We are rapidly approaching what is one of the most predictably awful exercises in a presidential campaign. The candidates are about to present their economic “plans”. We can expect the candidates to recite the usual pieties about tackling the deficit, and eliminating waste, fraud and abuse. At the same time they will save social security and Medicare, and create good paying middle-class American jobs in manufacturing.
For some reason or other the notion that the President can “manage” the economy has taken hold of the body politic like a dog on a mailman’s ankle. While it is certainly true that good economic policy will encourage economic growth, innovation and wealth creation, it is just as true that bad economic policy will tend to discourage those results. Which is to say that government can set the conditions that individuals and firms need to prosper, but that government is utterly incapable of doing much more than that.
The basic conditions that are necessary (but not sufficient) for prosperity are well known. They include free and competitive markets, the rule of law, an independent judiciary and protection of property rights, contract enforcement, sensible regulations, low taxes, neutral monetary policy, and political stability. Beyond that, government intervention generally results in more harm than good.
For example, the idea that government is going to “create jobs” and raise (real) wages is simply nonsense. Entrepreneurs and businesses create jobs as they seek to make profits. Real wages eventually rise (or fall) to the point where they equal marginal productivity. Firms assume the risks of hiring workers when they see the possibility to profit by creating new goods and services, or by improving on existing ones. They do not create jobs for their own sake. In fact businesses try to minimize inputs (like labor and capital) with respect to outputs. That’s how they maximize profits, which is the point of the enterprise.
On the other hand, government is incapable of creating jobs on balance, except insofar as those jobs are necessary to allow the larger economy (and society) to function efficiently and effectively. Sure, a government agency can hire somebody to dig holes in the sand and then hire someone else to fill the holes back in. But, with apologies to Lord Keynes, that doesn’t really create net employment because no wealth is created. Resources are just wasted. The money spent in make-work projects could have been spent on productive activity that actually created wealth. That would result in economic growth and greater opportunity.
Every dollar that government spends is a dollar taken from the private sector. With that in mind there are two tests that should be applied to the candidates’ economic policy proposals. First, is the policy directed at producing a public good. A public good is defined as one where (a) consumption is non-rival and (b) the costs of excludability are prohibitively high. For example, the classic example is defense. We all benefit from defense, and one citizen’s protection does not detract from another’s. Consumption is therefore non-rival.
On the other hand, only one of us can eat a given ice cream cone. An ice cream cone stands as a private good in contrast to defense, which is a public good.
The question of excludability of consumption addresses the problem of free riders. A classic example here is a lighthouse. The idea is that once the lighthouse is built, it is virtually impossible to stop a ship from using its beacon even if the ship hasn’t paid a fee. Since free-riders can’t be stopped from using the lighthouse’s services, the returns from building lighthouses are less than they should be, so fewer than the optimal quantity of lighthouses get built. The argument is that government should step in and supply lighthouses to rectify market failure.
(However, it is worth noting that in The Problem of the Lighthouse, economics Nobel laureate Ronald Coase pointed out that the problem could easily be solved by checking ships registries and charging on that basis.)
After the public goods question is resolved, the second test comes to the fore, namely the question of opportunity cost. Every dollar government spends is taken from the private sector, either directly by taxation, or indirectly by borrowing in competition with the private sector. So each dollar government spends should produce more goods and services (that the citizens actually want) than would have been produced by the private sector, had government not acted.
So we have three basic criteria for evaluating the candidate’s economic policy proposals. Are the policy proposals aimed at producing public goods as opposed to private benefits? Will the diversion of private sector funds to the public sector produce a result in a net output gain? Will the candidate’s respective economic proposals serve to strengthen or weaken the conditions necessary for prosperity?
These are the criteria that On Liberty Watch will use to evaluate the economic policy proposals of the candidates.
JFB
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