neighbor or a savings bank will lend him the rest in the form of a mortgage on the farm. If he wishes to buy a tractor, the tractor company itself, or a finance company, will allow him to buy it for one-third of the purchase price with the rest to be paid off in installments out of earnings that the tractor itself will help to provide.
But there is a decisive difference between the loans supplied by private lenders and the loans supplied by a government agency. Each private lender risks his own fund. (A banker, it is true, risks the fund of others that have been entrusted to him; but if money is lost he must either make good out of his own funds or be forced out of business.) When people risk their own funds they are usually careful in their investigations to determine the adequacy of the assets pledged and the business acumen and honesty of the borrower.
If the government operated by the same strict standards, there would be no good argument for its entering the field at all. Why do precisely what private agencies already do? But the government almost invariably operates by different standards. The whole argument for its entering the lending business, in fact, is that it will make loans to people who could not get them from private lenders. This is only another way of saying that the government lenders will take risks with other people’s money (the taxpayers’) that private lenders will not take with their own money. Sometimes, in fact apologists will freely acknowledge that the percentage of losses will be higher on these government loans than on private loans. But they contend that this will be more than offset by the added production brought into existence by the borrowers who pay back, and even by most of the borrowers who do not pay back.
This argument will seem plausible only as long as we concentrate our attention on the particular borrowers whom the government supplies with funds, and overlook the people whom its plan deprives of funds. For what is really being lent is not money, which is merely the medium of exchange, but capital…. What is really being lent, say, is the farm or the tractor itself. Now the number of farms in existence is limited, and so is the production of tractors (assuming, especially, that an economic surplus of tractors is not produced simply at the expense of other things). The farm or tractor that is lent to A cannot be lent to B. The real question is, therefore, whether A or B shall get the farm.
This brings us to the respective merits of A and B, and what each contributes, or is capable of contributing, to production. A, let us say, is the man who would get the farm if the government did not intervene. The local banker or his neighbors know him and know his record. They want to find employment for their funds. They know that he is a good farmer and an honest man who keeps his word. They consider him a good risk. He has already, perhaps, through industry, frugality and foresight, accumulated enough cash to pay a fourth of the price of the farm. They lend him the other three-fourths; and he gets the farm.
There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to a man. Credit on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him the loan. The banker is not giving something for nothing. He feels assured of repayment….
Now it is to A, let us say, who has credit that the banker would make his loan. But the government goes into the lending business in a charitable frame of mind because, as we say, it is worried about B. B cannot get a mortgage or other loans from private lenders because he does not have credit with them. He has no savings; he has no impressive record as a good farmer; he is perhaps at the moment on relief. Why not, say the advocates of government credit, make him a useful and productive member of society by lending hi enough for a farm and a mule or tractor ad setting him up in business?
Perhaps in an individual case it may work out all right. But it is obvious that in general the people selected by these government standards will be poorer risks than the people selected by private standards. More money will be lost by loans to them. There will be a much higher percentage of failures among them. They will be less efficient. More resources will be wasted by them. Yet the recipients of government credit will get their farms and tractors at the expense of those who otherwise would have been the recipients of private credit. Because B has a farm, A will be deprived of a farm. A may be squeezed out either because interest rates have gone up as a result of the government operations, or because farm prices have been forced up as a result of them, or because there is no other farm to be had in his neighborhood. In any case, the net result of government credit has not been to increase the amount of wealth produced by the community but to reduce it, because the available real capital (consisting of actual farms, tractors, etc.) has been placed in the hands of the less efficient borrowers rather than in the hands of the more efficient and trustworthy.[i]
There’s so much in this example: the broken glass theory, the story of Davy Crockett[ii] learning that government shouldn’t be in the business of charity. Hazlitt explains why government shouldn’t be in the business of economic interference at all. There will always be those pesky negative consequences.

On the other hand, trusting the free market, while concentrating our efforts on being better, more compassionate individuals, might just work out those perceived issues.

[i] Henry Hazlitt, Economics in One Lesson, 50th Anniversary Edition, Laissez Faire Books, © 1996, pp. 27-31.

[ii] I the retell this story on the Spherical Model website, in the Economic section, under the heading “Free-Enterprise Zone.” [   ] I first heard this Davy Crockett story from Nina Hendee, who tells Texas history stories to school groups at the family restaurant Taste of Texas. I later found the full story: “Not Yours to Give,” originally published in The Life of Colonel David Crockett, by Edward Sylvester Ellis, republished at, © 2002 The Junto Society.

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