An economy will work best when it is built on a framework of clear and predictable rules on which individuals and companies can depend when making their own plans.
—Margaret Thatcher. Speech to the Economic Club of New York, June 18, 1991.
Economic cycles are natural and normal, like the tides. The government should no more try to resist them than a harbor master should bolt ships to a wharf. Absent government interference, economic cycles tend to cause mild contractions which affect industries rather than economies, mildly correcting markets rather than collapsing them. The violent peaks and troughs in economic activity that affect whole countries, or even the globe, occur only when the government has force-fed the credit cycle through the provision of cheap credit. As Ludwig von Mises explained: “If one wants to avoid the recurrence of economic crises, one must avoid the expansion of credit that creates the boom and inevitably leads into the slump.” (The Theory of Money and Credit, 1912.)
Economic stimulation through government spending
If spending money like water was the answer to our country’s problems, we would have no problems now. If ever a nation has spent, spent, spent and spent again, ours has. Today that dream is over. All of that money has got us nowhere, but it still has to come from somewhere. Those who urge us to relax the squeeze, to spend yet more money indiscriminately in the belief that it will help the unemployed and the small businessman, are not being kind or compassionate or caring. They are not the friends of the unemployed or the small business. They are asking us to do again the very thing that caused the problems in the first place. We have made this point repeatedly.
—Margaret Thatcher. Speech to the Conservative Party conference, Brighton, October 10, 1980.
Government spending may provide a short-term respite from a downturn, but only at the cost of exacerbating the structural problems that caused the downturn. Spending taxpayers’ money in a conscious effort to distort the market only causes more dislocation that further dampens prosperity. For example, if the computer industry has overheated and the market dictates that a computer programmer should be retrained as an architect, a short stint working as a government programmer is not going to make that transition any easier.
Parable of the broken window
Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son happened to break a square of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—“It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”
Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.
Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.
But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”
It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.
—Frédéric Bastiat. That Which Is Seen, and That Which Is Not Seen, 1850.
If a person saves money, he does it for the sensible reason that he wants to buy something. If you tax him of his savings, you prevent him from spending it on whatever he was saving for. You prevent the bank that held those savings from lending them to someone else who was going to expand a business.
Thus the whole theory of economic stimulation through government spending is as flawed as the theory of perpetual motion.
Economic stimulation through force-fed credit
Likewise it is fantasy to imagine that the rules that apply to a small island economy are somehow changed by the complexities of a national economy. The same rules of flotation that apply to a dinghy applied to the Titanic: its size, the fact that it was dubbed unsinkable, the wealth of the passengers, the luxury of its state cabins, all made no difference—it still sank upon losing its buoyancy. Likewise with economies, the creation of artificial capital through force-fed credit will avail an economy, regardless of its size or complexity, nothing. The only thing that excessive credit achieves is mal-investment.
In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones. By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market, is that both success and failure must be permitted to happen when they are earned. But instead with a bailout, the rewards are reversed—the proceeds from successful entities are given to failing ones … We need to reject corporate cronyism, and allow the natural regulations and incentives of the free market to pick the winners and losers in our economy, not the whims of bureaucrats and politicians.
—Ron Paul. The Bailout Surge, November, 24, 2008.
Quite aside from the practical folly of distorting the market system by rewarding incompetence and punishing wisdom, the redistribution of wealth for the greater good is a gross infringement of property rights. No company is too big to fail. In fact, the reverse is true: if there is an unprofitable company that is so large that its collapse will seriously injure the economy or cause a chain reaction of crashes, then it is vital that it be brought down as soon as possible. In this respect, it is like an old, rotting tree overhanging a residential area: it is dangerous and short-sighted to prop it up. The only exception is banks facing a run during a liquidity crisis. However, this will never be needed if there is no force-fed credit and if the banks are required to maintain adequate capital and to prevent them from engaging in risky business best left to hedge funds. The price of such assistance should always be their controlled liquidation thereafter in order to give their shareholders incentive not to take risks in reliance upon bailouts.