Looking Beyond the Immediate Effects of Policy

"Nature recks nothing of intentions, good or bad; the one thing she will not tolerate is disorder, and she is very particular about getting her full pay for any attempt to create disorder." ~ Albert Jay Nock, Our Enemy, the State, The Caxton Printers, 1950, p. 197.

The great economist Henry Hazlitt long ago observed that "Economics is haunted by more fallacies than any other study known to man." To Hazlitt this was no accident given the "persistent tendency of men to see only the immediate effects of a given policy."

This failure had to do with the inability of economic practitioners to look beyond the first visible result of policy proposals. Simplified, there's no doubt governments can stimulate any one sector of an economy, but with nothing in life free, such stimulation would have to be achieved at the expense of other economic sectors.

Hazlitt's reasoning looms large at present given the bipartisan desire among politicians to fix an economy seen by many as performing at suboptimal levels. As President Obama put it recently, "We have a long way to go to fully restore our economy."

Obama is far from alone in suggesting that the federal government must play a major role when it comes to righting our economic ship. This is surely one of the fallacies to which Hazlitt pointed. Indeed, it's becoming apparent that much as they did back when Hazlitt wrote Economics In One Lesson in the 1940s, politicians today are once again failing to look beyond the immediate effects of policy.

Phony job creation. With the US unemployment rate presently at 10 percent, it's no surprise that politicians of both parties are looking for ways to create jobs. According to one proposal floated by the Republicans, including House Minority Whip Eric Cantor, the federal government would grant U.S. firms a $3,000 tax credit for each new hire made in 2010.

At first glance government efforts to lower the cost of hiring might seem a useful way to put people back to work. But as is often the case when politicians use the tax code to achieve certain outcomes, they fail to look beyond the initial impact.

For one, companies aren't in business to create jobs. Instead, they form and attract investment based on their presumed ability to be profitable, ideally with the fewest amount of workers possible. There are no jobs without capital, and hiring motivated purely by the tax code could lead to inefficiencies that would ultimately repel investment.

Secondly, workers are themselves a precious and limited form of capital. If the tax code is used to lower the cost of hiring, this to some degree will promote non-economic utilization of labor which will divert it from its best use. Just as artificially low interest rates tend to create bad debt, artificially low hiring costs will create bad (i.e., unproductive) employment. Workers will ultimately lose out.

In July Congress also passed a minimum wage increase. No doubt a federally mandated pay rate is good for those who can capture same. But the simple truth is that some workers are not worth the minimum wage, which means that when Congress places a floor on pay, the economy is deprived of the services of certain workers who might otherwise be employable. Everyone must start somewhere; so while a minimum wage might seem compassionate, the long-term result may well be that the minimum wage squeezes out some workers who, for being sidelined by articificially set wages, miss the opportunity to gain the experience necessary to command higher wages in the future.

Congress also recently passed a law extending unemployment benefits in the 27 states where the jobless rate is above 8.5 percent. These will surely provide comfort during a difficult period for hiring, not to mention that the benefits may well enable the unemployed to maintain their living standards. The problem is that the existence of jobless benefits raises the cost of luring the unemployed back into the labor force. Potential workers are able to choose whether or not to work based on the difference between government benefits and the prevailing market wage.

As USA Today recently reported, there is a positive tradeoff to slow economic times: small business owners have access to higher-quality candidates, an improved work ethic among existing workers and higher employee retention. To the extent that unemployment benefits make losing one's job less problematic, employers miss these opportunities.

Protectionism. Last September the Obama administration announced a 35 percent tariff on Chinese tire imports. As is often the case when governments intervene in the flow of goods, there are near-term winners. In this case, U.S.-based tire manufacturers will likely see an increase in sales at the expense of the Chinese.

But what the Obama administration ignored are the other, less economically enhancing results of tariffs. For one, tariffs are on their face exploitative of the broad population of consumers who will now be forced to pay higher prices for tires given the government's desire to protect a politically privileged sector of the U.S. economy.

Second, and most unfortunate for the economy, tariffs serve to enlarge our least efficient industries at the expense of our most efficient. And in elevating the industries that don't match our skills as much, tariffs necessarily lower our wages over the long-term as Americans pursue work that doesn't maximize their talents.

Bailouts. Though GMAC Financial Services was already the recipient of over $12 billion worth of federal loans through December of 2008, it was recently announced that the U.S. Treasury is in the process of preparing another $5.6 billion loan to the gasping lender. As the Wall Street Journal put it, "The willingness by Treasury officials to deepen taxpayer exposure to GMAC reflects the troubled company's importance to the revival of the auto industry."

So while it would be naïve to assume that GM and Chrysler won't benefit from a recapitalized GMAC, Treasury officials neglected to recognize that nothing is ever free. GM and Chrysler will doubtless see their sales rise thanks to increased lending on the part of GMAC; but other, healthier businesses will no doubt suffer as the Treasury mops up even more capital to support companies left for dead by the private sector.

Also not considered here is the basic truth that "capital" is at its core people and equipment. When federal bureaucrats offer funds to failed businesses, what they're really doing is diverting capital of both the human and mechanical variety from private interests that might have utilized both more productively.

Long forgotten is the fact that the disappearance of horse-drawn carriages back in the early part of the 20th century released underutilized capital to numerous industries, including the nascent automobile industry. Today, the immediate effect of the continued bailout of GMAC may well be a healthier auto sector. But the unseen and more negative long-term effect will parodoxically reveal itself through industries that never see the light of day thanks to bailouts that keep capital in the wrong hands.

Housing. Eager to create home-buying incentives among individuals in order to prop up the listing housing market, Republican Senator Johnny Isakson inserted an $8,000 tax credit for first-time purchasers of homes in the 2009 stimulus bill. And while the federal government has already sent out buyer credits totaling $8.5 billion, Isakson likely never considered the longer-term implications of the housing credit.

For one, the program created massive fraud opportunities. Indeed, according to the Treasury tax-oversight office, at least 19,000 tax filers who hadn't purchased a home claimed $139 million in tax credits. Not only did this incentive stimulate consumption on housing to the detriment of other sectors of the U.S. economy, it's apparent that a not insignificant number of Americans essentially robbed their fellow citizens thanks to legislation whose rules the IRS wasn't able to police effectively.

Worst of all for future economic growth is the basic truth that housing is mere consumption. It ties families to a location at a time when labor mobility is even more critical than usual. And when people buy hard, non-productive assets, the productive sectors of the economy must suffer as money is essentially directed into the ground.

A reflation of the housing market was seen by politicians as the way to save a sagging banking sector, but unfortunately the political class got it backwards. In normal times, home purchases are the consumptive result of productive economic activity, not the driver. To stimulate the housing market is to depress the growth parts of the economy.

Monetary policy. In its latest press release, the Federal Open Market Committee (FOMC) announced that it would "maintain the target range for the federal funds rate at 0 to 1/4 percent." The Fed anticipates that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Everyone allegedly loves "cheap money," and with the economy slow, access to money at low rates of interest is supposedly essential for the economy to grow.

But what policymakers fail to see, when they blindly advocate low interest rates, is that the Fed's maintenance of an artificial money rate distorts and likely reduces available capital. Just as past government efforts to keep prices of consumer goods low have always led to scarcity by causing demand to outstrip supply, much the same applies here.

When the rate for money is set by central bank edict rather than by market forces, the supply of and demand for capital is disrupted. Conversely, in a rate environment whereby market forces are allowed to set the short rate for money, supply and demand for capital are equalized by the rate itself.

At present, the short rate set by the Fed is near zero, and for those unable to see beyond the immediate effects of policy, the zero rate signals "cheap money." Sadly, however, markets don't work that way. Indeed, the effect of keeping interest rates low is merely to increase demand for capital while reducing the supply.

Federal Reserve officials will continue to suggest that the Fed's low rate target is stimulative, but the unseen in all this is how the artificially low rate is reducing the incentive to save, thus making capital difficult to access. Rather than stimulating the economy, the Fed's attempts to mandate easy access to money are likely achieving the opposite.

Conclusion. Sensing that the economy is not growing fast enough to please the electorate, politicians on both sides of the aisle are pursuing all manner of policies designed to stimulate an economy that allegedly won't grow fast enough on its own. Sadly, however, the impact of the vast majority of these interventions will make things worse rather than better.

This should not surprise us. As Albert Jay Nock long ago observed, "Any contravention of natural law, any tampering with the natural order of things, must have its consequences, and the only recourse for escaping them is such as entails worse consequences."

Economies left alone can only grow given our need to clothe and feed ourselves. Right now the economy struggles not due to a lack of desire in the private sector, but thanks to government efforts to disrupt the natural order of things. If left alone the U.S. economy has always righted itself. Continued government intervention will not only fail, but the long-term consequences of the intervention almost certainly ensure results even more inimical to our economic health.