In his State of the Union address earlier this year, President Obama spoke of the need for the federal government to help boost the economy by making “investments” in a wide variety of areas, including construction jobs, high-speed rail, education, biomedical research, “clean energy” technology, and even high-speed wireless Internet access. But this “investment” is just a code word for more spending on pet programs. This will only lead to more economic stagnation, not economic recovery, because the wealth-consuming nature of public investment is fundamentally different from the wealth-creating nature of private investment. Taxpayers ignore this difference at their peril.

President Obama’s form of investment promises to “create countless new jobs for our people,” but he does not stop to ask from where the money to pay for all these new jobs will come. It must be taken from others “of our people,” either today, through tax increases, or tomorrow, through borrowing (which will harm the economy in the future and delay the ultimate recovery). Of course, taking money from taxpayers to fund these new jobs means there is less money left in the private sector to invest in new jobs and business growth.

The crucial difference between the public sector and the private sector is that the public sector cannot create wealth; it can only shift resources from one group of people to another (after skimming some off the top to placate special-interest campaign donors and support bureaucratic inefficiency, of course). In the private sector, job growth—and economic growth generally—occurs when firms create something that consumers value. In the public sector, government growth occurs whenever government can appropriate more money from the people, and these funds are directed to whatever politicians desire.

The government’s “investment” in green energy startup Solyndra Inc. is a case in point. Last May, President Obama visited the Fremont, California-based solar panel maker in a highly publicized photo-op to hail it as the kind of business in which he thinks the country should invest. And that’s just what the government did. In September 2009 the administration announced that it was awarding Solyndra $535 million in taxpayer-funded loans to finance the construction of a new solar-equipment factory. The following June, just one month after the President’s visit, the company cancelled its initial public offering, and its CEO quit the following month. In November 2010 the company announced it was abandoning its plans to expand its Fremont facility (and the planned hiring of a thousand workers) and would even have to close another factory in the East Bay, eliminating nearly 200 additional workers. That’s some investment.

Throwing Good Money after Bad

This episode did not prevent Obama from visiting another green-energy company two days after delivering his State of the Union address to tout the benefits that surely would come from investing in such technology. During his trip to renewable-energy firm Orion Energy Systems in Manitowoc, Wisconsin, Obama lamented that the United States was falling behind the investment of even more centrally planned economies: “China’s making these investments and they have already captured a big chunk of the solar market, partly because we fell down on the job. We weren’t moving as fast as we should have. Those are jobs that could be created right here that are getting shipped overseas.” While China has made great strides toward a more open economy in the past couple decades, the communist country is hardly a model for economic policy. China’s growth is due to its economic liberalization, not the arbitrary decisions of the ruling elite, yet these command-and-control elements of economic planning that remain in China seem to be Obama’s model of the ideal. This does not bode well for economic liberty and growth here in the United States.

Government has never been particularly good at picking economic winners. Consider, for example, the government “investments” in Amtrak, which has never turned a profit since it began service in 1971 and has lost about $35 billion in its 40 years of operation—or the U.S. Postal Service, which lost a record $8.5 billion last year alone and has projected an additional $6.4 billion loss this year.

The reason for this failure of government investment is not simply poor leadership (although this is certainly endemic and does not help matters) but rather an inability to determine value in the public sector. There is no market price system in government, so there is no measure of profit and loss. As Mises noted in Human Action, “There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were.” In Bureaucracy he added, “Bureaucratic management is management of affairs which cannot be checked by economic calculation.”

Value

In a free market prices are determined by supply and demand, by changing consumer preferences, differing knowledge and evaluations of market information, and the risk-taking of entrepreneurs. A greater desire for a good or service will be reflected in consumers’ willingness to pay more for it and bid up the price.

In the political sphere “value”—such as how much to spend on a particular government program—is determined by the force and influence politicians, bureaucrats, and special interests can exert to extract money from taxpayers and divide it up as these elites please. There is rarely even any semblance of competition for the provision of these services and thus little incentive to maximize productivity and service quality or minimize costs. Since there are no price signals to reveal people’s preferences for one thing or another, there is no good mechanism to determine if programs are useful or satisfying constituent demands.

In the absence of a true market price mechanism, how do you tell if an investment is profitable? And where is the incentive to avoid unprofitable investments? If a government program is deemed successful, there are calls to provide more funding. If it is a failure, we are told we must double down on the spending in order to turn it into a successful program.

Private investment means putting your own money at risk in anticipation of realizing a gain later; public “investment” means taking and spending someone else’s money to support your idea of how you think they should live, or to satisfy the special interests that help get you reelected. Private investment requires putting off spending today so that you may (hopefully) earn more in the future; public “investment” is all about spending today.

Unfortunately, the federal government has not learned the lessons history has tried to teach us about subsidizing business and illusory job growth. This ignorance is especially on display when politicians react to the onset of a recession. The prescription made famous by economist John Maynard Keynes is to “stimulate” the economy through government spending and job creation (otherwise known as “make-work”). Never mind that this means fighting a problem of too much debt by incurring even more debt. As Freeman columnist Robert Higgs, senior fellow in political economy at the Independent Institute and author of Crisis and Leviathan, has said, “Every drunk understands this way of fighting depressions.”

Lost Decade

In the 1990s—and beyond, as it turned out—Japan faced a financial crisis as asset bubbles in the real estate and stock markets, stoked by the central bank’s expansionist monetary policy of the late 1980s, burst and prices came crashing down. The ensuing government response and policy errors paralyzed the economy and ultimately led to a series of economic recessions. Japan followed the Keynesian remedy—with disastrous results—and the country still has not recovered to this day. During the 1990s, Japan passed ten fiscal stimulus packages, focused largely on public works. When one construction plan did not work (meaning it did not return the economy to rapid growth), another was tried. Altogether the Japanese government spent about $6.3 trillion on construction-related projects between 1991 and 2008. Those plans did not revive the economy, but they did saddle the nation with a mountain of debt that postponed any recovery at all for many years, leading the period to be dubbed Japan’s “Lost Decade.”

The construction jobs for the government’s infrastructure projects were not sustainable and did not lead to systemic economic growth. Public debt skyrocketed, unemployment actually doubled, and the economy remained stagnant. (Does any of this sound familiar?) As Gavan McCormack, Pacific and Asian history professor at the Australian National University, noted in his book The Emptiness of Japanese Affluence, “The construction state is in some respects akin to the military-industrial complex in Cold War America (or the Soviet Union), sucking in the country’s wealth, consuming it inefficiently, growing like a cancer and bequeathing both fiscal crisis and environmental devastation.”

The Great Depression

Even during the Great Depression, often held up as a great example of government creating jobs to help get the nation out of an economic recession, President Roosevelt’s massive spending program, which actually had its roots in the Hoover administration, did not stimulate the economy. Despite all that spending and all those jobs programs, unemployment remained extremely high. Prior to the stock market crash in 1929, the unemployment rate stood at a little over 3 percent. By 1933, in the midst of massive spending and public-works projects, it had risen to 25 percent. Even after years of New Deal programs unemployment remained around 15 percent or higher through 1940. It was not until World War II that unemployment dropped back to the low single digits (and then only because millions were drafted into military service).

This led Henry Morgenthau, treasury secretary under Roosevelt, to make a startling admission in 1939:

We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. . . . I say after eight years of this administration we have just as much unemployment as when we started. . . . And an enormous debt to boot! (Morgenthau Diary, Roosevelt Presidential Library)

The fact is that economic recessions—and even more serious depressions—need not be so severe or so long-lived. It is government policies that prevent the natural pressures and incentives of the market from purging bad investments and other economic decisions and returning to a path of stable growth. As Murray Rothbard wrote in the introduction to the third edition of his book, America’s Great Depression,

Before the massive government interventions of the 1930s, all recessions were short-lived. The severe depression of 1921 was over so rapidly, for example, that Secretary of Commerce [Herbert] Hoover, despite his interventionist inclinations, was not able to convince President Harding to intervene rapidly enough; by the time Harding was persuaded to intervene, the depression was already over, and prosperity had arrived. When the stock market crash arrived in October, 1929, Herbert Hoover, now the president, intervened so rapidly and so massively that the market-adjustment process was paralyzed, and the Hoover-Roosevelt New Deal policies managed to bring about a permanent and massive depression, from which we were only rescued by the advent of World War II. Laissez-faire—a strict policy of non-intervention by the government—is the only course that can assure a rapid recovery in any depression crisis.

After more than two and a half years and trillions of dollars worth of bank and auto industry bailouts, stimulus packages, and Federal Reserve interventions, the American economy remains sluggish and unemployment is still about 9 percent. According to Federal Reserve Chairman Ben Bernanke, it could take another four or five years for the labor market to “normalize fully.” Unless the government’s interventionist policies are abandoned and reversed, it appears that the United States is headed for its own Lost Decade.

The United States’ $14 trillion federal debt and annual deficits of over $1 trillion are reducing productivity and hindering economic growth. It is time we learned the repeated lessons of the past that government spending, particularly when used to try to stimulate an economy, is simply a bad investment.

Let’s concede for argument’s sake there is something unattractive about viewing patients as consumers. Krugman writes, “Medical care, after all, is an area in which crucial decisions—life and death decisions—must be made. Yet making such decisions intelligently requires a vast amount of specialized knowledge.”

All true, but not necessarily decisive in answering Krugman’s question—because if we reject the patient-as-consumer model, we must then ask: What’s the alternative?

I believe the answer is this: If the patient is not a consumer he or she will be a ward of the State or a government-empowered insurance company. If the choice is between consumer and ward of the State, consumer doesn’t look so bad after all.

To see what ward status means, ponder Krugman’s thoughts on the Independent Payment Advisory Board, Obamacare’s Medicare cost-cutting apparatus:

“About that advisory board: We have to do something about health care costs, which means that we have to find a way to start saying no. In particular, given continuing medical innovation, we can’t maintain a system in which Medicare essentially pays for anything a doctor recommends. . . .

“And the point is that choices must be made; one way or another, government spending on health care must be limited” (emphasis added).

Much of what Krugman says here is correct. Resources are finite. Choices must be made. No matter how medical care is paid for, spending will be limited—regardless of what demagogues imply. But under Krugman’s patient-not-as-consumer model (which is largely in effect today), government experts make all the important decisions. Bureaucrats will have a global budget for medical spending, and it will be their job to stick to that budget. They will not be the patients’ agents. Advocates of this scheme insist the quality of medical care will not be cut along with costs. They assure us they will prohibit only “unnecessary” and “wasteful” procedures. But how objective are those categories? And why should we trust unaccountable bureaucrats and “experts” to make the right decisions, as though there were one-size-fits-all answers in medicine?

The upshot is that anyone who has his or her medical bills paid by the taxpayers will ultimately be at the government’s mercy. If you’re not a consumer you’re a ward of the State.

But won’t private medical coverage also have restrictions? The difference is that if medical coverage were offered in a freed market—no privileges, no licenses, no protectionism—the environment would be competitive. When government is in charge competition disappears or is vastly constrained to the point where it hardly matters. In a competitive environment entrepreneurs seek to discover what services best satisfy their customers’ requirements. Note well: This environment includes nonprofit solutions, such as mutual-aid societies, which through “lodge practice” managed to provide decent medical coverage to people of modest means in earlier times (tinyurl.com/cjca68).

Competition is a discovery process (Hayek). Government is the habitat of bureaucrats who pretend they know it all already.

Krugman cautions, “[B]ear in mind that we’re not talking about limits on what health care you’re allowed to buy with your own (or your insurance company’s) money. We’re talking only about what will be paid for with taxpayers’ money.” This is disingenuous.

After being taxed all their lives, how many elderly people are in a position to forgo Medicare in favor of private insurance? Government creates dependence, then exploits that dependence to justify its power.

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Even if the flawed Consumer Price Index isn’t quite showing it yet, there is talk of inflation in the air. What exactly is going on? One of our sharp economy watchers, Warren Gibson, doesn’t like what he sees.

Advocates of government expansion have not found the Constitution a terribly formidable barrier. Could a better-written preamble have helped? James Payne thinks perhaps it would have.

Schools run by state and local governments are bad enough, but how about a single national school system run from Washington, D.C.? The best-kept secret these days is the Obama administration’s moves toward a national curriculum. Neal McCluskey has the unpleasant details.

H. L. Mencken famously suggested that fear among the people is the government’s best friend. James Bovard finds ample empirical evidence for Mencken’s thesis.

Why are markets, despite their palpable benefits, morally tainted in so many people’s eyes? F. A. Hayek thought it’s because markets don’t embody the nurturing morality of the family that we first learn as children. Dwight Lee endorses Hayek’s explanation and points out that we wouldn’t like the results if great societies were run like families.

After a natural disaster the high-profile first response leaves the impression that no alternative to a centrally planned recovery is available. Peter Boettke says that’s a failure to look more closely.

Labor unions continue to be at the center of controversy. Despite appearances, Wendy McElroy writes, government-backed unions limit workers’ ability to organize in their own interest.

Just because two things are called by the same name is no reason to assume they are actually the same. Take the case of private-sector and government investment. Adam Summers does just that.

Our columnists’ inquiring minds have produced a smorgasbord of provocative fare: Thomas Szasz ponders the legal status of suicide. Stephen Davies looks at Japanese commercial virtues. John Stossel thinks police making arrests have no right to privacy. David Henderson says no particular person can say how much manufacturing Americans should engage in. And Gary Chartier, encountering a newspaper columnist’s claim that opposing military intervention indicates indifference to suffering, responds, “It Just Ain’t So!”

Books on the mistreatment of taxpayers, economics, and an infamous automobile catch the fancy of our reviewers.

Few historians, however, describe the costs of the war. Not just the 620,000 individuals who died, or the devastation to southern states, but the economic costs of waging total war. What was the economic impact of the Civil War on American life?

The first and most important point is that the Civil War was expensive. In 1860 the U.S. national debt was $65 million. To put that in perspective, the national debt in 1789, the year George Washington took office, was $77 million. In other words, from 1789 to 1860, the United States spanned the continent, fought two major wars, and began its industrial growth—all the while reducing its national debt.

We had limited government, few federal expenses, and low taxes. In 1860, on the eve of war, almost all federal revenue derived from the tariff. We had no income tax, no estate tax, and no excise taxes. Even the hated whiskey tax was gone. We had seemingly fulfilled Thomas Jefferson’s vision: “What farmer, what mechanic, what laborer ever sees a tax-gatherer of the United States?”

Four years of civil war changed all that forever. In 1865 the national debt stood at $2.7 billion. Just the annual interest on that debt was more than twice our entire national budget in 1860. In fact, that Civil War debt is almost twice what the federal government spent before 1860.

What’s worse, Jefferson’s vision had become a nightmare. The United States had a progressive income tax, an estate tax, and excise taxes as well. The revenue department had greatly expanded, and tax-gatherers were a big part of the federal bureaucracy.

Furthermore, our currency was tainted. The Union government had issued more than $430 million in paper money (greenbacks) and demanded it be legal tender for all debts. No gold backed the notes.

The military side of the Civil War ended when Generals Ulysses S. Grant and Robert E. Lee shook hands at Appomattox Court House. But the economic side of the war endured for generations. The change is seen in the annual budgets before and after the war. The 1860 federal budget was $63 million, but after the war, annual budgets regularly exceeded $300 million. Why the sharp increase?

First, the aftermath of war was expensive. Reconstruction governments brought bureaucrats to the South to spend money on reunion. More than that, federal pensions to Union veterans became by far the largest item in the federal budget (except for the interest payment on the Civil War debt itself). Pensions are part of the costs of war, but the payments are imposed on future generations. In the case of the Civil War, veterans received pensions only if they sustained injuries severe enough to keep them from holding a job. Also, widows received pensions if they remained unmarried, as did their children until they became adults. Confederates, of course, received no federal pensions.

Pensions and Tensions

The Civil War pensions shaped political life in America for the rest of the century. First, northern states benefited from pension dollars at the expense of southern states. That kept sectional tensions high. Second, Republicans “waved the bloody shirt” and blamed Democrats for the war. Republican presidents had incentives to keep the pension system strong, and the Grand Army of the Republic (GAR) lobbied to get as much money for veterans as possible.

The federal government established pension boards to determine whether injuries to veterans warranted a pension. But the issue was complex. Sometimes, veterans created or faked injuries; others argued that injuries received after the war—for example, falling off of a ladder while fixing a roof—were really war injuries. If the pension board turned down an application, the veteran sometimes pleaded to his congressman—who was often able to get a special pension for his constituent through Congress. The corrupt pension system corroded politics for the whole 1865-1900 period.

President Grover Cleveland tried to stop congressmen from voting pensions to constituents with bogus injuries by vetoing bill after bill. His successor, Benjamin Harrison, “solved” the problem by signing the Blair bill, which liberalized pensions to the point that even old age made a veteran eligible for a pension. During the 1890s, after most veterans had died, pension payments remained a huge and corrupting item in the federal budget.

The economic impact of the Civil War extended beyond pensions. One argument made during the war was that transportation needed to be improved to connect California with the other Union states. President Lincoln signed a bill establishing federal subsidies for building two transcontinental railroads.

Lincoln was a gifted writer and an able defender of natural rights, but on railroad subsidies he had a reverse Midas touch. During the 1830s, for example, when Lincoln was in the Illinois legislature, he helped lead the charge for a $12 million subsidy to bring railroads to the major cities of Illinois. Unfortunately for Lincoln, the money was wasted and the railroads largely went unbuilt. According to William Herndon, Lincoln’s law partner, “[T]he internal improvement system, the adoption of which Lincoln had played such a prominent part, had collapsed, with the result that Illinois was left with an enormous debt and an empty treasury.”

Bribes Across America

When Lincoln signed the transcontinental railroad bill in 1862, he was creating an even larger boondoggle. The Union Pacific and Central Pacific Railroads were to be paid by the mile to lay track from Omaha to Sacramento. Thus, the UP and CP had incentives to create mileage, but not quality mileage. Their railroads were sometimes not straight, and other times went over hilly terrain that was impossible for a train to surmount. When finished, parts of what they had built were unusable, but both lines had paid off politicians (with some of their subsidy money) to continue the subsidies and not inquire closely on how they were being spent.

Lincoln is not responsible for the corruption that occurred after he died, but the Republican leaders during the war committed themselves to many federal interventions other than the constructive one of ending slavery. The National Banking Act of 1863, and amendments to it, brought greater federal control to banking and imposed a 10 percent tax on state bank notes.

The Morrill Act of 1862 gave 17.4 million acres of federal land to states to build land-grant colleges to teach citizens agriculture and science. Gifts of land and statements of educational focus seem like minor interventions, but the Constitution gave no role to the federal government in subsidizing education or creating universities. The Morrill Act became an entering wedge for later interventions (the Hatch Act of 1887 and the Smith Lever Act of 1914) that established direct federal subsidies to those same land-grant colleges.

Once the federal government intervenes in an area, it’s hard to remove the controls and easy to expand them. The Gilded Age generation did, however, halt some of those Civil War interventions. Those moves back to freer markets in the late 1800s help account for the tremendous economic growth during that time.

Some Rollbacks

The starting point here is the decision after the Civil War to reduce the $2.7 billion national debt. From 1866 to 1893, the U.S. government had budget surpluses each year and slashed the national debt to $961 million. Annual revenue during these years was about $350 million and expenses were about $270 million—most of which consisted of Civil War pensions and interest on the national debt.

One reason the federal budgets tended to be lower in the 1880s than in the 1860s and 1870s was that interest payments on the debt declined sharply as the debt disappeared. For example, the annual interest on the national debt dropped from $146 million in 1866 to only $23 million in 1893. The generation that fought the Civil War became the politicians of the Gilded Age, and they had the fortitude to wipe out almost two-thirds of the Civil War debt.

Speaking of Civil War politicians, those in the Grant administration—long maligned by historians—established many of the conditions for the freedom and prosperity of the Gilded Age. For example, Grant helped make sure the U.S. government had budget surpluses by winning $15.5 million from Britain for damages done to Union ships by the Alabama and other ships the British built for the Confederates. In 1875 Grant also signed the Specie Resumption Act, which promised to redeem the Civil War greenbacks for gold. Grant committed the United States to a sound currency and fiscal restraint.

Also under Grant, the income and estate taxes were abolished in 1872. He committed the U.S. government to budget surpluses with revenue almost exclusively drawn from tariff duties and excise taxes on alcohol and tobacco. Even before Grant was able to abolish the income tax, he had it changed from a progressive to a flat tax.

The income tax during the Civil War—the first in U.S. history—was not onerous by today’s standards. Early in the Civil War, Congress passed a flat 3 percent tax on all income over $800 (which was much more than most families earned). Then Congress made the tax progressive and raised the top marginal rate to 10 percent.

When Grant had the income tax abolished, he returned the nation to the tax system envisioned by the Founders. In Federalist 21, for example, Alexander Hamilton defended a system of consumption taxes (tariffs and excises) against income taxes—which can be more divisive and more easily manipulated by politicians. Under consumption taxes, Hamilton argued, “The amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources.”

Hamilton added, “If duties are too high, they lessen the consumption. . . . This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.”

After the Civil War, Americans chose to consume alcohol and tobacco in sufficient quantities to help pay down the debt each year for most of the rest of the century. American industry recovered under such limited government, and the Civil War generation paved the way for economic greatness. They overcame much of the financial damage from the Civil War.

What prompted the compromise was the looming increase in everyone’s income tax rates on January 1 and Obama’s inability to maintain the middle-class rates while letting the rate on the top 2 percent of income earners rise, as he had promised to do during his campaign.

The first thing to note is that the media and other participants in the discussion have been sloppy (at best) in calling this a debate about tax cuts. Preventing a tax increase—even one set on automatic—is not a cut. Under the bill passed the tax rates in effect on December 31 were the same as those in effect on January 1. How is that a cut?

More important, all players in the game have revealed themselves to be interventionists. Regardless of party, they see the economy as something to fix by turning a knob here, pulling a lever there, and stepping on a pedal over yonder in order to get the desired performance: higher consumer spending, lower unemployment, and increased investment. It’s as though the economy were a machine. But an economy is not a machine. It’s a network of people engaged in myriad exchanges of goods and services—pursuing end-oriented activities informed by subjective values and expectations. Such information is largely unavailable to politicians, bureaucrats, and their economic advisers. That’s why politically managed economies are chronically problem-ridden.

With unemployment at press time officially at 9.4 percent, the economy indeed remains in the doldrums. None of the palliatives that George W. Bush or Obama tried has worked, but instead of realizing that government and its corporate-state policies are the obstacles to a flourishing economy, the ruling elite remains committed to the managed economy. So it’s decided not to raise taxes—for two years—and to reduce the employee payroll tax—for one year. These expiration dates are signs of political management. Understanding the necessity of a freed market would lead one to call for permanent—not temporary—government retrenchment.

Some questions were apparently overlooked. If tax rates may go up in two years, why make tax-sensitive long-term plans? If the payroll tax is to be two points lower in 2011, that implies it will most likely be two points higher in 2012. Will people spend the extra money next year or save it in anticipation of the tax increase to come? In any event, they will need to make an unpleasant adjustment in their household economies on January 1, 2012. People do think long-term, even if politicians don’t.

Of course, there was scarcely an acknowledgment during the debate that money subject to taxation belongs to someone and not the State. You’d think it magically appears in a common pot and the government’s job is to ladle it out effectively and fairly.

In objecting to politicians’ taking money through taxation, I am not unmindful that in America much money is made through what sociologist Franz Oppenheimer called “the political means” (as opposed to the economic means: voluntary exchange). The plutocracy is real, thanks to the centralizing effect of much government intervention and the nature of politics. But the way to prevent accumulations of wealth via the political means is not taxation but elimination of privilege—that is, all competition-stifling interventions, including barriers to self-employment. The answer to government power can never be more government power. All that gets you is bigger government.

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In 1950 FEE founder Leonard E. Read faced a hostile congressional committee. Those were the days when advocates of individual liberty were subpoenaed by government investigators because of their views. David Beito tells the story.

Regardless of what selected statistics indicate, for many people the Great Recession goes on. Angel Martín Oro discusses the various theoretical explanations of what’s happening.

Newsweek has declared the U.S. presidency an impossible job. Did it therefore recommend shrinking the size and scope of government? Richard Fulmer analyzes the mainstream news magazine’s solution.

Though expelled from the monetary system long ago, gold refuses to go away. Why does it have such an allure, and will it make a comeback? Warren Gibson begins a two-part series on what some call real money and Keynes called the “barbarous relic.”

When the United States was demoted from “totally free” to “mostly free” in a recent measure of economic freedom, Kevin Carson wondered when it was “totally free.” That depends on whose freedom matters to the measurers, he explains.

Advocates of freedom constantly look for an effective strategy to roll back the power of government. What about establishing freedom outside government’s reach on the high seas? Patri Friedman and Brad Taylor see promise in that approach.

Much of the impetus for government stimulus of the economy comes from the notion of “underutilized resources.” Private spending is insufficient to put labor and capital to work fully, so government spending will have to do it. Tyler Watts exposes the bad economic theory within.

Our columnists have these enlightening offerings: Thomas Szasz explores how psychiatry thinks about coercion. Robert Higgs revisits Lyndon Johnson’s Great Society. John Stossel asks why some people in the world are stuck in poverty. Charles Baird warns of union card check by nonlegislative means, while Art Carden and Steven Horwitz, having been bombarded with the message that the TSA keeps us safe, respond, “It Just Ain’t So!”

Books on liberty, too-big-to-fail, economic self-interest, and intellectuals have occupied our reviewers.

The book is somewhat bloated, but the tale is compelling. It starts as Bear Stearns, the smallest of the five Wall Street investment houses, wobbles on the edge of bankruptcy. Treasury Secretary Henry Paulson and the Federal Reserve facilitate JP Morgan’s takeover of Bear, leaving Lehman the smallest of the remaining investment banks. Its stock drops precipitously.

From a huge cast of characters, one man emerges as a tragic figure—Lehman chief executive Richard Fuld. He became obsessed with short sellers (traders who borrow and sell shares to profit from a future price decline), blaming them for spreading malicious rumors about Lehman instead of confronting the bank’s real weakness. That was one in a series of dreadful mistakes. With Fuld’s backing, Lehman president Joseph Gregory had pushed the bank into mortgages, commercial real estate, and leveraged loans. He put inexperienced managers in charge of those activities and got rid of specialists who warned of danger. Catastrophic losses from the real-estate slump were killing Lehman by 2008. Short selling the stock was a symptom rather than a cause of the disease.

Sorkin recounts Lehman’s destruction, which occurred despite Fuld’s increasingly frantic efforts to raise capital or sell the company. Bank of America bought Merrill Lynch instead of Lehman, with the blessing of the Treasury and the Fed. A deal was worked out with Barclays Capital but scuttled at the last minute by British regulators, a debacle their American counterparts could almost certainly have prevented.

Timothy Geithner, then head of the New York Federal Reserve, was fixated on merging other banks. During a tense phone call, he effectively ordered Morgan Stanley chief John Mack to sell his company to JP Morgan for almost nothing. “I just won’t do it,” Mack said and hung up. There was no good business reason for the merger, and JP Morgan chief Jamie Dimon did not want it either.

Mack managed to save Morgan Stanley by getting capital from the Japanese bank Mitsubishi. Had Geithner succeeded in bulldozing Mack into selling, tens of thousands of employees would have lost their jobs and the too-big-to-fail problem would have been exacerbated. The incident does not inspire confidence in Geithner, currently Treasury secretary.

Another bad shotgun marriage was arranged by Sheila Bair, head of the Federal Deposit Insurance Corporation, who decided to sell Wachovia to Citigroup with a government guarantee for toxic assets. Fortunately, Wells Fargo chief Richard Kovacevich, who was interested in Wachovia all along, took action just in time. Wells Fargo was willing to pay a higher price without a taxpayer guarantee.

These events raise the question of why government agents can dispose of other people’s property. They certainly don’t seem to worry about preserving the value of businesses or reducing taxpayer liability.

What’s the lesson in this? Unfortunately, Sorkin doesn’t make the big picture clear. The boom-and-bust happened because the Fed opened the floodgates to easy money. That’s what got everybody, from the second-mortgaged homeowner to Lehman Brothers, to leverage up. Our supposedly expert government players apparently never realized this: Their conceit that they know how to manage the economy is the root of our trouble.

They might avoid fueling bubbles, but let’s leave that aside, since Sorkin doesn’t dig that deep. He describes interventions notable, among other things, for their sheer arbitrariness. The Fed and Treasury backstopped Bear Stearns debt in the acquisition by JP Morgan, but would not do the same for Lehman. The first action created expectations that the same support would be available for other banks and led to a false sense of security. There is no obvious reason why two sets of bond holders should be treated differently. It would be vastly better if government officials were deprived of the authority to bail out anyone.

Our financial system has suffered tremendously as a result of capricious interventions by government officials who themselves never bear any costs from the adverse effects of their decisions. If anything, they benefit. Though the entire boom-bust cycle provides evidence that government agencies, from the Fed on down, should have far less discretion, the massive financial regulation law passed this year rewards them with greater powers and wider room to do whatever they want. We should be afraid of the economic and social damage their arbitrary actions will wreak in the future.

Eventually, politicians sensed there would be votes coming their way if they put supposedly expert and compassionate ideas like public housing into effect. The result was that many people were displaced into worse housing than they’d previously had and those “lucky” enough to get into the new government housing projects soon found them abominable. But what about the intellectual progenitors of public housing? They suffered in no way. No professorships were lost; no reputations were damaged. If any intellectuals who had advocated “urban renewal” had any pangs of conscience over it, they issued no mea culpas.

In Intellectuals and Society Thomas Sowell essays a devastating assessment of the role that intellectuals play in modern life. Their impact, he argues, is overwhelmingly detrimental and stems from their ability to use their primary skill (“verbal virtuosity,” he terms it) to get those in power to reorganize the world in accordance with their theories about how society should function. Those theories usually entail government coercion euphemistically called “planning” or “regulation.”

When it’s good, this book is magnificent. Here is one of many excellent, quotable passages: “Intellectuals are often extraordinary within their own specialties—but so are chess grandmasters, musical prodigies and many others. The difference is that these other exceptional people seldom imagine that their talents . . . entitle them to judge, pontificate to, and direct a whole society.” That sums up the problem with intellectuals very nicely.

Intellectuals are usually so absorbed in their visions for a better world that they have no patience for the gradual change that comes through market processes and voluntary action. Why wait for “social justice” outcomes such as the elimination of poverty or the end of discrimination if the government can simply mandate higher wages or outlaw “unfair” hiring practices? Sowell acknowledges that some intellectuals understand that State coercion, no matter how splendid the intentions behind it, is counterproductive. Most of them, however, continue advocating programs built around mandates, prohibitions, and taxes. Power is their opiate.

Sowell highlights a curious feature of many intellectuals: namely, their indifference to evidence that questions the wisdom of their pet policies. Gun control is a good example. Do gun control laws actually reduce violence? A wealth of data shows that antigun statutes have precisely the opposite effect. You might expect that people who are ostensibly committed to rationality would change their minds when faced with such evidence, but that is almost never the case. On the contrary, if you challenge a pro-gun-control intellectual, you are apt to be met with condescension and invective.

It is the same with scores of other issues in which intellectuals adhere dogmatically to cherished beliefs about the benefits of government intervention, no matter how strong the case that they’re actually harmful.

There is, however, a serious flaw in the book. Although Sowell quite correctly observes that the “Progressive” intellectuals managed to embroil the United States in needless wars (especially World War I, but also other conflicts), he cannot or will not see that “right-wing” intellectuals have done similar damage by providing the rationales for our disastrous military escapades this century. Sowell doesn’t explain why the influence of interventionist intellectuals who favored war in the former era was harmful, but the influence of interventionist intellectuals who favor war today is good.

Or we might turn this around and ask why the aversion to conflict and efforts at “nation-building” that characterized Woodrow Wilson’s opponents was sensible, but when (some) intellectuals today question the same sorts of policies, Sowell regards them as blind ideologues. It is the pro-intervention crowd here that is oblivious to the consequences of their favored actions. Convincing a neoconservative intellectual that our “war against terrorism” is counterproductive seems to be on the same order of difficulty as convincing a Progressive that rent-control and minimum wage laws are counterproductive.

Aside from that serious blind spot, however, Intellectuals and Society is a sharp and enlightening book.

Meanwhile, Congress put the finishing touches on a mammoth regulatory bill called the Restoring American Financial Stability Act of 2010. (Editor’s note: It was passed and signed in mid-July.) As I write there is no way to know what final shape it will take. But considering how it was shaping up, what are the probable effects?

The rationale for this vast expansion of government oversight is to prevent, or at least reduce, financial instability, as the bill’s title declares. Therefore it is useful to remind ourselves of why and how markets became so unstable in the first place.

There are two fundamental reasons why markets gyrate. One is human emotion, in particular a penchant for over-optimism about financial prospects, which turns into panic once things go downhill—a pattern known colloquially as greed and fear. Business cycles are unavoidable to the extent they’re rooted in human behavior. On top of this, governments have caused normal cycles to become extreme and destructive with a multiplicity of interventions and their own financial woes—as with Greek sovereign debt.

Thus the boom in the American housing market was set off by optimism that property prices would keep rising and the bust initiated by the panic that ensued when prices faltered. But the cycle became monstrous because the Federal Reserve kept money creation too loose in 2001–2004. To make matters worse, Congress pushed the two government-created entities, mortgage buyers Fannie Mae and Freddie Mac, to go easy on less creditworthy loans.

As a result of these policies, taking out a mortgage became child’s play. People who might have otherwise been more prudent mortgaged up to the hilt, and enormous piles of mortgages became available to be bunched together and turned into securities—a lucrative activity that drew the attention of Wall Street, but was done largely by Fannie Mae and Freddie Mac.

When real estate turned, it took down banks that lent heavily to developers, homeowners who borrowed beyond their means, and financial companies that held or insured mortgage-backed securities. As for Fannie and Freddie, they continue to suck down billions of dollars of taxpayer money every month, with no end in sight.

Human nature has not changed, and the government is becoming more interventionist, not less so. So the conditions that produced the dramatic bubble-and-bust remain in place. How, then, will the Financial Stability Act prevent crises?

Since it is not practical to analyze all the disparate elements that constitute a 2,300-page grab bag of a bill, I will focus on the centerpieces that were most likely to become law. These are from the version of the bill introduced April 15, sponsored by Sen. Christopher Dodd.

The first is the creation of a supra-bureaucracy called the Financial Stability Oversight Council, with nine voting members who are to make decisions by majority vote. Among them are the Treasury secretary, the Federal Reserve chairman, the Securities and Exchange Commission chairman, the director of the Federal Housing Finance Agency, and an independent member appointed by the president.

Almost all council members are heads of departments and agencies that have been around for decades and shown not the slightest ability to prevent risky behavior by financial firms, the population at large, or for that matter themselves and fellow government entities. Somehow, they are supposed to do together what they don’t do on their own.

The act also adds a new bureaucracy, the Office of Financial Research, with responsibility to collect and process data and conduct studies for the council. This newly created apparatus of the council and research office is to work as “an early warning system to detect and address emerging threats to financial stability and the economy,” according to a congressional committee report.

The research office would get the power to subpoena information from any financial company. It is “to develop and maintain metrics and reporting systems for risks to the financial stability of the United States” and “monitor, investigate, and report on changes in system-wide risk levels and patterns.”

If you ask what the systemwide risks are, you won’t find an answer in the act. The director of the office, appointed by the president for a six-year term, “shall have sole discretion in the manner in which” he or she exercises the authority provided by the bill. Indeed, the wide discretion the bill provides to future bureaucrats is remarkable. What they’re going to do to promote stability is about as clear as how snake oil was supposed to cure cancer, bunions, and lovesickness.

The act says certain bank companies may be required to have a “risk committee” with “at least one risk management expert having experience in identifying, assessing, and managing risk exposures of large, complex firms.” That is like requiring water to flow downhill. Almost every financial business already has risk control people. Even hedge funds have risk managers.

Risk management is a well-established discipline with an ever-increasing number of practitioners who spend their time trying to measure and reduce future hazards. In finance the number of risk management experts has grown tremendously in past years—without any legal mandate. These specialists have been notably unsuccessful in preventing occasional crises, as the past several years demonstrated.

Risk experts constructed the mathematical models that gave misleadingly benign views of the dangers in mortgage-related complex instruments. The models will improve over time, but will occasionally be mistaken regardless of legal requirements. It is not the case that financial companies want to lose money.

The basic reason they sometimes do lose money is that making money requires some risk. This is no different from many other activities, such as drilling for oil. Yes, you can end up with a nasty spill, but no risk, no oil. Similarly, no financial risk, no financial gain.

The object is not to avoid risk but rather to keep it under control, and that has always been a most delicate task. The early twentieth-century economist Frank Knight made a distinction between risky situations, where the possible outcomes and their odds can be estimated, and uncertainty, where there is no meaningful way to know the probabilities. There are known unknowns and then there are unknown unknowns.

Throwing dice exemplifies risk with known odds. By contrast, Fannie Mae (which, along with Freddie Mac, is unaddressed in the new law) is a source of uncertainty; the consequences of its creation were unexpected, and its future is an unknown unknown at this time. It stands as a shadowy but colossal monument to man’s ability to create monsters in the name of doing good.

Dealing with risk is hard enough; we’re lost dealing with uncertainty. This shows up especially with rare but big events—known as the tail risk of a bell-shaped probability distribution. More vividly, Nassim Nicholas Taleb, a trenchant critic of financial industry practices, has dubbed them black swans.

As long as an event like the real estate slump has not yet happened, people make money by ignoring it. Therefore risk managers “play politics, cover themselves by issuing vaguely phrased internal memoranda that warn against risk-taking activities yet stop short of completely condemning [them],” to quote from an earlier book by Taleb, Fooled by Randomness, published a decade ago—when risk managers were already recognized players.

Same Goes for Government

This criticism applies no less to government agents. Nobody has a reliable way to predict rare events, and human nature is all for ignoring them. Regulators don’t do any better—from the chairman of the Federal Reserve on down, officials issue vague warnings but don’t stop risk-taking. After all, they are subject to the same behavioral biases and face similar incentives. Just as shareholders are displeased when a bank does not make money, voters are displeased when a government imposes economic hardship.

Therefore, like banks, governments keep dancing as long as the music lasts. It is hard to imagine that changing. So preventing future crises is the least likely outcome of the Stability Act. But might it have some other benefit?

Emergency measures used by the U.S. Treasury and the Federal Reserve to prop up companies in 2008–2009 left in their wake the absurd problem of too-big-to-fail—taxpayers appear to be on the hook for any large financial concern whose failure might have far-reaching impact. Given that taxpayers also ended up with the vast pension liabilities of General Motors, the problem of bailouts is not really confined to financial companies, though it is widely described as such.

Nobody wants a repeat of the widespread panic and losses caused by the bankruptcy of Lehman Brothers in September 2008. That failure resulted in market chaos in large part because the assets of Lehman clients got tied up in bankruptcy courts, not just in the United States but in the United Kingdom. With their capital frozen in years-long litigation, the clients sold securities to raise money, with the predictable catastrophic effect on prices.

So instituting a process by which large financial companies can be shut down without a lengthy bankruptcy case would both reduce the impact of failures and get rid of the notion that investment banks need to be bailed out. Expeditious, orderly, and internationally coordinated winding down of failed companies is an obvious solution for the too-big-to-fail problem.

The act gives the Treasury, in conjunction with judges from the U.S. Bankruptcy Court for the District of Delaware and other agencies, broad powers to take control of a financial business perceived as a threat to the system and turn it over to the Federal Deposit Insurance Corporation (FDIC) for liquidation. The FDIC, which unwinds failed commercial banks, is to do the same for other financial businesses.

“Once a failing financial company is placed under this authority, liquidation is the only option; the failing financial company may not be kept open or rehabilitated,” says a Senate committee report.

That may sound like a way to prevent bailouts, but the government is given such open-ended discretion that perverse outcomes are possible. To go this liquidation route a company does not need to be actually in default as long as the Treasury determines that it is a sufficiently serious threat. On first read, my primary concern was that companies that were not going to fail might be liquidated.

On second thought, it is just as possible that those which are failing will be bailed out instead of being liquidated. This could happen if there are politically powerful interests behind a company. Think of the unions that came out on top in the government’s handling of GM. In effect, we’re asked to trust politicians and bureaucrats. No doubt they will make politically advantageous decisions, with goodies for the politically favored and sticks for the politically vulnerable.

A better alternative to the creation of this extensive authority would be to streamline bankruptcy to make it simpler and faster. The act calls for studies of bankruptcy and international coordination, the latter of which is necessary because large investment banks are global entities—but the possibility of bankruptcy reform is remote. That could reduce legal fees, not something that a Democratic Congress will allow. Lawyers are a major constituency for the Democrats. They will be among the big winners of the regulatory onslaught, which is bound to increase the demand for legal services.

More Of The Same

It is ironic that the act expands the government’s domain in the name of stability, since public policies have increased instability, public functionaries have been clueless in foreseeing threats, and politicians have created uncertainty—with Fannie Mae, for instance.

One of the members of the Stability Council, the Federal Housing Finance Agency, was set up by a 2008 law to be the successor to the Office of Federal Housing Enterprise Oversight. The latter, the overseer of Fannie and Freddie, presided over debacle after debacle, year after year, from accounting shenanigans to endless taxpayer bailouts. Congress obviously wanted an agency with a different name.

But the new bureaucracy is simply the old one merged with another entity. So the same bureaucrats that did so well ensuring the safety and soundness of Fannie and Freddie are supposed to ensure financial soundness on a wider stage in the new setup! If that does not inspire confidence, neither do other members of the council.

The Securities and Exchange Commission let Bernard Madoff continue his Ponzi scheme year after year despite repeated complaints from a whistleblower and even news stories about the fraud. More recently another astounding SEC failure came to light.

In 2009 Texas resident Robert Allen Stanford was nabbed for an $8 billion fraud—Stanford International Bank had for years sold certificates of deposit promising unachievable returns. An investigation found that the SEC Fort Worth office had known since 1997 that Stanford was likely operating a scheme. Despite examinations indicating this, the enforcement division chose not to take action.

The preferred excuse for numerous government debacles is that the bureaucracies lacked authority, personnel, or information. Yet the SEC in fact repeatedly examined Stanford and had the power to stop his activities.

Here is the punch line to the Stanford affair. In a dramatic instance of the revolving door for former regulators, the SEC lawyer who made enforcement decisions at Fort Worth left and represented Stanford—before he was told that this was improper. That’s how regulation works in reality.

Expanded Crony System

The vast new powers given to regulators will no doubt enhance the fees and salaries that former bureaucrats like this SEC lawyer command. They will have greater opportunities to sell their protection and expertise to the regulated and will also, of course, benefit from enlarged budgets while in public employment. Politicians and political staffers, too, will be able to extract more money from the regulated and get lucrative jobs in the financial industry.

This is already an established trend, with President Obama’s former White House counsel moving to Goldman Sachs and a former aide to Rep. Barney Frank on the House Financial Services Committee taking a job with a derivatives exchange. Such crossovers will no doubt become even more common as firms look to protect themselves while government agents get a broad mandate to intervene and decide which companies to liquidate and which to bail out—who’s a systemic risk and who’s not.

Even as they go “tsk-tsk” chiding business lobbies, the President and Congress are laying the groundwork for an infinite growth in the crony system intermingling government with private interests. The rest of us will pay for the resources that will be redistributed in favor of bureaucrats, politicians, lawyers, and the politically favored. The impact of the act on financial stability is uncertain at best, but its corrupting influence on the Republic is a sure thing.

That man was Karl Marx.

Advocates of liberty often suffer bouts of despair. How can the cause of freedom ever triumph in a world so dominated by interventionist and welfare-statist ideas? Governments often give lip service to the benefits of free markets and the sanctity of personal and civil liberties. In practice, however, those same governments continue to encroach on individual freedom, restrict and regulate the world of commerce and industry, and redistribute the wealth of society to those with political power and influence. The cause of freedom seems to be a lost cause, with merely temporary rear-guard successes against the continuing growth of government.

What friends of freedom need to remember is that trends can change, that they have in the past and will again in the future. If this seems farfetched, place yourself in the position of a socialist at the time that Marx died in 1883, and imagine that you are an honest and sincere advocate of socialism. As a socialist, you live in a world that is predominantely classical liberal, with governments in general only intervening in minimal ways in commercial affairs. Most people—including those in the “working class”—believe that it is not the responsibility of the state to redistribute wealth or nationalize industry and agriculture, and are suspicious of government paternalism.

How could socialism ever be victorious in such a world so fully dominated by the “capitalist” mindset? Even “the workers” don’t understand the evils of capitalism and the benefits of a socialist future! Such a sincere socialist could only hope that Marx was right and that socialism would have to come—someday—due to inescapable “laws of history.”

Yet within 30 years the socialist idea came to dominate the world. By World War I the notion of paternalistic government had captured the minds of intellectuals and was gaining increasing support among the general population. Welfare-statist interventionism was replacing the earlier relatively free-market environment. And the socialist ideal of government planning was put into effect as part of the wartime policies of the belligerent powers beginning in 1914.

Socialism triumphed during that period because while socialists advocated collectivism, they practiced a politics of individualism. They understood that “history” would not move in their direction unless they changed popular opinion. And implicitly they understood that this meant changing the minds of millions of individual people.

So they went out and spoke and debated with their friends and neighbors. They contributed to public lectures and the publishing of pamphlets and books. They founded newspapers and magazines, and distributed them to anyone who would be willing to read them. They understood that the world ultimately changes one mind at a time—in spite of their emphasis on “social classes.”

They overcame the prevailing public opinion, defeated powerful special interests, and never lost sight of their long-term goal of the socialist society to come, which was the motivation and the compass for all their actions.

The Superiority of Freedom

What do friends of freedom have to learn from the successes of our socialist opponents? First, we must fully believe in the moral and practical superiority of freedom and the free market over all forms of collectivism. We must be neither embarrassed nor intimidated by the arguments of the collectivists, interventionists, and welfare statists. Once any compromise is made in the case for freedom, the opponents of liberty will have attained the high ground and will set the terms of the debate.

FEE’s founder, the late Leonard E. Read, once warned of sinking in a sea of “buts.” I believe in freedom and self-responsibility, “but” we need some minimum government social “safety net.” I believe in the free market, “but” we need some limited regulation for the “public good.” I believe in free trade, “but” we should have some form of protectionism for “essential” industries and jobs. Before you know it, Read warned, the case for freedom has been submerged in an ocean of exceptions.

Each of us, given the constraints on his time, must try to become as informed as possible about the case for freedom. Here, again, Read pointed out the importance of self-education and self-improvement. The more knowledgeable and articulate we each become in explaining the benefits of the free society and the harm from all forms of collectivism, the more we will have the ability to attract people who may want to hear what we have to say.

Another lesson to be learned from the earlier generation of socialists is not to be disheartened by the apparent continuing political climate that surrounds us. We must have confidence in the truth of what we say, to know in our minds and hearts that freedom can and will win in the battle of ideas. We must focus on that point on the horizon that represents the ideal of individual liberty and the free society, regardless of how many twists and turns everyday political currents seem to be following. National, state, and local elections merely reflect prevailing political attitudes and beliefs. Our task is to influence the future and not allow ourselves to be distracted or discouraged by who gets elected today and on what policy platform.

Let us remember that over the last hundred years virtually every form of collectivism has been tried—socialism, communism, fascism, Nazism, interventionism, welfare statism—and each has failed. There are very few today who wax with sincere enthusiasm that government is some great secular god that can solve all of mankind’s problems. Statist policies and attitudes continue to prevail because of institutional and special-interest inertia; they no longer possess the political, philosophical, and ideological fervor that brought them to power in earlier times.

There is only one “ism” left to fill this vacuum in the face of collectivism’s failures. It is classical liberalism, with its conception of the free man in the free society, grounded in the idea of consent, peaceful association, and individual rights. If we keep that before us, we can and will win.

This misapprehension is helped along by a good part of the economics profession, many of whose members see themselves as the aspiring mechanics.

To state the obvious: an economy isn’t a machine. The term is an abstraction, even a metaphor, and we always get ourselves into trouble by taking metaphors literally. As F. A. Hayek was fond of pointing out, the word “economy” has its roots in the Greek word for household. (Remember those home-economics courses?) Even though a household is composed of individuals, it can usefully be thought of as a unit in the sense that its financial affairs are largely arranged around a single set of ends. (There’s a limit,of course, to how far that can be taken.) We go astray the moment we apply this description to larger collections of people. As soon as we begin talking about the city’s, state’s, or nation’s economy we have severed our moorings from reality because those groupings do not have a single set of ends.

That is why Hayek preferred the word “catallaxy” to “economy”; it comes from the Greek word for “exchange.” A catallaxy is “not a single economy but a network of many interlaced economies” (Law, Legislation, and Liberty, volume 2).

Another economist and Nobel laureate who is sensitive to this matter is James Buchanan, one of the pillars of the Public Choice school of political economy. His concerns are collected in the Liberty Fund volume What Should Economists Do? In the title essay (originally an address given in 1963) Buchanan identifies what can only be described as the central collectivist premise of most economics, namely: some entity larger than the individual—usually the nation—must allocate scarce resources.

Many heavyweights in twentieth-century economics—not just socialists—regrettably let that premise stand, Buchanan points out: Lionel Robbins never identified the allocator; Frank Knight attributed economic activity to the “social organization”; and even Milton Friedman held that (Buchanan quoting) “economics is the study of how a particular society solves its economic problem.” Not that those men did not realize that groups consist of individuals. But as economists, Buchanan fears, they too readily left the impression that economics deals with a collective’s solution to an allocation problem. It’s a short step from a collective to a machine.

That’s not how Buchanan sees economics. In contrast to the view that the economy is a “means of accomplishing the basic economic functions that must be carried out in any society,” he believes “The market or market organization is not a means toward the accomplishment of anything. It is, instead, the institutional embodiment of the voluntary exchange processes that are entered into by individuals in their several capacities.” He adds: “This is all that there is to it.”

Contemplate how different this conception of economy is from the general impression. As Buchanan writes, “Individuals are observed to cooperate with one another, to reach agreements, to trade. The network of relationships that emerges or evolves out of this trading process, the institutional framework, is called ‘the market.’ It is a setting, an arena, in which we, as economists, as theorists (as onlookers), observe men attempting to accomplish their own purposes, whatever these may be.”

In such a conception of economy, where is there room for words like “overheated,” “cooled down,” and “stimulus”?

Economic Subjectivism

In another essay in his book, “General Implications of Subjectivism in Economics,” Buchanan flaunts his affinity with the Austrian school of Hayek and Ludwig von Mises. Here he writes, “The principle that exposure to economics should convey is that of the spontaneous coordination [of individuals] which the market achieves. The central principle of economics is not the economizing process.” And he warns that economics will “become applied mathematics or engineering” if its practitioners think it is.

Subjectivism in economics is the recognition that economic phenomena emerge from what human beings believe, think, and do, and not from data they may know nothing about or rarefied statistical aggregates and averages. Subjectivism is good insurance against seeing the economy as a machine and the government as its vital attendant. Or as Buchanan puts it, “to the extent that subjectivism tends to concentrate attention on the interaction among persons and away from the ‘economic problem,’ an understanding of the principle of order is facilitated rather than retarded.”

Subjectivism can be seen most starkly in the notion of costs. Much economic theorizing (and bureaucratic meddling) regard costs as objective. That perspective encourages social engineering. After all, if those who would move us about the national chessboard had to confess that they cannot know the costs of their maneuverings, they would have a harder time justifying their power.

But they cannot know those costs. “The costs that influence ‘choice’ are purely subjective and these exist only within the mind of the decision-maker,” Buchanan writes. When one confronts two alternatives, one is really confronting two mental projections of what the world might be like in the future. Either or both projections could be wrong. At best they are educated guesses. And since one of those imagined worlds will never be realized, the chooser will never know if he was wrong about that one. But that world forgone is the true cost of the alternative chosen because that’s what the chooser gives up to achieve it. We often think of costs as money paid. But while money is indispensable for making calculations, it does not express the true opportunity cost of a choice. No one wants money for its own sake, but only for what it can buy now or later.

An economy is people cooperating to better their situations. Thus a “stimulus package” is fundamentally objectionable not because of anything that may be in the bill. (Tax cuts are always welcome.) It is objectionable because of its rationale. Government should endeavor to stay out of the way of productive activity at all times, not just when various numbers are deemed too high or low.

But that doesn’t mean federal loan guarantees are in order.

Government should not be trying to pick winners and losers in the energy industry. If one company has its loans backed by the government, other companies without guarantees will have trouble borrowing capital. Bureaucrats don’t know and can’t know whether (or in what combination) nuclear energy, biodiesel, ethanol, solar energy, hydroelectricity, fuel cells, or any other alternatives are “best” for meeting our energy needs. This information can only emerge through market competition.

This is not just about energy. We don’t know—once and for all—the best way to build a computer chip. We don’t know the ingredients for the next tasty trend in food. We’re ignorant about a lot of things we would like to know. Markets—and competition—produce the information that allows us to make decisions. But governments distort it by intervening in the capital markets, by doing things like guaranteeing loans to particular firms.

In other words, we do not find the best way to build a computer chip by having the government offer loan guarantees to firms that use particular production processes. We let firms compete for customers, and in a free market without government interference, firms earn profits when they use resources wisely and produce things people want at prices they are willing to pay.

Solving these problems—what to produce and how—requires information embodied in prices. Few of us buy golden faucets, because they’re too expensive. Prices help producers decide whether to use gold or steel, or try to come up with something better. F. A. Hayek called competition a “discovery procedure.” As they compete with one another for profits, firms discover the best way to produce things. The firms that can maximize the difference between the price of what they produce and the cost of producing it will survive and thrive; those that cannot must change or perish.

Energy prices might not reflect the full costs of production and consumption. There are additional costs—the harm caused by air pollution or climate change (if that’s what’s going on)—that producers do not pay but are imposed on the public generally. Therefore they produce too much energy from dirty sources like coal and too little energy from clean sources like nuclear power. It is intuitively appealing, therefore, to have the government simply pick a cleaner energy source and subsidize it. But this is a mistake that leaves too many questions unanswered. It is a mistake for the same reason that it would be a mistake to order all chip manufacturers to use a 32-nanometer process, or subsidize cake makers that use margarine: The government is in no position to know if these are the best processes to produce the desired results. A 32-nanometer process would be expensive overkill for a pocket calculator, and many people prefer cakes made with butter. The market reaches these conclusions by punishing firms that ignore them.

Similarly, we do not know how much more nuclear power to use, how many more plants to build, and at what point we should start using other energy sources instead.

Firms competing in truly free markets will find the best ways to get desired results. Competition forces the answers on them.

What About Externalities?

But what about those costs that aren’t reflected in prices, the ones from so-called externalities like pollution?

In principle there are better alternatives to government interventions that choose winners and losers. While far from ideal, pollution could be taxed or tradable permits to emit certain pollutants could be established. Power companies with dirtier plants would suddenly find themselves at a disadvantage versus other companies with cleaner plants and would have an incentive to shift toward cleaner energy. Pollution-reduction mechanisms we haven’t even imagined could emerge as firms search for ways to reduce their pollution costs. Maybe nuclear power would make huge gains in the resulting competition; maybe it would not. We cannot know, but we can say that the resulting victors in that competition will be the energy providers that found ways to reduce pollution at the lowest cost.

These are superior, more market-oriented alternatives, but their effective implementation rests on similarly implausible assumptions about the policymakers’ knowledge and incentives. They assume we know (or can know) all the relevant external costs of pollution. They further assume we know (or can know) the socially optimal level of emissions that would prevail in the absence of externalities. They also assume that people acting through the political process are immune to the perverse incentives the programs create. At various times and places environmental initiatives have been co-opted by special interests. Thus we should keep in mind that even more market-oriented regulations will be difficult to get right. There’s no real substitute for the free market.

We can take other actions in addition to those designed to internalize the externalities. For example, government-granted advantages for other forms of energy production should be repealed—the special tax treatment for oil exploration, wind, and ethanol should be eliminated. Instead of targeted favors, taxes should be cut across the board. We should remove regulatory barriers that make it hard to start new power plants but easy to keep innovative competitors out. And, importantly, special limited tort liability must not be permitted for nuclear power or anyone else; thus the Price-Anderson Act, which was passed in 1957 to encourage civilian nuclear power, should be repealed.

The government should stop trying to pick winners and let the competitive process sort things out.

Moore argues that the nuclear plants will create jobs, but this is a canard. When the government assumes a company’s risks, it does not create net new economic activity. It merely reallocates it from one line of production to another. Having government-guaranteed loans for a nuclear power company means other businesses go without loans. Without undistorted prices, profits, and losses, there is no way to know whether value has been created or destroyed.