Thursday, March 26, 2009

Government and Markets

A student writes:

>...from the looks of your blog I take it you don't think that the government's capital injection is a good thing. Doesn't a moratorium on taxes simply benefit those with wealth while restricting governments ability to address things like infrastructure revitalization, entitlements (social security and medicare), dependency on foreign sources of energy, the war on terror (read withdraw from Iraq, beef up in Afghanistan, missile defense in Europe and Japan). I guess what I am saying is isn't it government's job to structure markets rather than let them run free?

I respond:

Good point about government. I don't think it works. The common law provides a stable structure for capital markets. The distinguishing difference between medieval history in which there was limited progress, life expectancy of 25-35 years and people in places like England slept with their sheep and horses in the same cottage (with no stone fireplace, just a hole in the roof to let the smoke out from the fire in the center of the room) was a reduction in government. This occurred around the time of the English Civil War mostly by accident. Also, the Protestant reformation discarded prohibitions on lending at interest and did not condemn but rather supported acquisition of wealth. This lead to an explosion of economic activity. There was still a debate in the 17th and 18thg centuries between the mercantilists who advocated what today is called "progressivism" such as Hume, Steuart and Shaftesbury, and the advocates of limited government, notably Adam Smith. In the 19th century the limited government people won the argument and the pace of progress became much more rapid. However, there was a concomitant escalation of anxiety and popular resentment, as expressed, for example, through violent strikes in factories. This occurred despite rapidly (by historical standards) rising real wages, and became most intense at the very time that real wages were rising most rapidly.

The issue was clouded by the association of Social Darwinism with laissez faire capitalism, which did not occur until the mid to late nineteenth century. Until then laissez faire was a working class or entrepreneurial movement and mercantilism was the movement of the rich. It was assumed that government would subsidize the rich at the expense of the poor. The precursors of the Republicans, the Whigs, were essentially mercantilists. Socialism found its response in Social Darwinism, which unfortunately became associated with the formerly mercantilist Republicans. Thus laissez faire went from being the ideology of the poor to the ideology of the rich, but it became entangled (unnecessarily) with Social Darwinism.

The Progressives then transformed the argument by saying that since laissez faire results in Social Darwinism (a false premise) big government is necessary to modify the ill effects of markets. This led to creation of the Federal Reserve Bank and various social welfare programs. The Progressive reforms escalated with the Great Depression.

Milton Friedman has argued that the Great Depression was the direct result of Progressive reforms, specifically policies of the Federal Reserve Bank. Since the Fed's creation, fluctuations in the business cycle have been considerably more painful than they were in the 19th century and recessions and depressions lengthier. The social welfare programs that the New Deal created have been weak despite large sums expended. Social Security, for instance, was a transfer from voters of the 21st century to voters of the 20th century. Now that the economic value of social security benefits is considerably less than the economic value of contributions for many if not a majority of taxpayers, it does not strike me as such a good idea.

Since 1971, when Progressivism reached its ultimate triumph in the abolition of the international dollar gold standard, the real hourly wage has declined. That is, after a century of Progressivism, roughly from 1908 until now, the triumph of 19th century laissez faire capitalism has been reversed. Instead of real hourly wages (I'm not talking about household income where people work more hours to hold even, but payment per hour) doubling every forty years, since 1971 real hourly wages have declined by close to 20%. Progressivism has undone the triumph of laissez faire capitalism.

This was accomplished through wealth transfers via inflation; through regulation that hampers entrepreneurial innovation; through taxes that discourage effort; and through misallocation of credit from entrepreneurial start ups to less productive projects that banks prefer. Government programs squander resources.

In the 1850s John D. Rockefeller financed his own business by working as a clerk for 3 years and personally saving his initial grubstake himself, about one year's salary, which he turned into a successful store. Upon the sale of the store he purchased his first oil refinery with a partner. Today, this would be impossible. The income tax prohbits the savings rate young Rockefeller was able to achieve, 30% per year. Capital gains taxes inhibit reinvestment--the sale of his store would have been taxed. As a result, entrepreneurs like Rockefeller face cost impediments that slow or eliminate the possibility of their ventures. While some still succeed, there are many who would have expanded wealth by starting businesses but have failed because of progressive taxation and regulation.

The needy have fared even worse under Progressivism than everyone else. Forced into unemployment by minimum wage laws; factory jobs driven from the city by zoning and urban redevelopment (we will discuss this in class vis-a-vis Robert Moses); crippled educationally by "progressive education" approaches that leave inner city youth unable to compete in the global labor market; and forced to live in urban "ghettoes" by urban redevelopment and redistricting in the 1950s, four generations of American blacks have been crippled by the overwhelming "kindness" of progressives or liberals, by the actions of government on "their behalf" and by "government structuring markets to help the poor".

So no, I do not think government has done much of value to structure markets. The current situation with the banks is but one more extension of a downward spiral of wealth transfer from the average American to the financial community. The transfer has killed economic growth and undermined capitalism.

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