Monday, September 24, 2001

When should government promote or assist private business?

POLS 475  Essay #1

by David Veksler


Never.  That is the short answer, and it is a substantial claim considering the plethora of subsidies and financial support given to business by the federal and state governments today.  There are several reasons why government assistance is actually harmful to the economy and they clearly explain the failure of each government assistance policy to achieve the desired goals.  The main policies used to “help” businesses are: tariffs and other protectionist measures, tax breaks and low interest loans, and subsidies to corporations and agriculture.  Unfortunately, while every one of these measures is widely used today, they all end up hurting competition, business, and consumers.

It is no secret that protectionist measures hurt consumers and competition, as any introductory economics class will quickly show, but Congress rarely heeds the free-trade argument.  America’s trade deficit at the end of 2000 was a record $370 billion according to Commerce Department figures, yet it accompanied the largest economic growth cycle in America’s history.  This confirms the idea that trade deficits do not cause poor economic performance; rather, they typically accompany improving economic conditions because they are a sign of increasing foreign and domestic investment.  Despite ideas to the contrary, trade deficits do not cause Americans to lose their jobs, as during the last nine (as of 2000) years of rising deficits, the unemployment rate has fallen by 0.4 to record lows.  As the Cato Institute reports, as the economy experienced the recent recession, the monthly deficit figures fell right along with the stock market.  (The 2000 U.S. Trade Deficit: Select Cato Commentary, February 21, 2001)  Nevertheless, the Bush administration has been invoking protectionist measures for the steel industry among others, in what is probably a sign of their political influence.  America’s protectionist policy is clearly a solely political one, and a costly one at that, as protectionist measures are harmful to consumers and manufacturers as well as hypocritical, since United States often encourages the WTO and other global free-trade organizations to lower their own member nation’s tariffs. 

Tax breaks, low interest loans and other such financials incentives are used mainly by states to attract business to their area.  These measures are costly to the taxpayers because as research shows, the money spent attracting business rarely pays of.  It is hard to measure the effect of government economic policy on a national level, but it is possible to learn a lot from looking at individual states’ policies.  As all states want to attract business to their area, all fifty states have passed a variety of tax and financial incentives that can be compared to measure their relative effectiveness.  According to a study by Thomas R. Dye in the Journal of Politics # 42 (Winter 1980) pp 1085-1077 titled “Public Policies and Economic Growth in the American States,” there is actually a negative relationship between the number of incentives enacted by states and the foreign and manufacturing investment as percentage of GDP (’92-’94) The r coefficient is only .108, so there is no statistically significant relationship visible.  There are however, several outliers, such as Minnesota and New Hampshire that only have one and two out of the six incentives studied and fare unusually bad in investment, while Kentucky, with all six investments, fares unusually well.  Perhaps, politicians are impressed by these exceptions and ignore the general failure of state incentives in attracting business.  If we look at employment growth, another important measure of a state’s economic well being, we find that there is a slight positive correlation, but the r-value is only .199, so once again there is no statistically significant relationship between economic incentives and employment growth.  Additionally, these incentives have little effect becuase all of the states have at least one incentive to attract business, and 48 have at least three, with the majority having five or six.  Once again, there is no relationship between the number of incentives provided, the wealth of a state, or the success it has in attracting business, and financially successful states like Texas and New Hampshire have three and two incentives respectively, while poorer southern states often have all six incentives enacted.  (Friedman, Miles.  Directory of Incentives for Business and Development in the United States.  Washington: The Urban Institute, 1991.)  As the evidence shows, the end effect of these state incentives to businesses is increased taxes to individuals with little or no reward in attracting business to a state.

Subsidies, the most expensive from of government assistance to business, otherwise known as “corporate welfare” are by far the most expensive form of government assistance to private business.  Subsidies to businesses cost more than $75 billion of the yearly federal budget.  ("Corporate Subsidies in the Federal Budget."  Testimony of Stephen Moore before the House Budget Committee, June 30, 1999.)  Instead of helping business, they have several harmful consequences.  Originally meant to correct marked failures, the highly political process of distributing these subsidies creates huge market distortions, effectively throwing a wrench in the market system.  As Stephen More says, “The major effect of corporate subsidies is to divert credit and capital to politically well-connected firms at the expense of their less politically influential rivals.”  While more than 90 percent of American businesses manage to survive just fine without subsidies, government grants, loan guarantees, or insurance, they do have to pay higher taxes to support their politically connected competitor, which lowers their competitiveness significantly.  Agricultural subsidies are yet another case of price supports harmful effects.  Out of 400 farm commodities, two dozen received price supports, of which 80 percent goes to farmers with a net worth of over $500,000.  The end effect agricultural supports is that the bigger, politically well-connected farms get subsidies from the government, while over a million small farmers struggle to compete with  them.  ("Corporate Subsidies in the Federal Budget.)  No wonder small farms have trouble staying in business. 

The end result of all this government “help” is quite clear -- government distorts the market system by politicizing the economy, and favors larger, better-connected bossiness over smaller, less influential ones.  State financial incentives cost money in higher taxes without any visible success in attracting investment.  Finally, tariffs lead to higher manufacturing costs for imported and domestic raw materials, and eventually lead to higher consumer prices.  Meanwhile, the group most hurt by these programs is the consumer, who has little influence or knowledge of these programs, but ends up paying for them due to higher prices for imported and domestic goods and higher state and federal taxes to pay for the various government programs.