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Visible Subsidies and Invisible Destruction
by Per Bylund and Michael S. Rozeff
by Per Bylundand Michael S. Rozeff
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Schumpeter's "creative destruction" describes how the free market's
new and more efficient industries push out old ones, creating economic growth.
The state's perversion of this process we may call uncreative destruction. The
state overtly subsidizes some industries and groups (including itself and its
employees), while covertly it destroys society's overall wealth and well-being,
lowering economic growth and welfare.
The state's magic act and trickery consists in attracting attention
to the subsidies of its right-handed spending while obscuring the even greater
destruction of its left-handed taxes and regulations. As French 19th century
economist Bastiat wrote, in his essay That Which Is Seen, and That Which Is Not
Seen, there are two effects of the state's actions: the visible and the
invisible. The state points to the economic activity of fixing real and
imaginary broken windows (the subsidies), while avoiding all mention of the
windows it breaks, the houses it bulldozes, and the people diverted from
building new and better houses (the destruction.)
The state, for example, advertises the stimulative effect of
wartime spending, which subsidizes all those businesses producing war matériel
and supports all those working in war industries. But its taxes to pay for the
war are extracted from a broad swath of the population who experience their
wealth diverted and destroyed. The destruction does not end there. With lower
wealth, people's capacities to save and invest in human and physical capital
are decreased. Innovation is stifled in the butter industries as production to
meet demands is curtailed and shifted to waste. Economic growth declines.
All state spending is like spending on wars in diverting production
away from what people want and value (the invisible) and into what people do
not want and do not value. And all of it causes destruction in more ways than
one. With more wealth going to guns and less to butter, people go unemployed in
the butter industries. People's lives and plans are disrupted. They must travel
and seek different employment elsewhere. Social and family relations are
disarranged, imposing heavy psychic costs on human beings. Meanwhile, the
state's takings make obsolete, divert, and destroy all forms of capital:
physical, human, and social.
We know that the destruction effects exceed the subsidy effects
simply because the taxes are coerced. And because the destruction includes not
only the immediate diversion of wealth away from goods people favor (butter),
but also the destruction of investment and innovation, the destruction of
preferred social arrangements, and the imposition of psychic costs on those
forced to alter their preferred living arrangements, we can be sure that the
destruction far exceeds the subsidy benefit. We can be sure that the net effect
of subsidy and destruction is net destruction.
All state programs have the same sorts of net negative impacts upon
society. A Social Security program, for example, is highly destructive. In this
case, a favored group of elderly is subsidized while an unfavored group of
employed taxpayers foots the bill. Saving, investment, and innovation are
stifled broadly throughout the entire society. Growth and progress diminish.
The many and varied negative social and economic impacts on family, work, and
attitude add to the negative total.
How large is the state's uncreative destruction? Very large.
Rothbard suggested that all of the state's spending was waste. How can we get
an idea of the extent of the net destruction? As a lower bound, we can consider
the long-term changes in the efficiency of American industry, and we can
consider the tax bite taken from taxpayers.
In the 1880's, American industry (in real terms) produced a 7
percent rate of return on invested capital. Today, the figure is 4 percent.
Suppose that firms retain all of this return and reinvest it. Then they will
grow at a 7 percent rate in 1880 and at a 4 percent rate in 2007. Although
industry does not retain all of its earnings, the large drop in profitability
suggests that a vast slowdown in the growth rate has come about because of the
state. Changes in taxes coincide with this slower growth and confirm it.
Suppose that the tax rate in 1880 was nil, and that the tax rate today is 30
percent. Then the after-tax return of a 7 percent rate today is reduced to 4.9
percent. A 40 percent tax rate reduces the return to 4.2 percent. As the state
absorbs returns and diverts that wealth to waste, both taxes and slower growth
reflect that diversion.
Not being historians and not being centagenarians, great numbers of
Americans are unaware that the American growth rate has slowed so noticeably.
Even if they recognized the visible loss in the decreased growth rate, would
they realize the tremendously huge wealth losses this entails? Probably not. As
growth begins from any base amount, it compounds. With a 4 percent growth rate,
the base grows more slowly and the increments are much smaller. With a 7
percent growth rate, not only is the growth rate higher but the increments are
larger and larger. There is a substantial growth-upon-growth effect, which is
exactly like an interest-upon-interest effect. One thousand dollars grows to
$50,000 in 100 years at 4 percent. It grows to $868,000 in 100 years at 7
percent. Although the growth rate is 75 percent higher (7/4 = 1.75), the ending
wealth is higher by a factor of over 17 or 1700 percent.
Add on to slower growth the less visible or invisible losses in
terms of technical innovations, education, health care, population growth,
longevity, and culture. Add to this the losses in quality of services provided
by states when they replace free market services. Add to this the sheer waste
when states force human activity into channels where it does not want to go. In
total, the destruction must be even greater than a 75 percent drop in growth
rate suggests. Below we assume that today's rate of government destruction is
greater by a factor of 125 percent than in 1880.
To view the two faces of government more concretely, we explicitly
introduce the subsidies to some businesses (guns) and the destruction to others
(butter.) Let the business product in 1880 be denoted BPAST. Suppose that in
1880, the effect of subsidies was to increase this by 20 percent or by
0.2BPAST, and suppose that the effect of destruction was to reduce this by 30
percent or by -0.3BPAST. The net effect on the 1880 economy is then -0.1BPAST.
Taxes measure this, since in total at all levels of government, they were
probably around 10 percent at that time. At 10 percent, the drag on the economy
in 1880 was relatively small.
Fast forward to 2007. The state is far larger. Its subsidies are
larger and its destruction is larger. Suppose that the subsidies have increased
by 50 percent compared with 1880. That is, the effect on today's product
(called BNOW) is 0.2 x 1.5 = 0.3. Today's subsidies are 30 percent of today's
product. Today's destructions have also amplified, by an even greater factor;
let us say by 125 percent. That means the destruction effect is now -.3 x 2.25
= -0.675 of BNOW.
The net destruction today on BNOW is then 0.3-0.675 = -0.375. This
figure of 37.5 percent approximates the tax rate being paid to the state today.
By supposing that the state's destruction has gone up faster than its subsidies
have (125 percent compared to 50 percent), we obtain a sensible numerical
result that replicates several facts: (1) the reduction in business efficiency
from 7 to 4 percent, and (2) the increase in taxes upon business (felt of
course by individuals).
Suppose that the business sector in a free market can produce and
grow at 7 percent, both in the past and today. Using the guesstimates, the real
growth rate in 1880, after the state's depredations, was 0.9 x 7 percent = 6.3
percent. Today, the real growth rate is 0.625 x 7 percent = 4.375 percent.
These numbers are speculative, but their difference provides a sensible
ballpark and lower bound estimate of the net effect of the state's destructions
over its subsidies. As taxes have jumped from low to high levels, the growth
rate of the economy has dropped by about 30 percent, that is, the difference
between 6.3 and 4.375 divided by 6.3.
Why does the state's destructiveness rise faster than the subsidies
it provides? There are several reasons. Economically, when the state taxes, it
first draws funds away from the lowest-valued projects that businesses wish to
invest in. Later it draws funds away from more highly valued projects. As they
seek to fund these, they run into capital costs rising at increasingly higher
rates. Another reason is that the state's regulations accompany its subsidies
and taxing, and these add whole new layers of destructiveness by hindering
innovation, forcing companies to divert resources to evasions, and driving
companies overseas. Third, the state introduces political uncertainty into the
business equation. Fourth, there are network effects. As destructiveness
spreads, it deteriorates and disrupts business inter-relations among different
industries. Fifth, as businesses learn that politics is influencing their
production, they seek out political favors so that favoritism and the
concurrent destruction grow. Sixth, the state is able to capture industries to
which it provides subsidies.
The state's only creativity is in designing its tricks and fooling
the public. We who are on the receiving end experience massive uncreative
destruction.
January 23, 2007
Per Bylund [send him mail] works as a business consultant in
Sweden, in preparation for PhD studies. He is the founder of Anarchism.net.
Visit his website.
Michael S. Rozeff [send him mail] is a retired Professor of Finance
living in East Amherst, New York.
Copyright © 2007 LewRockwell.com
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