Saturday, July 30, 2011

Pathologies of Conservative Economics

I've been thinking that one of the things that I find most objectionable about the conservative view on economics is that the proposed policies can only produce results that are diametrically opposed to the stated objectives of those policies. They claim to wish to shrink the role of government in the economy, but the policies advocated can only serve to make government more essential at all points in the economy. Now for many on the right this is intended. They have no more interest in shrinking the governments role in the economy than they are interested in shrinking the deficit. They want rich people to not have to pay for any part of government. Others seem to believe that conservative policies are related to shrinking government, so I've identified, I think, two areas where the policies cannot have the intended effect. These are the pathologies I refer to in the title.

1) Low taxes reduce the amount that a business needs to pay for government supplied services such as incorporation, using the radio spectrum, dumping waste in the environment, copyright protection and others. If these services are supplied at rates below what the market would demand for them (that is the price that would be charged by a private company supplying the services if the government did not and a private company could) then businesses using these services are at an advantage in the market. The profit expected from a given amount of effort and a given supply of capital will be larger for businesses that rely on government services compared to those who do not. Business that do not use government services must pay for the full value of all the inputs they need to run the business out of the revenue they can earn. Businesses relying on government services need only pay for those goods and services not supplied by the government and a part of those supplied by the government. The difference between what the government charges in taxes and the market value of what the government supplies adds to the businesses profits. Thus in a low tax regime investment dollars will go toward businesses that rely upon government services, because the profit margin (or at least the apparent profit margin) will be greater. Eventually these businesses will use those investment dollars for ever more marginal uses until the general return on investment in the industry, however much it uses government services, is equal to other industries not dependent upon the government. However, that dollar level of investment in such a business will be much higher than it would be if the government were not supplying inputs at a reduced rate. So we can expect that in a general low tax environment investment dollars, and thus the asset values of industries should be dominated by those that heavily rely upon government services.

What we see in the US today is, I believe, an economy dominated by the financial sector which depends upon the security provided by such elements as the FBI white collar crime unit, the content industries which rely upon copyright protection, various businesses dependent upon dumping waste products into the general environment, businesses that need to be incorporated, and the like. In short we have an economy that is heavily dominated by businesses that rely upon government services precisely because of having adopted conservative policies supposedly intended to stop government expansion in the economy. If we wanted to shrink the government we should make the government expensive, not free.

2) The operators of a publicly owned company have a fiduciary responsibility to the shareholders to maximize the value of the company. If there is some option available to increase the value of the company to the shareholders and the CEO and other offices fail to take advantage of that opportunity they are failing in their responsibility and acting unethically. So if the government is to provide services at a rate below the market value (by this I mean the amount that would be charged by a private company if the services were provided by such an entity) then the operators are obliged to take advantage of this sub-market price to increase the value of the firm they operate.

To put this in specific terms, consider that there are many projects the firm can undertake that will bring in just a bit more revenue than it would cost to undertake. These the firm are most likely engaging in so as to maximize the firm's income and thus value to shareholders. There are other projects that would bring in less revenue than it would cost to carry out, these the firm does not undertake. But if the government is charging sub-market for some of the inputs the firm needs, that will make otherwise unprofitable projects, profitable, at least as far as the firm's books are concerned. As the price charged by the government falls, then the firm will increase the extent to which it engages in projects which are made profitable only due to the effective subsidy of the government providing services at below market rates. As the prices government charges fall a firm could certainly find itself so heavily invested in projects that depend upon this government subsidy that its overall profitability is dependent upon this government subsidy. I think it likely that, again as a result of conservative policies, a large fraction of American business remain a going concern only as a consequence of this government subsidy via below market pricing.

That is not to say that they could not become truly profitable again, should the government return to a more sensible pricing scheme. But at this point, it is likely that American firms are highly dependent upon the government.

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