Slam the brakes on bailouts
16 December 2008
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Tax and Fiscal Policy
12 December 2008
Energy and Environment
29 December 2008
Economic Theory
11 November 2024
Following the bailout of several banks, the government is now considering measures to ‘save’ the British car industry.
Such a bailout would be wrong in itself but would also set a very dangerous precedent. The political pressure to support other struggling industrial sectors will be immense. And given the impossibility of bailing them all out, how should the government decide which firms should survive and which should fail?
Politicians are notoriously bad at picking winners and there is a high risk that rent-seeking behaviour will play a bigger part in the decision-making process than economic considerations. But, even if that were not the case, government simply does not have the ability to decide which businesses have been unlucky but are sound long-term prospects and are therefore deserving of support.
Worse still, the increased government borrowing and higher taxes needed to finance further bailouts will remove capital from healthy businesses and some of those will fail as a result. Overall, a greater share of economic resources will be allocated to ‘lame ducks’ rather than vibrant, high-growth sectors.
Corporate failure is an essential part of the creative renewal that drives market economies forward. Moreover, firms that behaved recklessly must face the full consequences of their actions if moral hazard is to be avoided.
State rescues hamper this self-correcting adjustment process. They risk prolonging the downturn and creating perverse incentives that will make future crises more likely. Of course this all goes back to Bastiat’s distinction between the “seen” and the “unseen” – there is a action to save the noisy businesses who campaign for support but less obvious are the thousands of businesses that struggle as a result.
Such a bailout would be wrong in itself but would also set a very dangerous precedent. The political pressure to support other struggling industrial sectors will be immense. And given the impossibility of bailing them all out, how should the government decide which firms should survive and which should fail?
Politicians are notoriously bad at picking winners and there is a high risk that rent-seeking behaviour will play a bigger part in the decision-making process than economic considerations. But, even if that were not the case, government simply does not have the ability to decide which businesses have been unlucky but are sound long-term prospects and are therefore deserving of support.
Worse still, the increased government borrowing and higher taxes needed to finance further bailouts will remove capital from healthy businesses and some of those will fail as a result. Overall, a greater share of economic resources will be allocated to ‘lame ducks’ rather than vibrant, high-growth sectors.
Corporate failure is an essential part of the creative renewal that drives market economies forward. Moreover, firms that behaved recklessly must face the full consequences of their actions if moral hazard is to be avoided.
State rescues hamper this self-correcting adjustment process. They risk prolonging the downturn and creating perverse incentives that will make future crises more likely. Of course this all goes back to Bastiat’s distinction between the “seen” and the “unseen” – there is a action to save the noisy businesses who campaign for support but less obvious are the thousands of businesses that struggle as a result.
22 thoughts on “Slam the brakes on bailouts”
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You are right. I assume, no one has yet a receipe for the way out of the crisis. Decisions made are based on what was done in the past, but current situation is someting which wasn’t ever experienced. At the same time, governments (EU, US, Japan, Russia, China) cannot just watch how their economies will fall down. To let market self-regulated now – is to allow major bancruptcies; economies and currencies’ worth falling further down, and seeing the kind of turmoil like Russia had in 1991-2000.
You are right. I assume, no one has yet a receipe for the way out of the crisis. Decisions made are based on what was done in the past, but current situation is someting which wasn’t ever experienced. At the same time, governments (EU, US, Japan, Russia, China) cannot just watch how their economies will fall down. To let market self-regulated now – is to allow major bancruptcies; economies and currencies’ worth falling further down, and seeing the kind of turmoil like Russia had in 1991-2000.
If this new drive for bail-outs combines with a surge in protectionism, we’re in for a new ‘mixed economy’ which will be a rent-seekers’ paradise.
At least, the lecturers of Public Choice seminars will have enough illustrative examples on hand, instead of just boring formulas.
If this new drive for bail-outs combines with a surge in protectionism, we’re in for a new ‘mixed economy’ which will be a rent-seekers’ paradise.
At least, the lecturers of Public Choice seminars will have enough illustrative examples on hand, instead of just boring formulas.
Richard, this is based on a false premiss.
The cause of the crisis is the collapse of the financial sector based on usury. If the banks weren’t broken the issue of bailing out the car industry wouldn’t have arisen in the first place.
Then there’s the question of energy. What determines the wealth of nations is the extent to which they have command over energy resources. Think how much poorer we’d be without oil!
Richard, this is based on a false premiss.
The cause of the crisis is the collapse of the financial sector based on usury. If the banks weren’t broken the issue of bailing out the car industry wouldn’t have arisen in the first place.
Then there’s the question of energy. What determines the wealth of nations is the extent to which they have command over energy resources. Think how much poorer we’d be without oil!
Michael, the problem is that we never know why an industry fails. Is it because of a failure in the banking system? Is it because households have borrowed too much and no longer want to buy cars, or for some other reason? The government cannot tell with the car industry any more than it can with a small business employing two people. It has to do what is appropriate to the banking system and then allow financial markets to distribute investment funds.
Michael, the problem is that we never know why an industry fails. Is it because of a failure in the banking system? Is it because households have borrowed too much and no longer want to buy cars, or for some other reason? The government cannot tell with the car industry any more than it can with a small business employing two people. It has to do what is appropriate to the banking system and then allow financial markets to distribute investment funds.
Philip, the problem with the banking system is that the very activity of lending and credit operations is inseparable from the creation and destruction of money. In other words, the bulk of the money stock exists only because it has been lent/borrowed into existence.
What has happened is that the global banking system has been wrecked because a critical mass of mortgage debts in the USA went bad. Now the banks won’t lend because they’le like a bunch of frightened rabbits.
Philip, the problem with the banking system is that the very activity of lending and credit operations is inseparable from the creation and destruction of money. In other words, the bulk of the money stock exists only because it has been lent/borrowed into existence.
What has happened is that the global banking system has been wrecked because a critical mass of mortgage debts in the USA went bad. Now the banks won’t lend because they’le like a bunch of frightened rabbits.
Richard is correct on the general principle.
But the car industry is in this position because of government failure. It was government that lost control of the money supply and whose bank regulatory regime failed.
Also, the government has been directing our resources into ‘lame duck’ low productivity areas in the public sector. For example, the NHS (which consumes nearly 10% of GDP) has falling productivity and yet is still given more money every year, whilst burdening productive industry.
Richard is correct on the general principle.
But the car industry is in this position because of government failure. It was government that lost control of the money supply and whose bank regulatory regime failed.
Also, the government has been directing our resources into ‘lame duck’ low productivity areas in the public sector. For example, the NHS (which consumes nearly 10% of GDP) has falling productivity and yet is still given more money every year, whilst burdening productive industry.
Making money on money economies instead of making things are burning out. Only local value added economies work. You can not compete with economies that do not have the overhead of entitlements.
Fed Reserve Chairman Ben Bernanke says it all when he told the U.S. Congress the best way to stimulate the economy is for people to buy “domestically produced goods”. This points to core of our financial storms. Labor is a tangible asset that has been deflated.
See http://tapsearch.com/flatworld/
Making money on money economies instead of making things are burning out. Only local value added economies work. You can not compete with economies that do not have the overhead of entitlements.
Fed Reserve Chairman Ben Bernanke says it all when he told the U.S. Congress the best way to stimulate the economy is for people to buy “domestically produced goods”. This points to core of our financial storms. Labor is a tangible asset that has been deflated.
See http://tapsearch.com/flatworld/
Measures taken are not in millions, they are many hundreds of blns, and decisions made so quickly – it really makes every one worry. Fundamentally quite interesting is where all the money went after the crisis. Physically it cannot disappear, so is it in hands (cash)? How about electronically transmited funds? Who has the money surplus? And how to reverse the flow back to the banks? Without it it means inflated global economy in up-coming years.
Measures taken are not in millions, they are many hundreds of blns, and decisions made so quickly – it really makes every one worry. Fundamentally quite interesting is where all the money went after the crisis. Physically it cannot disappear, so is it in hands (cash)? How about electronically transmited funds? Who has the money surplus? And how to reverse the flow back to the banks? Without it it means inflated global economy in up-coming years.
@HJ:
The article is not saying that it’s all the car industry’s own fault. It leaves the possibility open that some companies acted soundly and are now suffering from adverse effects which originated elsewhere. But it rejects the idea that governments were able (or even willing) to pick the “right” ones. And much less, not to penalise the “even righter” ones in the process.
@HJ:
The article is not saying that it’s all the car industry’s own fault. It leaves the possibility open that some companies acted soundly and are now suffering from adverse effects which originated elsewhere. But it rejects the idea that governments were able (or even willing) to pick the “right” ones. And much less, not to penalise the “even righter” ones in the process.
“A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves money from the public treasury. From that moment on the majority always votes for the candidates promising the most money from the public treasury, with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship.”
Alexander Tyler, “The Cycle of Democracy” 1778.
“A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves money from the public treasury. From that moment on the majority always votes for the candidates promising the most money from the public treasury, with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship.”
Alexander Tyler, “The Cycle of Democracy” 1778.
“Three-quarters of the Italian economic system has been subsidized by government.”
Benito Mussolini, 1934.
“In Fascist Italy the state pays for the blunders of private enterprise.”
Gaetano Salvemini, “Under the Axe of Fascism”,
Viking Press, 1936.
“Three-quarters of the Italian economic system has been subsidized by government.”
Benito Mussolini, 1934.
“In Fascist Italy the state pays for the blunders of private enterprise.”
Gaetano Salvemini, “Under the Axe of Fascism”,
Viking Press, 1936.