{"id":40612,"date":"2021-06-24T08:21:00","date_gmt":"2021-06-24T12:21:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=40612"},"modified":"2021-07-02T16:01:50","modified_gmt":"2021-07-02T20:01:50","slug":"government-intervention-in-the-economy","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/government-intervention-in-the-economy\/","title":{"rendered":"The Danger of Government Intervention in the Economy"},"content":{"rendered":"\n

Are there any negative effects of government intervention<\/a>? How does government intervention in the economy<\/a> influence the supply-and-demand equilibrium? <\/p>\n\n\n\n

When the government intervenes in the economy\u2014even in an effort to help\u2014it interferes with the natural equilibrium of supply and demand. This may create unintended ripple effects.\u00a0<\/p>\n\n\n\n

Keep reading to learn about different types of government intervention and how they affect the economy at large.<\/p>\n\n\n\n\n\n\n\n

When the Government Intervenes<\/h2>\n\n\n\n

We\u2019ve seen over and over the ill effects of government intervention in the economy. Despite occasional short-term pains to specific groups (which interventions often aim to prevent), the economy maintains balance and high productivity levels when it\u2019s governed by supply and demand. <\/p>\n\n\n\n

There are three main ways government intervention can damage the economy.<\/p>\n\n\n\n

1. Government Loans Support Inefficient Businesses<\/strong><\/h3>\n\n\n\n

Fallacy:<\/strong> Government loans enable individuals and businesses to achieve prosperity that they otherwise couldn\u2019t, which contributes to collective productivity and wealth. <\/p>\n\n\n\n

Reality:<\/strong> Government loans divert resources away<\/em> from the businesses and individuals who could create the most productivity and wealth, to<\/em> businesses and individuals who would and should be weeded out by private industry standards. <\/p>\n\n\n\n

Similar to the drawbacks of excessive taxes, government loans and credits are problematic when you consider the cost to taxpayers in order to provide those loans. Supporters of government loans argue that the government should make investments that are too risky for private industry\u2014in other words, proponents say that the government should make investments with other people\u2019s (taxpayers\u2019) money that private individuals and institutions won\u2019t risk with their own money.<\/strong> As we\u2019ll see, this leads to wasted capital and lower production. <\/p>\n\n\n\n

In order to receive any loan, a borrower must have assets or a reputation for honesty and high productivity, so that the lender can be confident that the loan will be repaid. Private lenders risk their own money, thus they have strict standards for selecting loan recipients. (Banks technically risk other people\u2019s money, but, if a borrower defaults, the bank has to come up with the funds.) By contrast, the government risks taxpayers\u2019 money, thus it gives loans to people who fall short of private lenders\u2019 standards.<\/strong> In effect, this means that the government awards loans to people who are less likely to have the skills and experience to make enough profits to repay the loans. <\/p>\n\n\n\n

To illustrate this, we\u2019ll use the example of government loans that enable farmers to buy equipment, livestock, land, or other forms of capital for their business. Proponents argue that these kinds of loans tip the scales for farmers who can\u2019t afford land or equipment on their own. The government money enables a farmer to either launch her business or increase her productivity, both of which help her to earn profits that she can use to repay the loan. As a result, proponents say that the farmer ends up contributing more to the economy than she otherwise would have, which makes the return on the loan greater than the government\u2019s initial investment. <\/p>\n\n\n\n

The proponents\u2019 argument would hold up if the loan were from a private lender, but, since the government uses lower standards for lending, the loan actually results in reduced production and collective wealth. The government\u2019s lower standards for lending has two consequences: <\/p>\n\n\n\n

  1. Many government loans are never repaid<\/strong>, because the farmers aren\u2019t reliable to pay the debt or because they lack skill and experience to make the business successful.<\/li>
  2. Farmers who get government loans produce less from their capital<\/strong>\u2014such as land and farm equipment\u2014than more highly skilled farmers would.<\/strong> The farmer who receives the government loan is inherently less skilled and less productive than farmers who can get approved for private loans. A limited amount of capital exists, meaning that the capital one farmer gains is capital that is unavailable for another farmer (for example, there are limited acres of farmland, and when one farmer buys 100 acres, that\u2019s 100 acres off the market for another farmer). If the less-skilled farmer receives her government loan before a more competent farmer receives a private loan, then limited resources are being allocated to an inefficient producer. <\/li><\/ol>\n\n\n\n

    For example, Farmer Adam and Farmer Ben are eyeing the same plot of farmland. Farmer Adam has an impressive record of productive, efficient farming and high profits\u2014he\u2019s an ideal candidate for a private loan. Farmer Ben, on the other hand, can\u2019t get a private loan because he has no savings and no record of successful farming. <\/p>\n\n\n\n

    Since Ben has no other way to get the money he needs to buy the land, government loan advocates favor lending him the money, reasoning that Adam has other options through private loans. In these advocates\u2019 view, giving Ben the opportunity to become a productive farmer is in the community\u2019s best interest. However, when Ben gets the government loan and buys the land, it\u2019s no longer available for Adam. Adam may have other sources of money, but there was just one 100-acre parcel available in the region. <\/p>\n\n\n\n

    While Ben may succeed and become a high-producing farmer, collectively, the farmers who meet the government\u2019s lower borrowing standards are less efficient and more likely to fail\u2014yet they get capital at the expense of more productive farmers<\/strong> who are denied government credits because they meet private lenders\u2019 higher standards. If there is more land available for Farmer Adam, he could still face higher interest rates or higher land prices as a result of the government\u2019s loans. Either way, the community ends up worse off\u2014not better\u2014because of the obstacles that competent Farmer Adam must face. <\/p>\n\n\n\n

    Government-Guaranteed Loans and Subsidies<\/strong><\/h4>\n\n\n\n

    In addition to direct loans, the government also invests in individuals and companies through government-guaranteed loans as well as subsidies. As with government loans, these investments reduce overall productivity and wealth because they fund individuals and businesses who otherwise would\u2014and should\u2014be weeded out in private industry. <\/strong><\/p>\n\n\n\n

    (Shortform note: In a government-guaranteed loan, the borrower receives a loan from a private lender, and the government agrees to cover the debt if the borrower defaults. A subsidy to an individual or a company removes financial burdens\u2014due to market failures or other external forces\u2014either directly, via a cash payment, or indirectly, via a tax cut.)<\/p>\n\n\n\n

    First, we\u2019ll look at the home-building industry as an example of the ripple effects of government-guaranteed loans and mortgages to businesses and individuals. As with government loans, there are similarly low standards for borrowers on government-guaranteed loans. The loans enable people to buy houses that they can\u2019t afford, which falsely signals the building industry to erect more homes, which raises the cost of construction, and that high cost is transferred to homebuyers\u2014<\/strong>including those with government-guaranteed mortgages.<\/p>\n\n\n\n

    In the case of government subsidies, the funding resuscitates businesses that are in danger of failing. As with any government-funded venture, the money used for the subsidies is funded by taxes from individuals and businesses\u2014and, as we\u2019ve discussed, those taxes reduce taxpayers\u2019 purchasing power to support other businesses. Although there may be circumstances under which subsidies are merited, in general, subsidies support <\/strong>unsuccessful <\/em><\/strong>businesses at the expense of <\/strong>successful <\/em><\/strong>businesses.<\/strong><\/p>\n\n\n\n

    2. Tariffs Support Inefficient Industries<\/strong><\/h3>\n\n\n\n

    Fallacy:<\/strong> Tariffs help industries compete in a global market, which prevents employees in those industries from losing their jobs. <\/p>\n\n\n\n

    Reality:<\/strong> Tariffs shift money, manpower, and productivity away from efficient industries in order to support inefficient industries. <\/p>\n\n\n\n

    Policies that put a thumb on the scales of the market in order to support employment levels\u2014such as public works projects and spread-the-work practices\u2014ultimately hurt production and, consequently, national wealth. Tariffs are another example of a misguided attempt to support employment that, in reality, has no impact on employment and actually hurts production and wages. <\/strong><\/p>\n\n\n\n

    With tariffs<\/em>, companies that aren\u2019t efficient and productive enough to compete in the global market are able to stay in business. Without tariffs<\/em><\/strong>, the resources and manpower that would have gone to those inefficient businesses can be redirected to industries that have high production levels, which increases overall productivity. <\/strong>Higher productivity leads to greater national wealth, which raises wages overall. In other words, everyone benefits when people can buy what they want at the best price available, because that structure supports the businesses that are most productive and efficient. <\/p>\n\n\n\n

    As with everything else, there are certain tariffs that may be necessary, such as those supporting essential wartime industries. Problems arise when the tariffs are imposed primarily to support American employment, wages, or wealth, as we\u2019ll see in the next example. <\/p>\n\n\n\n

    Tariff\u2019s Invisible Consequences<\/strong><\/h4>\n\n\n\n

    Let\u2019s look at the impact of tariffs using the example of an American sweater manufacturer. The U.S. company sells sweaters for $30 each, and it\u2019s losing business to a British manufacturer that sells sweaters for just $25. The American company asks the government to impose a $5 tariff, which makes the British sweaters cost $30 for Americans and allows the U.S. company to be competitive. Proponents of the tariff point to all the employees of the American company who will lose their jobs if the business fails. Passing the tariff keeps American sweater workers employed, so that they can earn money to spend, thereby supporting wages in other industries. <\/p>\n\n\n\n

    However, the British company then has fewer profits to spend on goods, including imports from the U.S. The tariff that helped the American sweater industry hurts other industries, especially those with large export markets. <\/strong>In the sweater example, the tariffs hurt British sweater sales, which means that those manufacturers have less money to import American wool and American-made parts for its machines. <\/p>\n\n\n\n

    On the other hand, if the tariff is denied, there are several positive ripple effects<\/strong>: <\/p>\n\n\n\n