Chapter Six
Chapter Six
CREDIT DIVERTS PRODUCTION
Government "encouragement" to business is sometimes as much to be feared as government hostility. This supposed encouragement often takes the form of a direct grant of government credit or a guarantee of private loans.
The question of government credit can often be complicated, because it involves the possibility of inflation. We shall defer analysis of the effects of inflation of various kinds until a later chapter. Here, for the sake of simplicity, we shall assume that the credit we are discussing is non-inflationary. Inflation, as we shall later see, while it complicates the analysis, does not at bottom change the consequences of the policies discussed.
The most frequent proposal of this sort in Congress is for more credit to farmers. In the eyes of most Congressmen the farmers simply cannot get enough credit. The credit supplied by private mortgage companies, insurance companies or country banks is never "adequate." Congress is always finding new gaps that are not filled by the existing lending institutions, no matter how many of these it has itself already brought into existence. The farmers may have enough long-term credit or enough short-term credit, but, it turns out, they have not enough "intermediate" credit; or the interest rate is too high; or the complaint is that private loans are made only to rich and well-established farmers. So new lending institutions and new types of farm loans are piled on top of each other by the legislature.
The faith in all these policies, it will be found, springs from two acts of shortsightedness. One is to look at the matter only from the standpoint of the farmers that borrow. The other is to think only of the first half of the transaction.
Now all loans, in the eyes of honest borrowers, must eventually be repaid. All credit is debt. Proposals for an increased volume of credit, therefore, are merely another name for proposals for an increased burden of debt. They would seem considerably less inviting if they were habitually referred to by the second name instead of by the first.
We need not discuss here the normal loans that are made to farmers through private sources. They consist of mortgages; of installment credits for the purchase of automobiles, refrigerators, radios, tractors and other farm machinery, and of bank loans made to carry the farmer along until he is able to harvest and market his crop and get paid for it. Here we need concern ourselves only with loans to farmers either made directly by some government bureau or guaranteed by it.
These loans are of two main types. One is a loan to enable the farmer to hold his crop off the market. This is an especially harmful type; but it will be more convenient to consider it later when we come to the question of government commodity controls. The other is a loan to provide capital-often to set the farmer up in business by enabling him to buy the farm itself, or a mule or tractor, or all three.
At first glance the case for this type of loan may seem a strong one. Here is a poor family, it will be said, with no means of livelihood. It is cruel and wasteful to put them on relief. Buy a farm for them; set them up in business; make productive and self-respecting citizens of them; let them add to the total national product and pay the loan off out of what they produce. Or here is a farmer struggling along with primitive methods of production because he has not the capital to buy himself a tractor. Lend him the money for one; let him increase his productivity; he can repay the loan out of the proceeds of his increased crops. In that way you not only enrich him and put him on his feet; you enrich the whole community by that much added output. And the loan, concludes the argument, costs the government and the taxpayers less than nothing, because it is "self-liquidating."
Now as a matter of fact this is what happens every day under the institution of private credit. If a man wishes to buy a farm, and has, let us say, only half or a third as much money as the farm costs, a neighbor or a savings bank will lend him the rest in the form of a mortgage on the farm. If he wishes to buy a tractor, the tractor company itself, or a finance company, will allow him to buy it for one-third of the purchase price with the rest to be paid off in installments out of earnings that the tractor itself will help to provide.
But there is a decisive difference between the loans supplied by private lenders and the loans supplied by a government agency. Each private lender risks his own funds. (A banker, it is true, risks the funds of others that have been entrusted to him; but if money is lost he must either make good out of his own funds or be forced out of business.) When people risk their own funds they are usually careful in their investigations to determine the adequacy of the assets pledged and the business acumen and honesty of the borrower.
If the government operated by the same strict standards, there would be no good argument for its entering the field at all. Why do precisely what private agencies already do? But the government almost invariably operates by different standards. The whole argument for its entering the lending business, in fact, is that it will make loans to people who could not get them from private lenders. This is only another way of saying that the government lenders will take risks with other people's money (the taxpayers') that private lenders will not take with their own money. Sometimes, in fact, apologists will freely acknowledge that the percentage of losses will be higher on these government loans than on private loans. But they contend that this will be more than offset by the added production brought into existence by the borrowers who pay back, and even by most of the borrowers who do not pay back.
This argument will seem plausible only as long as we concentrate our attention on the particular borrowers whom the government supplies with funds, and overlook the people whom its plan deprives of funds. For what is really being lent is not money, which is merely the medium of exchange, but capital. What is really being lent, say, is the farm or the tractor itself. Now the number of farms in existence is limited, and so is the production of tractors (assuming, especially, that an economic surplus of tractors is not produced simply at the expense of other things). The farm or tractor that is lent to A cannot be lent to B. The real question is, therefore, whether A or B shall get the farm.
This brings us to the respective merits of A and B, and what each contributes, or is capable of contributing, to production. A, let us say, is the man who would get the farm if the government did not intervene. The local banker or his neighbors know him and know his record. They want to find employment for their funds. They know that he is a good farmer and an honest man who keeps his word. They consider him a good risk. He has already, perhaps, through industry, frugality and foresight, accumulated enough cash to pay a fourth of the price of the farm. They lend him the other three-fourths; and he gets the farm.
There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to a man. Credit, on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him the loan. The banker is not giving something for nothing. He feels assured of repayment. He is merely exchanging a more liquid form of asset or credit for a less liquid form. Sometimes he makes a mistake, and then it is not only the banker who suffers, but the whole community; for values which were supposed to be produced by the lender are not produced and resources are wasted.
Now it is to A, let us say, who has credit, that the banker would make his loan. But the government goes into the lending business in a charitable frame of mind because, as we saw, it is worried about B. B cannot get a mortgage or other loans from private lenders because he does not have credit with them. He has no savings; he has no impressive record as a good farmer; he is perhaps at the moment on relief. Why not, say the advocates of government credit, make him a useful and productive member of society by lending him enough for a farm and a mule or tractor and setting him up in business?
Perhaps in an individual case it may work out all right. But it is obvious that in general the people selected by these government standards will be poorer risks than the people selected by private standards. More money will be lost by loans to them. There will be a much higher percentage of failures among them. They will be less efficient. More resources will be wasted by them. Yet the recipients of government credit will get their farms and tractors at the expense of what otherwise would have been the recipients of private credit. Because B has a farm, A will be deprived of a farm. A may be squeezed out either because interest rates have gone up as a result of the government operations, or because farm prices have been forced up as a result of them, or because there is no other farm to be had in his neighborhood. In any case the net result of government credit has not been to increase the amount of wealth produced by the community but to reduce it, because the available real capital (consisting of actual farms, tractors, etc.) has been placed in the hands of the less efficient borrowers rather than in the hands of the more efficient and trustworthy.
The case becomes even clearer if we turn from farming to other forms of business. The proposal is frequently made that the government ought to assume the risks that are "too great for private industry." This means that bureaucrats should be permitted to take risks with the taxpayers' money that no one is willing to take with his own.
Such a policy would lead to evils of many different kinds. It would lead to favoritism: to the making of loans to friends, or in return for bribes. It would inevitably lead to scandals. It would lead to recriminations whenever the taxpayers' money was thrown away on enterprises that failed. It would increase the demand for socialism: for, it would properly be asked, if the government is going to bear the risks, why should it not also get the profits? What justification could there possibly be, in fact, for asking the taxpayers to take the risks while permitting private capitalists to keep the profits? This is precisely, however, as we shall later see, what we already do in the case of "non-recourse" government loans to farmers.
But we shall pass over all these evils for the moment, and concentrate on just one consequence of loans of this type. This is that they will waste capital and reduce production. They will throw the available capital into bad or at best dubious projects. They will throw it into the hands of persons who are less competent or less trustworthy than those who would otherwise have got it. For the amount of real capital at any moment (as distinguished from monetary tokens run off on a printing press) is limited. What is put into the hands of B cannot be put into the hands of A.
People want to invest their own capital. But they are cautious. They want to get it back. Most lenders, therefore, investigate any proposal carefully before they risk their own money in it. They weigh the prospect of profits against the chances of loss. They may sometimes make mistakes. But for several reasons they are likely to make fewer mistakes than government lenders. In the first place, the money is either their own or has been voluntarily entrusted to them. In the case of government-lending the money is that of other people, and it has been taken from them, regardless of their personal wish, in taxes.
The private money will be invested only where repayment with interest or profit is definitely expected. This is a sign that the persons to whom the money has been lent will be expected to produce things for the market that people actually want. The government money, on the other hand, is likely to be lent for some vague general purpose like "creating employment;" and the more inefficient the work-that is, the greater the volume of employment it requires in relation to the value of product- the more highly thought of the investment is likely to be.
The private lenders, moreover, are selected by a cruel market test. If they make bad mistakes they lose their money and have no more money to lend. It is only if they have been successful in the past that they have more money to lend in the future. Thus private lenders (except the relatively small proportion that have got their funds through inheritance) are rigidly selected by a process of survival of the fittest. The government lenders, on the other hand, are either those who have passed civil service examinations, and know how to answer hypothetical questions hypothetically, or they are those who can give the most plausible reasons for making loans and the most plausible explanations of why it was not their fault that the loans failed. But the net result remains: private loans will utilize existing resources and capital far better than government loans. Government loans will waste far more capital and resources than private loans. Government loans, in short, as compared with private loans, will reduce production, not increase it.
The proposal for government loans to private individuals or projects, in brief, sees B and forgets A. It sees the people in whose hands the capital is put; it forgets those who would otherwise have had it. It sees the project to which capital is granted; it forgets the projects from
CREDIT DIVERTS PRODUCTION which capital is thereby withheld. It sees the immediate benefit to one group; it overlooks the losses to other groups, and the net loss to the community as a whole.
It is one more illustration of the fallacy of seeing only a special interest in the short run and forgetting the general interest in the long run.
We remarked at the beginning of this chapter that government "aid" to business is sometimes as much to be feared as government hostility. This applies as much to government subsidies as to government loans. The government never lends or gives anything to business that it does not take away from business. One often hears New Deal- ers and other statists boast about the way government "bailed business out" with the Reconstruction Finance Corporation, the Home Owners Loan Corporation and other government agencies in nineteen thirty-two and later. But the government can give no financial help to business that it does not first or finally take from business. The government's funds all come from taxes. Even the much vaunted "government credit" rests on the assumption that its loans will ultimately be repaid out of the proceeds of taxes. When the government makes loans or subsidies to business, what it does is to tax successful private business in order to support unsuccessful private business. Under certain emergency circumstances there may be a plausible argument for this, the merits of which we need not examine here. But in the long run it does not sound like a paying proposition from the standpoint of the country as a whole. And experience has shown that it isn't.
None of this means, I repeat, that it is unwise to make foreign loans, but simply that we cannot get rich by making bad ones.
For the same reasons that it is stupid to give a false stimulation to export trade by making bad loans or outright gifts to foreign countries, it is stupid to give a false stimulation to export trade through export subsidies. Rather than repeat most of the previous argument, I leave it to the reader to trace the effects of export subsidies as I have traced the effects of bad loans. An export subsidy is a clear case of giving the foreigner something for nothing, by selling him goods for less than it costs us to make them. It is another case of trying to get rich by giving things away.
Bad loans and export subsidies are additional examples of the error of looking only at the immediate effect of a policy on special groups, and of not having the patience or intelligence to trace the long-run effects of the policy on everyone.
Chapter Thirteen
Chapter Thirteen
"PARITY" PRICES
Special interests, as the history of tariffs reminds us, can think of the most ingenious reasons why they should be the objects of special solicitude. Their spokesmen present a plan in their favor; and it seems at first so absurd that disinterested writers do not trouble to expose it.
But the special interests keep on insisting on the scheme. Its enactment would make so much difference to their own immediate welfare that they can afford to hire trained economists and "public relations experts" to propagate it in their behalf. The public hears the argument so often repeated, and accompanied by such a wealth of imposing statistics, charts, curves and pie-slices, that it is soon taken in. When at last disinterested writers recognize that the danger of the scheme's enactment is real, they are usually too late. They cannot in a few weeks acquaint themselves with the subject as thoroughly as the hired brains who have been devoting their full time to it for years; they are accused of being uninformed, and they have the air of men who presume to dispute axioms.
This general history will do as a history of the idea of "parity" prices for agricultural products. I forget the first day when it made its appearance in a legislative bill; but with the advent of the New Deal in nineteen thirty-three it had become a definitely established principle, enacted into law; and as year succeeded year, and its absurd corollaries made themselves manifest, they were enacted too.
The argument for "parity" prices ran roughly like this. Agriculture is the most basic and important of all industries. It must be preserved at all costs. Moreover, the prosperity of everybody else depends upon the prosperity of the farmer. If he does not have the purchasing power to buy the products of industry, industry languishes. This was the cause of the nineteen twenty-nine collapse, or at least of our failure to recover from it. For the prices of farm products dropped violently, while the prices of industrial products dropped very little. The result was that the farmer could not buy industrial products; the city workers were laid off and could not buy farm products, and the depression spread in ever-widening vicious circles. There was only one cure, and it was simple. Bring back the prices of the farmer's products to a "parity" with the prices of the things the farmer buys. This parity existed in the period from nineteen oh nine to nineteen fourteen, when farmers were prosperous. That price relationship must be restored and preserved perpetually.
It would take too long, and carry us too far from our main point, to examine every absurdity concealed in this plausible statement. There is no sound reason for taking the particular price relationships that prevailed in a particular year or period and regarding them as sacrosanct, or even as necessarily more "normal" than those of any other period. Even if they were "normal" at the time, what reason is there to suppose that these same relationships should be preserved a generation later in spite of the enormous changes in the conditions of production and demand that have taken place in the meantime? The period of nineteen oh nine to nineteen fourteen, as the basis of "parity," was not selected at random. In terms of relative prices it was one of the most favorable periods to agriculture in our entire history.
If there had been any sincerity or logic in the idea, it would have been universally extended. If the price relationships between agricultural and industrial products that prevailed from August, nineteen oh nine to July, nineteen fourteen ought to be preserved perpetually, why not preserve perpetually the price relationship of every commodity at that time to every other? A Chevrolet six-cylinder touring car cost two thousand one hundred fifty dollars in nineteen twelve; an incomparably improved six-cylinder Chevrolet sedan cost nine hundred seven dollars in nineteen forty-two: adjusted for "parity" on the same basis as farm products, however, it would have cost three thousand two hundred seventy dollars in nineteen forty-two. A pound of aluminum from nineteen oh nine to nineteen thirteen inclusive averaged twenty-five and a half cents; its price early in nineteen forty-six was fourteen cents; but at "parity" it would then have cost, instead, forty-one cents.
I hear immediate cries that such comparisons are absurd, because everybody knows not only that the present-day automobile is incomparably superior in every way to the car of nineteen twelve, but that it costs only a fraction as much to produce, and that the same is true also of aluminum. Exactly. But why doesn't somebody say something about the amazing increase in productivity per acre in agriculture? In the five-year period nineteen thirty-nine to nineteen forty-three an average of two hundred sixty pounds of cotton was raised per acre in the United States as compared with an average of one hundred eighty-eight pounds in the five-year period nineteen oh nine to nineteen thirteen. Costs of production have been substantially lowered for farm products by better applications of chemical fertilizer, improved strains of seed and increasing mechanization- by the gasoline tractor, the corn husker, the cotton picker. "On some large farms which have been completely mechanized and are operated along mass production lines, it requires only one-third to one-fifth the amount of labor to produce the same yields as it did a few years back." Yet all this is ignored by the apostles of "parity" prices.
The refusal to universalize the principle is not the only evidence that it is not a public-spirited economic plan but merely a device for subsidizing a special interest. Another evidence is that when agricultural prices go above "parity," or are forced there by government policies, there is no demand on the part of the farm bloc in Congress that such prices be brought down to parity, or that the subsidy be to that extent repaid. It is a rule that works only one way.
Dismissing all these considerations, let us return to the central fallacy that specially concerns us here. This is the argument that if the farmer gets higher prices for his products he can buy more goods from industry and so make industry prosperous and bring full employment. It does not matter to this argument, of course, whether or not the farmer gets specifically so-called "parity" prices.
Everything, however, depends on how these higher prices are brought about. If they are the result of a general revival, if they follow from increased prosperity of business, increased industrial production and increased purchasing power of city workers (not brought about by inflation), then they can indeed mean increased prosperity and production not only for the farmers, but for everyone. But what we are discussing is a rise in farm prices brought about by government intervention. This can be done in several ways. The higher price can be forced by mere edict, which is the least workable method. It can be brought about by the government's standing ready to buy all the farm products offered to it at the "parity" price. It can be brought about by the government's lending to farmers enough money on their crops to enable them to hold the crops off the market until "parity" or a higher price is realized. It can be brought about by the government's enforcing restrictions in the size of crops. It can be brought about, as it often is in practice, by a combination of these methods. For the moment we shall simply assume that, by whatever method, it is in any case brought about.
What is the result? The farmers get higher prices for their crops. Their "purchasing power" is thereby increased. They are for the time being more prosperous themselves, and they buy more of the products of industry. All this is what is seen by those who look merely at the immediate consequences of policies to the groups directly involved.
But there is another consequence, no less inevitable. Suppose the wheat which would otherwise sell at one dollar a bushel is pushed up by this policy to one dollar and fifty cents. The farmer gets fifty cents a bushel more for wheat. But the city worker, by precisely the same change, pays fifty cents a bushel more for wheat in an increased price of bread. The same thing is true of any other farm product. If the farmer then has fifty cents more purchasing power to buy industrial products, the city worker has precisely that much less purchasing power to buy industrial products. On net balance industry in general has gained nothing. It loses in city sales precisely as much as it gains in rural sales.
There is of course a change in the incidence of these sales. No doubt the agricultural-implement makers and the mail-order houses do a better business. But the city department stores do a smaller business.
The matter, however, does not end here. The policy results not merely in no net gain, but in a net loss. For it does not mean merely a transfer of purchasing power to the farmer from city consumers, or from the general taxpayer, or from both. It also means a forced cut in the production of farm commodities to bring up the price. This means a destruction of wealth. It means that there is less food to be consumed. How this destruction of wealth is brought about will depend upon the particular method pursued to bring prices up. It may mean the actual physical destruction of what has already been produced, as in the burning of coffee in Brazil. It may mean a forced restriction of acreage, as in the American AAA plan. We shall examine the effect of some of these methods when we come to the broader discussion of government commodity controls.
But here it may be pointed out that when the farmer reduces the production of wheat to get "parity," he may indeed get a higher price for each bushel, but he produces and sells fewer bushels. The result is that his income does not go up in proportion to his prices. Even some of the advocates of "parity prices" recognize this, and use it as an argument to go on to insist upon "parity income" for farmers. But this can only be achieved by a subsidy at the direct expense of taxpayers. To help the farmers, in other words, it merely reduces the purchasing power of city workers and other groups still more.
There is one argument for "parity" prices that should be dealt with before we leave the subject. It is put forward by some of the more sophisticated defenders. "Yes," they will freely admit, "the economic arguments for parity prices are unsound. Such prices are a special privilege. They are an imposition on the consumer. But isn't the tariff an imposition on the farmer? Doesn't he have to pay higher prices on industrial products because of it? It would do no good to place a compensating tariff on farm products, because America is a net exporter of farm products. Now the parity-price system is the farmer's equivalent of the tariff. It is the only fair way to even things up."
The farmers that asked for parity prices did have a legitimate complaint. The protective tariff injured them more than they knew. By reducing industrial imports it also reduced American farm exports, because it prevented foreign nations from getting the dollar exchange needed for taking our agricultural products. And it provoked retaliatory tariffs in other countries. None the less, the argument we have just quoted will not stand examination. It is wrong even in its implied statement of the facts. There is no general tariff on all "industrial" products or on all non-farm products. There are scores of domestic industries or of exporting industries that have no tariff protection. If the city worker has to pay a higher price for woolen blankets or overcoats because of a tariff, is he "compensated" by having to pay a higher price also for cotton clothing and for foodstuffs? Or is he merely being robbed twice?
Let us even it all out, say some, by giving equal "protection" to everybody. But that is insoluble and impossible. Even if we assume that the problem could be solved technically-a tariff for A, an industrialist subject to foreign competition; a subsidy for B, an industrialist who exports his product-it would be impossible to protect or to subsidize everybody "fairly" or equally. We should have to give everyone the same percentage (or would it be the same dollar amount?) of tariff protection or subsidy, and we could never be sure when we were duplicating payments to some groups or leaving gaps with others.
But suppose we could solve this fantastic problem? What would be the point? Who gains when everyone equally subsidizes everyone else? What is the profit when everyone loses in added taxes precisely what he gains by his subsidy or his protection? We should merely have added an army of needless bureaucrats to carry out the program, with all of them lost to production.
We could solve the matter simply, on the other hand, by ending both the parity-price system and the protective-tariff system. Meanwhile they do not, in combination,
even out anything. The joint system means merely that Farmer A and Industrialist B both profit at the expense of Forgotten Man C.
So the alleged benefits of still another scheme evaporate as soon as we trace not only its immediate effects on a special group but its long-run effects on everyone.