Britannia Radio

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

--
Sean Gabb
Director, The Libertarian Alliance
sean@libertarian.co.uk
Tel: 07956 472 199
Skype Username: seangabb

http://www.libertarian.co.uk
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http://libertarianalliance.wordpress.com

Linkedin Details: http://www.linkedin.com/in/seangabb
Wikipedia Entry: http://tinyurl.com/23jvoz

FREE download of my book - "Cultural Revolution, Culture War: How
Conservatives Lost England, and How to Get It Back" -
http://tinyurl.com/34e2o3