The Roots of Our Economic Trouble

Ever since the election, most of the talk in the nation has been about the “fiscal cliff.” Listening to it, you would think that whether the economy gets better or goes off the cliff and crashes depends on small adjustments in tax rates and a minimal change in our enormous annual budget deficit.

The fact is that no matter what the politicians do about tax rates and the size of the deficit, it won’t have any effect on the roots of our economic trouble. As long as the federal government’s mammoth size and appetite for wealth are suffocating the economy, growth will remain slow and unemployment high.

To understand why, we need to get down to some economic fundamentals.

Goods and services that we want do not miraculously appear. They have to be produced. How much we can produce depends on how well we use the limited resources available to us -- land, labor, capital. Robinson Crusoe on his island had to figure out how to best allocate his time and energy, how best to use the land, and how best to employ the tools he managed to salvage. He knew that if he wasted his time, made bad use of the land, or let his tools rust away, he would suffer the consequences by having less to eat, less to wear, less shelter, less security, and so on.

Thus, his standard of living depended on making the optimal use of his limited resources.

Things are no different when we are talking about a collection of people, even a huge nation. The standard of living depends on how well or how poorly the people use the resources available to them.  In countries where the people are left free to decide on the best uses of their resources, they will prosper. Hong Kong is a good current example. America of the 19th century was another. Government absorbed and directed very little of the resources. It interfered hardly at all with people’s incentives to produce.

On the contrary, in nations where the government absorbs and directs a lot of the resources and interferes widely with people’s incentives, the standard of living will necessarily be lower than otherwise. Rulers (elected or not) will use land, labor, and capital for their purposes. The more they do so, the poorer the people will be, because political decisions tend to be short-sighted and if they turn out badly, the loss falls on the taxpayers, not on them.

Growing government means more people working at government jobs, often producing little or no value, except to the politicians and special interest groups. Growing government means more land used (or often kept from use) according to the wishes of the politicians. Growing government means that more capital is siphoned away from the competitive process and allocated according to political pull.

Growing government also means that people will put more of their efforts into trying to obtain favors through lobbying or bribery.