Free Life Commentary,
A Personal View from
The Director of the Libertarian Alliance
Issue Number 179
28th January 2009
Linking url: http://www.seangabb.co.uk/flcomm/flc.179

The Car Industry Bail Out:
Are There no Politicians Now Who Understand Economics?
by Sean Gabb

The British Government has just announced what may be £2,000 million of subsidies for the car industry in this country. Responses to the announcement range from gratitude that jobs and manufacturing capacity are to be saved to complaints that the subsidies do not go far enough. My reading and viewing may not be comprehensive, but I have seen nothing in the mainstream media denouncing the subsidies as at best politically motivated – much of the car industry being located in constituencies held by Labour – and at worst economically illiterate. Since the first grounds of denunciation ought, after nearly twelve years of these people, to be self-evident, I will devote myself here to the second.

We are continually told at present – which is somewhat more than usual – how government spending had created, or will create, so many jobs. Therefore, the immense expansion of the British State since 1997 has created three hundred thousand jobs or whatever. Some deplore this because most of those employed can be expected to vote Labour. Hardly anyone denies there has been a net addition to the number of employed. The same reasoning underlies all discussion of how we are to get through the recession on which we have now started.

The truth is, however, that government spending does not so much create as displace employment. Every pound spent by the Government must first be taken from the people, who cannot then spend it for themselves. If the money is taken is taken through taxes, it exactly reduces the ability of the people to spend or invest it for themselves as they wish, or to save it for transfer, via the banking system, for others to spend or invest as they wish. If the money is borrowed, it again exactly reduces the amount of money that the people can borrow to spend or invest.

It is more complex if the money is printed by the Government – or, more likely nowadays, borrowed from the banks in a fractional reserve system. But if its effects are often hard to trace until after the event, inflation is no less a tax than any other means of providing money to governments. It may reduce the actual purchasing power of money left in the hands of the people. Given the downward pressure on manufacturing costs we have seen during the past generation, inflation will at best reduce the potential purchasing power of money that already exists.

This being so, the argument that government spending creates employment relies on a blindness to the concept of opportunity cost – that every pound spent on paying one salary is a pound less to spend on another salary. Put more simply, it is a case of what Bastiat described as “what is seen and what is not seen”. We see the jobs created by the Government in it “regeneration” projects. We do not see the jobs that would otherwise have been created to supply things that people actually would have bought had the money been left in their own pockets.

For the past six months, the argument has been reinforced by the claim that government spending is needed to make up for a disinclination by others to spend or invest. This being so, it will not be a zero sum game, but will create net employment. There is no doubt that there has been a deflation. People are borrowing less and saving more. The banks have been increasing their financial reserves. But it does not follow from this admission that government spending is needed to make up the deficiency. The fall in spending is not the cause of the problems we face, but is a symptom.

For perhaps the past decade, many central banks in the rich world have kept interest rates below the level needed to balance the supply of savings and the demand for loans. When other prices are forced below their equilibrium – rent control, for example – the result is shortages. In the fractional reserve system that we nowadays have, however, pushing interest rates below their equilibrium has simply enabled the commercial banks to create money out of nothing. In the past, this would have led almost at once to price increases. This time, with most consumer goods made in countries where supply curves are very elastic, and with exchange rates only loosely related in the short term to the financing of foreign trade, and with financial and property markets able to absorb what long seemed to be limitless amounts of money, the result was a speculative bubble, in which consumer prices hardly rose, and in which most of us were persuaded that we were growing richer.

These bubbles never last. The new money is brought into being through bank lending that cannot continue forever. There comes a point where people have taken as much debt as they can service, or  where they have invested on the basis of trends that stop rising. It is then that some event that would otherwise have been overlooked becomes the excuse for a panic. The bubble bursts. Net borrowing turns negative. Prices of overbid assets fall. Prices of securities fall to the value of their underlying assets – assuming there are any that can be identified. Much investment in new capacity is shown to have been unwise.

On this reasoning, the present fall in spending is not an event in itself that needs to be and can be cured by higher government spending. What we now have is really part of a cycle that began with the artificial lowering of interest rates, and that will end with the liquidation of the unwise investments and the correction in asset prices. The British Government’s policy of trying to halt the deflation with higher spending and even lower interest rates cannot do better than lengthen the cycle during its unpleasant phase. It also increases the size of the State – which already takes far too much of our money and spends it on things we would never buy given a free choice.

But I return to the bail out of the car industry. This is not a case of limiting collateral damage. The car industry is not a fundamentally sound victim of circumstances. It is instead one of those sectors in which unwise investments were made. There is no shortage of finance for businesses that really are considered sound. Even I still receive one or two pre-approved loan offers from banks I never knew existed. If the car companies cannot borrow to maintain their working capital, it is because no one believes in their fundamental soundness. Even at the height of the boom, it was claimed that there were too many car makers, given present and future demand for cars. There will now be several years when hardly anyone with an ounce of common sense will spend money unless he must on a new car. No one seems to care if estate agents all over the country are losing their jobs. If car workers are now to lose their jobs, it is for the same reason.

Of course, there are things the Government could do and ought to do to help the car industry. These are all negative. For the past twelve years, it has been running propaganda campaigns and piling taxes and regulations that have tended to make driving less attractive than it might otherwise have been. These propaganda campaigns should be ended. The road excise and petrol duties should be cut. The cameras and yellow and red lines should be taken away. The police officers now deployed to harass drivers should be dismissed – there being, in any event, more policemen than needed to enforce the laws of a free country.

I move back now to the general difficulties we face. With increasing desperation, Gordon Brown is denouncing anyone who questions his policy of inflation as wanting to do nothing. Well, doing nothing at all would be an improvement on what he has been doing. However, there are things the Government could do. None of it would take us back straightaway to the prosperity we have lost. But it would shorten and moderate the pain that stands between us and recovery. I suggest the following:

• The Government should balance its budget – and do so not by increasing taxes, but by spending less. This would tend to restore confidence to markets that are presently working on the assumption of a soft pound, and where default on the national debt is no longer thought impossible.
• The Government should force all banks that have limited liability to reveal their true financial position. This would not be an interference in their private affairs, as limited liability is a privilege bringing responsibilities that may be varied as thought reasonable. This would again tend to restore confidence, and it would do more than printing money has to persuade the banks to start lending to each other.
• The Government should return to a fully convertible gold standard. Unless otherwise contracted, it should be regarded as fraud for a banker to take a deposit and not have sufficient reserves to redeem it at once on demand. This would prevent the periodic explosions of credit that are behind the trade cycle.
• Of course, the Government should also abolish income tax, valued added tax and excise duties. If this does not cut the tax burden by three quarters, it should abolish some other taxes. To keep the budget balanced, it should also cut spending.

I could go on, making more and more claims unlikely ever to be conceded by the British Government or any other. But the first two, plus a few cuts, would go far to shortening the recession. Sadly, even these will not be tried – not at least until the Keynesian remedies everyone wants have been tested to destruction.

Further Reading:

Murray Rothbard, America’s Great Depression
Henry Hazlitt, Economics in One Lesson
Hans-Hermann Hoppe, Credit Creation or Financial Intermediation?: Fractional-reserve Banking in a Growing Economy

NB—Sean Gabb’s book, Cultural Revolution, Culture War: How Conservatives Lost England, and How to Get It Back, can be downloaded for free from http://tinyurl.com/34e2o3