The Economic Way of Thinking, Part 8
Ask What the Long-Term Consequences of an Economic Action Will Be
MAY 01, 1994 by RONALD NASH
Filed Under : Inflation, Subsidies
Dr. Nash is a contributing editor of The Freeman and professor of philosophy and theology at Reformed Theological Seminary in Orlando, Florida. His many books include Freedom, Justice and the State and Social Justice and the Christian Church, both published by University Press of America.
In June of 1992, I was nearing the end of a set of lectures in Moscow, Russia, when I learned that a member of the Congress of Peoples’ Deputies was coming by my hotel to meet some people in our party. I decided that I would use the meeting to try to learn more about what makes Boris Yeltsin’s opponents in the Russian Congress tick. When the deputy revealed that he was an important player in economic decisions made by the Congress, I brought up the subject of the massive increase in Russia’s money supply that had just been announced. In a matter of weeks, Russia planned to double its money supply. Didn’t anyone in the Russian Congress realize, I asked the deputy, what the announced action would do to the Russian economy? Didn’t anyone understand the horrendous inflation that would result?
The deputy made it clear that he and his allies in the Congress did not care about the long-term results. The huge inflation in Russia’s money supply was necessary in the short-run because, he claimed, it would alleviate serious problems resulting from his nation’s movement away from Socialism. Had the deputy been a bit more candid, he would have admitted that the planned inflation in the money supply was going to benefit the deputy and thousands of other Russian bureaucrats like him.
Actions like those just described, along with the blasé attitude toward the future exhibited by the Russian deputy, are an example of the folly that results whenever individuals or governments ignore the fourth principle of the economic way of thinking, which is the subject for this, the last in my eight-part series. This fourth principle of the economic way of thinking is the importance of always asking what the long-term consequences of any economic action will be.
Short-Run Versus Long-Range Consequences
Economic theories are testable in terms of their success in predicting and explaining what takes place in the real world. One way of assessing any economic proposal is to ask what its long-range consequences will be. It is a mistake to notice only the short-term or immediate consequences of economic activity. Any proposal or policy can affect the way people view a situation and thus can alter their incentives in ways that change their choices. Such a change in incentives often produces other effects that become noticeable only in the long run.
American politicians excel at adopting economic policies because they appear to produce desired consequences in the short run. What “the short run” usually means for American politicians is an effect likely to last through the next election. This has often been true of policies adopted because of the help it was claimed they would bring to the poor. But measures that appeared beneficial when viewed in the short term often look quite different after a longer period of time. This has certainly proved to be the case with the Russian government’s continued expansion of its money supply that has gone far beyond the one-hundred percent increase in mid-1992. The Russian ruble has become worthless and the incomes of tens of millions of Russians continue to plummet, leaving them further behind each week in their quest for the basic necessities of life. As the inflation rate continues to escalate, the leftist-controlled Congress has continued to slow down Russia’s feeble efforts to move towards democracy and a market economy.
But there is no need to say more about the insane economic policies of the Russian government; there are abundant examples of equally foolish acts by the American government.
How the U.S. Government Destroys Industries and American Jobs
In 1955, the United States produced half of the world’s cotton (some 18 million bales a year). But by 1969, only 11 million bales were being harvested in the United States. This dramatic decline resulted from growing competition from foreign cotton growers and synthetic fabrics. Lost in the fog of history and government statistics is the sad but true story of how U.S. governmental intrusion into the cotton and textile markets gave added strength to foreign intrusion in these markets.
The first leg of this governmental intervention were federally mandated price supports for U.S. cotton that by 1955 had reached a peak of 32 cents a pound. The short-run justification for this price support was the alleged good of cotton growers whose income would increase because of the government’s “wise and benevolent action.” But as we saw earlier in this series, every economic action involves some cost. If you artificially raise the price of U.S. cotton to raise the income of U.S. cotton producers, you open the door to the importing of lower priced cotton from foreign producers. Even more serious was the fact that the price supports raised the price of U.S. cotton above the world-wide market price, cutting dramatically into sales of U.S. cotton abroad. U.S. cotton producers were rapidly losing their niche in the world market.
The federal bureaucracy’s answer to this was to subsidize the price of U.S. cotton exported overseas in 1956. This immediately created problems for the American textile industry whose manufacturers were now forced to pay more for U.S. cotton than their foreign competitors. This meant that foreign producers of cotton goods could manufacture and sell their goods more cheaply than American millers. The U.S. government’s response was to add still another subsidy, this one for U.S. millers.
There was nothing mysterious or surprising in any of these long-term consequences resulting from our government’s intervention with the cotton and textile markets. Anyone attuned to the economic way of thinking could easily have predicted what was going to happen; and of course many economists and businessmen issued their warnings. But those warnings were ignored in the mad rush to produce some immediate but short-lived “solution” to some problem. Notice also that many American businessmen were eager accomplices in what eventually became the destruction of their industries.
Once the dangers of the government subsidies became apparent, assorted changes were made. But the damage had already been done. Foreign growers had already become established because the U.S. government’s actions gave them an incentive to enter the cotton market. Foreign millers became established because the U.S. government’s actions gave them an incentive. To appreciate fully the damages resulting from this last fact, it is necessary to visit some of the American communities that used to provide tens of thousands of textile jobs. The factories are closed, the jobs were terminated years ago, and the local economies were devastated. But few people recognize the role of the federal government in bringing about all this loss. And fewer people still recognize how inattention to the fourth principle of the economic way of thinking helped produce the situation. When contemplating any economic action, always ask what the long-term consequences of that action will be.
How Government Destroys a Housing Market
Failure to calculate the long-term consequences of an act has been a major factor in the housing crisis in New York City. When a locality like New York City imposes rent controls, it does so under the pretense that rent controls will stifle the greed of selfish property owners, reflect the greater compassion of the liberal bureaucrats who run the city, and presumably make more decent housing available at a lower cost. But anyone familiar with the principle of long-range consequences knows that the end result of rent controls will not be more available housing but less; and on top of all that, the condition of available housing will continue to deteriorate.
As we learned earlier in this series, people respond to incentives. Property owners think they are entitled to some return on their investment. When they begin losing money because of coercive rent controls, the first thing they begin to do is cut back on required maintenance of their property. As the condition of the property declines, it becomes increasingly less desirable to responsible people, who find other places to live. As the apartments become increasingly occupied by lower-class residents, the lack of maintenance coupled with the tendency of people to treat other people’s property with something less than loving care leads to still a further decline in the quality of the property. Many such properties deteriorate so badly that they eventually become condemned or mysteriously burn to the ground. If one doubts that this happens, all one need do is make a brief visit to the borough of New York known as the Bronx.
Other property owners will survive the rent controls by finding creative ways of getting around the restrictions. A black market in rental property may arise. People able to rent an apartment at the governmentally approved price may still have to make additional payments under the table, perhaps by renting additional furniture or paying for a cleaning service. A good exercise in the economic way of thinking would be to consider what would happen to housing in New York City if all rent controls were ended. The short-term consequence, of course, is that the price of housing in the city would jump dramatically. Of course, the ultimate blame for this would be the original, short-sighted view of the city bureaucrats. But the long-term consequence would be an enormous increase in the quantity of new housing as entrepreneurs rush into the market to build new housing in response to the incentives of higher rents. As the quantity of new housing increased, another long-term consequence would be the significant decrease in the cost of such housing when the quantity of acceptable housing then supplied by the market increased.
Given the obvious answer to New York’s housing crisis, the question to ask is why the liberal bureaucrats don’t admit their mistakes and abandon their self-destructive policies? One possible answer, of course, is that one must never underestimate the stupidity of politicians. Whatever the truth may be in the case of these bureaucrats, it is clear that the real losers are the people who live or would like to live in the city.
Another worthwhile exercise for the reader would involve the identification of other self-destructive economic policies that fail to consider long-range consequences. Even as I write, there is proposed legislation that would produce automatic increases in the minimum wage in response to inflation. Minimum-wage laws are justified as acts that will help low-skilled workers earn a living wage. But it is clear that such laws only force employers to lay off more unskilled workers. And so, the very law that was supposed to help unskilled workers earn more money has the long-range effect of costing many of them their jobs. Such is the nature of liberal “compassion” that ignores the economic way of thinking.