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Monday, October 1, 2007

Subsidies Hurt Recipients, Too

Federal Aid Can Stifle Individual Initiative

More than ever, historians need to study the economic consequences of government programs. Only by analyzing the results of past government intervention can we calculate the impact of future government intervention.

The Tennessee Valley Authority (TVA) provides a useful example. Established as part of the New Deal in the 1930s, it was a favorite program of Franklin Roosevelt’s. Under the TVA the federal government built dams and generated hydroelectric power for residents of theTennessee Valley. In the 1920s President Calvin Coolidge vetoed a TVA bill twice, and President Hoover vetoed it once. Both men believed that federal funding was unconstitutional, but FDR disagreed and signed it into law in 1933.

Many historians have praised the TVA as a centerpiece of the New Deal. “The TVA,” wrote William Leuchtenburg, dean of New Deal historians, “was the most spectacularly successful of the New Deal agencies, not only because of its achievements in power and flood control, but because of its pioneering in areas from malaria control to library bookmobiles, from recreational lakes to architectural design.”

Most historians have agreed.

But as TVA grew, some observers noticed problems. Standard bureaucratic inefficiency was one. Second were the Tennesseans who had to be relocated because of the flooding of land and destruction of property. Third were the existing private companies, such as the Tennessee Electric Light and Power Company, that had to compete with the taxpayer-subsidized TVA.

In fact, the taxpayer subsidy for TVA created what economist Henry Hazlitt called an “optical illusion.” “Here is a mighty dam, a stupendous arc of steel and concrete . . . .” Hazlitt observed, “[a]nd it is all presented . . . as a net economic gain without offsets.”

But 98 percent of the American population was subsidizing the 2 percent in the Tennessee Valley. “Again,” Hazlitt concluded, “we must make an effort of the imagination to see the private power plants, the private homes, the typewriters and television sets that were never allowed to come into existence because of the money that was taken from people all over the country to build the photogenic Norris Dam.”

What appeared to some Tennesseans to be an “economic miracle” was merely a transfer of wealth. But the voters in Tennessee made sure that they protected the TVA subsidy, and it has persisted and increased over time.

The case for the TVA (voters improving their lives through a federal subsidy) and the case against the TVA (bureaucratic inefficiencies plus the drain of taxpayer dollars) became standard arguments used to support or oppose other federal subsidies—both during and after the New Deal years.

Then came William U. Chandler with a devastating book, The Myth of TVA, written in 1983. Chandler said the problem was more complicated than that of the whole nation subsidizing a small part. He said the Tennessee Valley’s prosperity was actually being held back by the TVA.

Chandler’s evidence was astonishing. For example, Georgia, which had nothing equivalent to the TVA, and Tennessee had nearly identical levels of income before the TVA, but during the 1940s and 1950s Georgia (and other states nearby) began pulling ahead of Tennessee. “Among the nine states of the southeastern United States,” Chandler concluded, “there has been essentially an inverse relationship between income per capita and the extent to which the state was served by TVA. . . .”

How can receiving a giant dam and reduced costs of electricity stymie economic development? Chandler concluded that the cheap electricity gave farmers in Tennessee incentives to remain in small-scale agriculture rather than move into more promising areas of manufacturing, industry, and services. Meanwhile, many farmers in Georgia and North Carolina improved their education and moved to Atlanta, Raleigh, or Charlotte to start or work for businesses.

Chandler further discovered that people in the TVA area were even slower to adopt and use electricity than were people just outside the TVA area. With their ever-increasing incomes, Georgians and North Carolinians could afford more electricity than the more stagnant population in the Tennesse Valley

Chandler’s research should make all students of government intervention pause. The massive subsidy for the TVA hindered economic growth in the exact area targeted for federal help. If the TVA example is repeated elsewhere, that is a powerful argument against government subsidies—perhaps the strongest argument that can be made (outside the constitutional argument).

In fact, the TVA lesson does have widespread applicability. One of America’s first large subsidies was a multimillion-dollar gift to Edward Collins in the 1840s to build and operate four steamships to and from England to deliver passengers, freight, and mail. With the cushion of federal aid, Collins had no incentive to innovate with steel hulls or engine technology. Like the farmers of the Tennessee Valley, he could make do with federal help so why try something different? Within ten years Collins had lost the competitive race to Cornelius Vanderbilt, who had no federal subsidy but showed great innovation in steamship design and the economics of steamship operation.

The Union Pacific received tens of millions of dollars in federal aid and millions of acres of land to build a transcontinental railroad that was not as straight, not as well built, and not as stable as the Great Northern Railroad, which received not a cent of federal aid. The builders of the Union Pacific constructed their line to receive subsidies, not to transport passengers in the long run. James J. Hill had to compete with the Union Pacific, and he built the Great Northern piece by piece with the best track and over the best terrain possible. During the Panic of 1893, the Union Pacific went broke, but the Great Northern made profits each year. In some ways, the federal subsidy was actually the undoing of the Union Pacific.

Subsidies Change Behavior

Subsidies change the way the recipients behave, and these changes often work against, not for, them. That is the neglected argument against opening the door to federal aid in the first place; but it is an argument that needs to be studied and forcefully made.

The idea that recipients of subsidies are damaged by subsidies applies to individuals as well as businesses. The example of the rise of the welfare state is pertinent here. Americans naturally have compassion for people who are poor but who are trying to improve their lives. Federal aid, however, can stifle individual initiative. That is one reason charity was a private function in the United States so long. Private givers can more easily determine the quantity and duration of aid needed to restore broken lives.

During the 1960s, under the Aid to Families with Dependent Children program, money to unwed mothers increased substantially. As a result, recipients had an incentive not to get married or go to work because those activities would cause them to lose their federal assistance. Thus American taxpayers were not the only losers in the program. Recipients who never developed their talents were losers as well.

Most students of government intervention know that federal subsidies are a drain on those who pay for them. What needs more emphasis is that sometimes the recipients of tax dollars become worse off as well.

  • Burton Folsom, Jr. is a professor of history at Hillsdale College and author (with his wife, Anita) of FDR Goes to WarHe is a member of the FEE Faculty Network