The Deadwood of Crony Capitalism

Much of the recent rhetoric surrounding the supposed need to “create jobs” as a core goal of public policy has focused on the way in which government can, by promoting job creation in particular industries through subsidies and the like, also promote “sustainability” in both the economy and the environment.  One need only consider how much political energy has been spent arguing for “green jobs” as part of the stimulus program as well as the longer term policy and budget goals of the Obama Administration.

Unfortunately, as the recent example of Solyndra demonstrates, these sorts of subsidy programs, and related public-private partnerships, have shown themselves to be failures at both job creation and economic growth.  As I shall discuss below, the failure of Solyndra, after being given a $527 million government loan and being touted by the President as the exemplar of the “new economy,”  “green jobs,” and the future of public-private partnerships, is a point-by-point example of what’s wrong with this approach. At best, such programs are a particularly insidious form of crony capitalism that enriches a small group of people with access to those in political power distributing the economic goodies while wasting valuable economic resources in the process.  Continuing to funnel resources into such wasteful programs deprives the market of much needed capital, which entrepreneurs who are calculating on the basis of genuine market prices and profits and losses will use far more efficiently. In other words, the perhaps well-intentioned policies meant to produce a sustainable economy inevitably turn into a form of crony capitalism that is itself not sustainable.

Any discussion of job creation has to first recognize the problem with the very phrase “job creation.”  As a goal of economic policy, creating jobs is misguided.  After all, it’s very easy to create jobs.  For example, the federal government could order all US farmers to destroy every piece of machinery on their farms.  This would instantly create millions of jobs.  Of course it would also impoverish us greatly as the whole advantage of machinery is that we no longer need scarce human labor to perform that work.  Such labor is then freed up to perform more work elsewhere that we in our roles as consumers think is more valuable.  This has been the story of human prosperity from time immemorial.  Finding ways for machines to replace brute human effort is how we enrich ourselves.

Nowhere is this clearer than in agriculture, at which over 40 percent of Americans were employed at the start of the 20th century.  Over 100 years later, that number is less than 2 percent, yet our agricultural output is greater than ever, food is cheaper, people are better fed, and, most important, the jobs destroyed in agriculture have reappeared multiple times over in manufacturing, technology, the creative arts, and a million other places.  Manufacturing offers a similar story.  It is true that manufacturing jobs have remained roughly stable the last decade or two, but manufacturing output has continued to grow.  We are producing more with the same amount of labor, which means additions to the labor force do not need to go into manufacturing to add value.  They go, again, to technology, the arts, etc.  A healthy economy is one that destroys jobs that are no longer necessary because they can be done by machines and then discovers which new uses of labor people will now value with the additional income made possible by the declining costs and increased wages that mechanization and efficiency brings.

The key to this process is the way in which market signals provide the relevant knowledge and incentives for people to know which jobs are no longer needed and what jobs might produce value instead.  Entrepreneurs are not successful because of their vision or intelligence alone.  Their ability to use resources efficiently and to innovate depends crucially on their position within a market economy.  Market prices, and the profit and loss signals they generate, are what guide entrepreneurs in their attempts to produce what consumers value.  When we buy and sell in a genuinely free market, the prices that emerge serve as surrogates for our preferences and all the other knowledge that went into our buying and selling decisions, making all of that available to others.  The price system is a form of communication that allows decentralized and dispersed private owners of capital to figure out both what people want and how best to produce it.

Higher prices for output encourage entrepreneurs to produce more, lower prices less.  As input prices change, producers know that they need to shift their mix of inputs to keep costs in check.  Profits and losses provide not just an incentive to do this right, but knowledge about whether or not it has been done right.  Profits in a free market mean that the final product was more valued by people than the sum of the inputs, i.e., the producer has created value.  Losses mean the opposite;  the producer has destroyed value.  Profits tell producers to do more;  losses tell them to change their plans.  What healthy economies do is to create value, which is why profit and loss signals are so important. Without them, we have no way of knowing if production is value-creating.  It is value, not jobs, that we should be concerned about, especially because sometimes one has to destroy jobs to create more value.

With this perspective, we can see the multiple problems facing governments when they attempt to create jobs, and “good” or “green” jobs in particular.  The most fundamental question is whether, in fact, they are able to create jobs on net.  Government spending can certainly be used to pay people to do work, thereby creating very visible new jobs.  However, “doing work” might not create value, and those resources cannot be created out of thin air.  Government must either tax, borrow, or inflate before it spends.  Any of those options will mean that resources are taken from the private sector, making it thereby more difficult for jobs to be created there.  The firm that cannot get a loan because increased government borrowing has driven up rates, or because the firm has a larger tax payment, will either not hire new workers or potentially dismiss existing ones.  The jobs created by government are offset by losses in the private sector.  Compared to not having engaged in the spending, we are no better off and more likely worse off.

The proponents of government job creation schemes might respond that the jobs such policies would create would simply be “better” jobs than what the market would create.  What constitutes “better” in such arguments is not always clear, but normally this refers to them either being higher paying or more socially responsible, as in “green” jobs.  What is clear is that the claim is that free markets will not create “good” jobs on their own.  The problem is that governments are notoriously bad at figuring out what jobs are truly value creators.  Private producers have prices and profits to guide them; government bureaucrats do not.  Governments do not have the incentive and knowledge provided by the need to make a profit when they make loans or otherwise invest in private companies or create government owned ones.  They have little incentive to make sound loans and no way of knowing if the product created with the loan actually created value.  Eventually the mistakes and wasted resources of these programs will become clear, and the unsustainability of the jobs they are paying for will be obvious.

The best example of these problems is, again, Solyndra.  Solyndra manufactured an alternative to conventional silicon-based solar panels.  They applied for a government loan guarantee in 2008 and the Obama Administration approved a $527 million loan from the Treasury in the spring of 2009.  The President touted Solyndra as an example of the way in which government spending, particularly stimulus spending, could create the new, clean, green jobs of the future.  The loan went ahead despite concerns within other parts of the government.  Unfortunately, the price of silicon fell rapidly, making Solyndra unable to compete with conventional manufacturers, leading to bankruptcy and the laying off of over 1000 employees.  The taxpayers will be on the hook for most, if not all, of that $527 million.  The inability to foresee that possibility, and the weak incentive to think it through, correspond precisely to the problems noted earlier.  Unsurprisingly, it turns out that members of Solyndra’s management were also close with members of the Obama administration, illustrating perfectly the way in which when such funds are available, they will likely go to those with connections rather than the sustainable projects that the market will eventually reward.  Solyndra is hardly the only example one could raise, but it perfectly illustrates everything that is wrong with these sorts of programs and the way they waste valuable resources.

Without the guidance of profit and loss, governments have no way of allocating resources with an eye toward value creation.  Absent the rationality of the market, such programs will inevitably get politicized.  With resources to distribute, politicians will hand them out to those who lobby loudest and offer the most votes in return for those resources.  This process feeds on itself, as once firms see that the path to riches is to lobby effectively rather than produce value, they will devote more of their resources to what economists call “rent-seeking,” or the attempt to gain profit and privilege through the political process.  Not only will the original program not lead to value-creating jobs, but it will lead private sector firms to employ more people in lobbying and fewer in direct production.  These indirect effects of such programs exacerbate the immediate effects, and the combination is a multiplied diversion of resources away from wealth creation and into wealth transfer.

We call this system “crony capitalism.”  In free market capitalism, profits are made by creating value for consumers.  Under crony capitalism, profits are politicized.  Firms profit from their connections to politicians and bureaucrats, which have nothing to do with improving the well-being of consumers.  And CEOs usually get to keep their past high compensation even if the firm, like Solyndra, eventually goes under. Whatever one’s view of the morality of profits, it is far more likely that profits will be seen as legitimate when they arise from making things like iPhones and cheaper groceries than from having politicians hand you a loan because they think you’ll deliver votes for them.  Not only is government incapable of creating jobs that can be sustained over time, it inevitably ends up undermining the market more broadly by replacing value-creating capitalism with crony capitalism.

Government jobs programs suffer from what F. A. Hayek called “the pretense of knowledge.”  Politicians, bureaucrats, and economic planners might think they know what kinds of products or jobs are needed for the economy of the future, but they cannot possibly obtain such knowledge.  That knowledge is too dispersed and contextual, and it is often not even explicitly known by those who possess it.  The uncertainty of the future is a second problem, as no one can know what we will need down the road.  The way we try to discover that is by allowing numerous owners of private property to take their best guess at it by making use of prices and profits in the ways discussed earlier.  It is through the competition of a free market that we figure out the products and jobs that people want, because only through the market do we have a way of both encouraging the creation of value and knowing if we have been successful at it.  Those signals enable us to sustain value creation and economic growth in the long run. Government jobs programs create neither jobs nor value and ultimately destroy resources in the process.

Steven Horwitz blogs atCoordination ProblemandBleeding Heart Libertarians.

Reader Discussion

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on July 26, 2012 at 16:53:35 pm

Great article! Sort of a condensed version of both Hazlitt and Bastiat with a little Hayek thrown in for good measure. I plan to forward this to my brother and sister so my nieces and nephews can read it. It will help dispel some of the rhetoric they are bombarded with in public school and by the media. On a local note in NJ "republican hero" LOL Gov. Christie just signed one of those "crony capitalist bills forcing utilities to purchase more solar to prop up the rent seeking solar industry at the expense of the rate payers.

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on July 28, 2012 at 20:33:01 pm

Using agriculture as an example of free market capitalism is off the mark. Industrialized agriculture in the U.S. is heavily subsidized by the government.
The unintended consequences of this policy is to incentivize farmers (and I use this title loosely) to seek subsidies, loans and grants provided by the government to continue operating inefficiently. In effect the farmer has become a serf of the U.S.D.A.
Another unintended consequence (and a separate discussion point) is that, in general, the young people, being blissfully separated from the work and experiences involved in the sowing, harvesting, and marketing of food in their local economy have lost initiative, imagination, and a work ethic and have become dependent on the government to provide for them in the form of college grants, loans, and scholarships, food stamps, medical insurance, and housing. A great many of these people will spend the flower of their youth sitting on their Mother’s couch playing video games. In the mean time, this so called menial work has to be done so we make excuses why it’s OK for people to cross the border and do this hard honest labor while we ship our jobs overseas so the tedious task of actually creating something can be accomplished without getting our children’s hands dirty.
We’ve done it! We’ve succeeded where everybody else failed. We’ve managed to outsource our core competency. We've traded our work ethic, our vitality, and our future for cheap consumer goods. We've ended up serving each other coffee, commenting about “Who wants to be a Star”, and buying or selling crappy art on the coffee house wall.

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David Chandler
on August 16, 2012 at 12:03:57 pm

This article is off the mark. You claim that government can't "create" jobs or "encourage" certain industries into a sustainable path, because governments might fail at this. You give Solyndra as an example.

But you lack examples from the other side--the Internet spawned from DOD research, prosthetic devices spawned from VA research, materials science and telecommunications advancements from NASA, the Human Genome project, and on and on.

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George DeMarse

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