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January 23, 2011

Government Money Drives Out Private Capital

The damage that government subsidies to business do the economy is far worse than just the cost to the treasury; government money drives out private investment. Government money stifles innovation; government money destroys jobs. Government's role is to regulate; it can't do that effectively when it's a player (Chernobyl was state owned and operated nuclear plant). Government has a huge role to play as a customer; it can't play that role objectively when it is financing some of its potential suppliers.

My fellow businesspeople are no more immune to the lure of free money than anyone else. Nor are businesspeople averse to returning some of their "free" government money as campaign contributions when the time comes to keep the spigot open. It's frightening when even a left-leaning president like Barak Obama is a sudden convert to "industrial policy" – meaning government subsidies to business – and appoints a commission of businesspeople to figure out how to distribute the largesse. It's scary that Vermont, under both Republican and Democratic administrations, continues targeted subsidies to businesses despite the fact that the state economists, when asked to measure the results of these subsidies in terms of jobs or incomes, essentially threw up their hands and declared the measurement impossible.

Once government money is announced as available for a particular purpose, private money dries up. Who wants to invest in a company if its competitor is likely to get free money and an unfair advantage? What company CEO wants to pay interest or dividends if she or he can just get some government largesse? Yes, private money sometimes comes in AFTER the government money – but that is an investment in demonstrated grant-grubbing capability rather than in the other aspects of the business. And that private money slavishly follows the government investment, so we don't get the creative chaos and diversity of pure private investment.

Diversity is crucial in investment and it doesn't happen when government is the investor. Government won't deliberately invest in two companies, only one of which can survive; but private investors acting separately will bring an arena full of competitors to a marketplace. It's not that private investors individually are infallible; almost all investments in innovative startups result in losses. But individual investors swarm all over the landscape in search of breakthroughs; sometimes they find them. The results in our generation are companies like Microsoft, Intel, Google, Apple, and Facebook. Government choices are invariably driven by political correctness if not just plain politics.

There is huge angst over Massachusetts' subsidies to Evergreen Solar which just moved all of its manufacturing to China. The conclusion seems to be that government didn't invest enough to counteract Chinese subsidies to its solar manufacturers; even greater subsidies are needed! What actually happened, according to a NYTimes story, is that that price of solar panels plummeted as recession-hit governments around the world reduced the subsidies for the installation of solar panels. China and other governments had subsidized too much manufacturing capacity for the now limited demand. The Massachusetts plant had 800 factory jobs; all of these jobs, of course, were announced with great fanfare just a little over two years ago. But the new plant in China is almost completely automated; it's not just the Chinese labor is cheaper; it's that a lot less labor is going into making the panels in China.

"Jobs created" is often a well-meaning criterion for government investment. A private investor would have looked at how FEW jobs were needed to create the panels and only invested if the answer was small enough to be competitive. A private investor might have suffered a loss also; but the loss wouldn't have come at the expense of taxpayers.

A private investor might have asked what Is China not doing well? Where is the opportunity? Government was seduced by the promise of "green" jobs. Now the money is gone and so are the jobs.

Despite government "help", Americans continue to innovate – mainly in those areas where no government help is available. An interesting recent example is the commercialization of new drilling techniques for natural gas, which have the promise of giving America a significant low cost path to both greater energy independence and less carbon dioxide emissions. BTW, jobs drilling for natural gas in the US aren't going to China. Although there are subsidies for extractive industries (which we could do without), there were not government programs to develop these new technologies – just businesspeople trying to make buck. In fact, parts of the natural gas industry are hurt by the resulting lower prices; that's the way business goes.

Meanwhile government was "investing" in corny ethanol. Government mandates and subsidies have diverted a huge fraction of US farmland to corn for ethanol, driven up food prices worldwide, and made very little practical difference in either energy independence or reduction of CO2 emissions because of the energy inefficiency of producing ethanol from corn. Even Al Gore, an early and crucial supporter of ethanol subsidies, has changed his position and admitted his support had more to do with presidential politics than energy policy; he now opposes further subsidies. Unwinding these subsidies will be incredibly difficult since they've resulted in over-pricing of farmland and excess production. The point isn't that this particular investment was bad; that happens all the time with private investment. The point is that government invests politically at the expense of the real economy.

Barak Obama can become the most successful "pro-jobs" presidents in recent history if he concentrates on removing existing government subsidies for business – which often become the excuse for still more subsidies to other businesses. Strangely, his allies in eliminating subsidies may be the tea-party backed new legislators who are not yet in the pocket of businesses looking for handouts. It is morally as well as economically unacceptable to continue government subsidies to business while cutting back on public assistance programs. Private capital, which is being hoarded and/or invested in other parts of the world, will stay in the US (and flow into the US), if we don't insist on crowding it out with government subsidies.

Related posts:

Natural Gas Disrupts the Energy Industry

And Here Comes the Pork

Socialist Senator Sanders Saves Capitalism

Confessions of a Stimulator

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