Dr. Sennholz heads the Department of Economics at Grove City College, Pennsylvania.
Much confusion and controversy flow from the difference between old and new government intervention. Some people look only at old intervention, some only at new, each unaware of the other phase of intervention. In debating the desirability of certain policies, many disagreements spring from the fact that different people see different phases of intervention.
The distinction between the two rests on strict theoretical analysis and can be defined precisely. Old intervention is that government restriction or interposition to which the economy has fully adjusted. And we speak of new intervention when the economy has not yet adjusted to the new data, or is in the process of adjustment. The difference is crucial in any appraisal of the effects of government intervention.
Take, for instance, a corporate income tax, which is a popular form of intervention. A tax newly imposed, a new surcharge or a rate increase, immediately reduces the profitability of business. Companies earning high profits must curtail their expansion or modernization projects or reduce dividends. Those companies that had barely earned interest on the capital invested, or had just broken even, will be made "submarginal" by the tax. Their yields will fall below the minimum level needed to attract and preserve the necessary capital. The new tax causes these companies to curtail their operations, close plants and other facilities, and lay off some workers. Output declines and the supply of goods and services is diminished. There is business stagnation — a short-run effect of the new tax.
Wages now tend to decline, or at least stay lower than they otherwise would have been. Other business costs, too, are reduced gradually until various enterprises become profitable again and capital once more is lured back into investment and production. In fact, gross yields return not just to the pre-tax level, but rise above it to cover both the new taxes and the net yield of capital. Inasmuch as the government consumes some capital in the process of intervention, the yield per unit of capital tends to rise even higher while that of labor declines.
The new tax levy also causes a shift of production factors from employment for the people to that for the government. Capital goods industries and consumer goods industries tend to shrink while the "government sector" expands. This shift is facilitated and guided by price changes that point up the change in purchasing power.
All these are short-term effects. The economy gradually adjusts toward a new equilibrium that takes the new tax into full account. The long-term effects include the shift of production factors, the reduction of marginal labor productivity, and the rise in marginal capital productivity. They are less conspicuous than the short-term effects and difficult to demonstrate. After all, who can perceive what would have been in absence of the tax? This is why interventionists often deny that there is any undesirable effect of a new tax, a new surcharge, or a rate increase. They point at old taxes imposed ten or twenty years ago and at the new equilibrium, and fail to see any ill effects of rising taxation. They have forgotten the months and years of stagnation.
Deficits, Old and New
Or, take a government deficit as a new datum with many-sided effects. In the short run, the deficit burdens the capital market, drains it of loan funds, and causes interest rates to rise. Businessmen must curtail their borrowing because many projects no longer are profitable at high interest costs. Business stagnates insofar as it had been relying on the capital market. This is a short-run effect.
The stagnation bears all the symptoms mentioned above. Of course, the immediate beneficiaries of the deficit gain temporarily. When the budget is finally balanced, or the drain of loan funds ceases to strain the market, economic conditions achieve a more normal pattern.
In the long run, when all adjustments have taken place, there remains only the hole in capital reserves torn by the deficit. Economic development is retarded permanently.
In recent decades Federal deficits were often financed by inflation. Weak administrations lacked the courage to boost taxes that would cover the growing government outlays. And the capital markets could not absorb the extraordinary demands of the U. S. Treasury. Therefore the Federal Reserve System, which is the ultimate source of paper money, the U.S. engine of inflation, was called upon to "assist" the Treasury operations. It created the money to cover the budget deficits.
Inflation is a short-run policy. It raises the prices of goods at the point where the new money enters the market. Business becomes more profitable when sales increase and prices rise. This is what makes inflation so popular in the short run.
But after the pleasant boom effects, a recession usually follows. The previous maladjustments become apparent through soaring business costs, declining profit margins, and cancellations of orders. Some businesses suffer losses. The recession is also a short-run effect, although this particular effect or reaction may develop several years after the initial inflation.
The long-run effects of inflation are those that remain after all economic adjustments have taken place. The purchasing power of the money unit is reduced permanently; goods prices stay higher. Some people, especially the creditors, have suffered permanent losses in income and wealth; others have reaped permanent gains. Many years later, when the economic adjustment has run its course, it is impossible to ascertain the precise effects of the inflation. After all, who can calculate what economic reality would have been in a myriad of aspects without the inflation of 1914 to 1920? The short-run effects are forgotten, and the long-term effects are open to academic speculation only.
Government Regulation and Control
When a government resorts to legislation or regulation that aims to benefit some people at the expense of others, it effects changes that are short-term and long-term. Whether it aims to alleviate poverty, eliminate slums, improve transportation or communication or labor relations, or give tariff protection to industry, government intervention bears consequences that deserve economic analysis.
Urban renewal, for instance, is very popular with government planners because of some long-run effects. Planners are animated by the visible changes — new expensive buildings, broad boulevards and large plazas, museums and libraries, theaters and operas, public parks and, of course, the new Federal building and city hall.
But the planners usually fail to perceive the invisible effects which are very real and permanent. After all, urban renewal consumes vast quantities of resources and human labor. It tears down and lays waste old housing, in order to erect the new. And all expenses, whether covered by Federal grants, state aid, or local levies, are borne by taxpayers. These people are forced to forego enjoyment of countless goods and services so that the Federal building and city hall may be constructed.
The short-run effects are twofold: curtailment and recession of all those industries that must forego the capital, labor, and resources now put into urban renewal; and temporary prosperity and expansion of those construction industries engaged in the renewal. When the renewal is completed, all affected industries must adjust anew.
Or take the case of industrial protection by tariff. In the short run, an industry receiving such government favors may benefit. The new tariff reduces the available supply of competing goods and raises prices. Profit margins improve, employment expands, and wages may rise. But behind the new tariff wall the profitable conditions now invite expansion of domestic competition. New capital and labor enter that line of production until its attractive profit margins are erased. A few years later, when all necessary short-term adjustments are completed, the protected industry once again faces the very conditions that caused it to plead for protection.
The foreign industries discriminated against by the new tariff levies suffer lower sales, business losses, and unemployment. Similarly, the export industries in the country imposing the tariff face losses and depression because exports tend to fall when imports are restricted. After all, foreigners need to earn foreign exchange through exports in order to import.
The long-run effects remain when all production factors have fully adjusted to the tariff levy. The international division of labor is disrupted and trade is diminished. In all countries affected, the factors of production have been channeled into less useful employment. Goods prices are higher and standards of living lower.
Whether government intervention is old or new, it reflects the substitution of political action for economic choice, the rule of politicians over consumers. And the result is bound to be a net reduction in the satisfaction of human wants.