Thursday, 20 October 2016

Why We Cannot Ever Get Our Money's Worth From Governments

It shouldn’t be much of a surprise that we have a natural curiosity about whether morality can be assigned some sort of value system – value systems are inherent in most of our thinking. We measure with calculus, we calculate with algebra, we assess shapes with geometry, and perhaps most essentially here, we estimate and forecast with probability theory.

A question about value was asked this week on a BBC 2 programme called Who's Spending Britain's Billions? It asked the kind of question I'm repeatedly answering, even when you don't ask (heh!) - and that is: What sort of value does the government provide for us? The programme focused primarily on all the profligacy that comes as a result of officials spending other people's money more frivolously than they would their own, but I want to take a different angle tonight.

As I'll explain, and as you won't be surprised to hear, government value is far tinier than you may think. Perhaps the main reason that people think governments provide so much value is because they do not think of alternative providers or the countless ways that the public sector could be improved. That's not to deny that the government is worth having - it's just a very mixed bag.

As you'd expect, the government quite naturally spends its money wisely and poorly. But perhaps the big thing against it, aside from its waste and inefficiencies, is that its control of the market is so minimal it is virtually negligible. An economy is so complex that no individual group can hope to predict it accurately. Even when you find an accurate prediction, what you're seeing is cherry-picking, as that prediction almost always omits the parts the predictor got wrong or incorrect parts on which the predictor chose not to predict.

When the government spends well, the world gains. If it is prudently allocated foreign aid then mostly poorer people benefit from water, food clothes and shelter; if it is on health the sick benefit; if it is on road maintenance the drivers benefit. But if it is spent poorly, on wars (some wars are injudicious), on profligate enterprises like consultants fees and think-tanks (which are often a waste of money) then everyone need not necessarily suffer financially.

It may surprise some of you, but poor government spending can still lead to a somewhat accidental overall job growth, because when people’s resources hit a significant loss, borrowing increases, which hikes up interest rates, which dissuades people from holding onto money, which has the corollary effect of increasing spending, which drives up prices, which either leads to business expansion (creating more jobs), or a concomitant rise in employees’ wages commensurate with the employers’ profit increase, which means workers have more to spend, and so on.

But excepting the above, by and large when governments interfere in the economy they do more harm than good. When the government prints extra money it expands the money supply, but that means it devalues the economy. Say a government prints £1 billion pounds – the prices of all consumer goods are increased by exactly one billion.

This principle is easily explained – when you go out tonight and spend £100 in your local supermarket you put up the price of everything else by a net total of £100. If instead you burned the £100 (and of course I wouldn’t advise it) you would decrease the price of everything else by a net total of £100. Naturally those sums are so small that society never notices when we’ve made the economy richer or smaller, but technically we have.

Just like physics has the law of conservation of energy – it can be transferred but it cannot be created out of nothing – the same principle applies to the economy. Resources can be transferred from one state to another, but equity cannot be created from nothing. If the government prints £1 million pounds, the economy as a whole is £1 million worse off. If I have a million pounds and I put it under the floorboards and nail them shut the economy is £1 million pounds better off for as long as the money stays under the floorboards. It is true that governments can sometimes do better things with resources than most individuals (although not always) but when any amount of money is transferred in an economy it has a correlative effect elsewhere.

Imagine this as a microcosmic example of a macroscopic state of affairs; the government hikes up my taxes by 13%, which means I have 13% less of my equity to spend. The government gains more roadworkers or local council administrative officers, but my gymnasium loses in the subscription fee from which I withdraw. Then the gymnasium has less money in its bank, which means that bank has less to loan to Sue for starting up her new business, which means Sue’s shelf prices are higher than she planned, which means Mary her customer spends more on a washing machine, which means the curry she was going to have at the weekend is forgone, which means Roshes the Indian restaurateur has less money in his till, and so on.

That is how the economy works – and no government can make us richer on average, they can only shuffle money around from one place to another. There is also the little matter of the futility of governments getting involved in prices. To emphasise this point, you have to realise that prices find their level based on the entirety of human market transactions in the global society. It is literally impossible to make this more efficient by tweaking a few knobs - impossible.

To illustrate this, suppose the government decided to take control of the fruit and veg industry, whereby everything grown, imported and exported is under their management. Everyone in society would still be best off if all fruit and vegetables continued to be priced at its market clearing rate, because any price the government set outside of the market value would either be too high or too low, which means there'll be the wrong amount of fruit and vegetables.

If the price is fixed too low then demand will increase and willing suppliers will diminish, creating a shortage of supply. If the price is fixed too high then consumption will decrease, which in the case of fruit and vegetables will achieve the opposite of the desired effect. The only way to optimise the price is to leave it to market forces, which, of course, involves no price-fixing at all.

Finally, I'd like to draw your attention to this article from American economist Robert Murphy, who roughly (but soundly) calculates a $2.6 trillion increase in annual economic output if "the government were to restrict itself primarily to its classic role of protecting the country's residents from criminals and invaders".