Economics 101
Economics 101

Imagine inserting ‘government bureaucracy’ or ‘state’ for ‘private sector’ into the section in economics books dealing with externalities. Existing passages would be transformed and say something like:

“Government bureaucracy has no motivation to take into account costs that it causes to others but for which it does not have to pay. So goods that cause such externalities will be produced in undesirably large amounts by the state sector.”

No doubt that is why externalities in government activity are held up as a justification for market intervention in the state sector. Like hell they are. The two phenomena might as well occur in different worlds. They certainly are not connected in any way. The government rectifies market failure caused by externalities. It certainly does not make things worse because of its own failings.

Yet the average text book provides an even more detailed definition of externalities. Take Baumol and Blinder (1985) as an example. As well as the previous (edited) quote they go on to state that:

“An activity is said to generate a beneficial or detrimental externality if that activity causes incidental benefits or damages to others, and no corresponding compensation is provided to or paid by those who generate the externality” (Baumol & Blinder, 1985).

Now, what does that imply for government intervention? Could it mean that all state activity has negative externalities associated with it? It certainly seems that way. Government intervention invariably has unintended negative side effects. Welfare creates welfare dependency. Taxation destroys the incentive to create wealth. Raising money to fund measures to create jobs destroys jobs. Discouraging drinking, smoking, eating chocolate or having sex might make some healthier; but it certainly makes others miserable. At least if the government discouragement has any effect. No need to go on and cover the impact of banning products, books, movies or other services people want to buy and supply.

Clearly government intervention has unintended negative side effects. But does this matter? Can’t the government just compensate those it hurts through its intervention. Afraid not. The state sector has to fund its revenue raising and distributing bureaucracy; this chews up some of the money it taxes, so it can never give back as much as it takes. Thus it can’t provide compensation for the damage it causes. Attempting to do so would merely exasperate the problem because the act raising the compensatory revenue would cause further damage. Don’t even think about intergenerational debt and the government paying for its “good deeds” on the never never. Borrowed money has to be paid back, with interest.

So all government activity by definition has negative externalities associated with it. We do not even need to get into the psychological effects on producers or welfare recipients. But the dis-empowerment associated with “the state will take care of it” attitude is arguably the most detrimental effect. In the long run there is only one place this attitude will lead and it is not to a workers utopia.

OK, so basic economics texts generally fail to examine, let alone highlight, the negative externalities associated with state activity. But at least they examine the impact on government employees’ behavior of working in the absence of a profit motive. They show that without profit acting as an external measure of performance, government bureaucracies have no unbiased measure of performance. But they have to go on something. Like office politics.

There is nothing better for an organization than promoting those who are good at double guessing what the boss wants and avoiding making attributable mistakes. Needless to say, the best way not to make an attributable mistake is not to make an attributable decision. Long live the committee. So goes the elements of the “theory of the bureaucracy”, which is set alongside the “theory of the firm” in just about all elementary economic texts. Yeah, sure it is.

The failure of basic economics texts to examine the government sector could have been understandable 100 years ago, a time when the government sector accounted for only around 6% of GDP in the UK and Germany. But the world has changed in the intervening period. The government sector is now too big not to be properly scrutinized. But how did it grow so much in such a relatively short time?

War, depression, recession and even international competition are all used as excuses to raise the level of taxation and the extent of government interference in our lives. And what happens when the recession, depression or war is over? Does the level of government activity drops back to what it was before the crisis. Yeah, sure it does. That’s why there is a permanent ratcheting up of the size of the government sector.

Many people already spend more than half their working life slaving away for the government, or more precisely, getting the money to pay taxes to fund the government. This is in the free west not some communist country. People spend so long working to pay the state because of its tendency to confiscate more and more of the rewards of peoples labor. But you do not have to be a genius to realize that this is an unsustainable trend. People will be stifled and societies will eventually self-destruct a la communist Europe and the former Soviet Union.

No doubt the next generation of economics texts will include sections on government externalities and the theory of the bureaucracy as rationales for market intervention in the state sector. Universities will include it in introductory courses. People will no longer be able to call for the “government to do something” without being castigated for their callous disregard for human suffering. Well, we can all dream. The funny thing is that exponents of the Austrian School have been pointing out the destructive effects of government intervention for years. But how much Austrian Economics is taught to first year students?



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