Against the Welfare State – and Bank Bailouts

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The welfare state is undoubtedly one of the elements of government opposed by libertarians, not only due to its inherent injustice and economic destructiveness, but also because of its ability to provide fuel and sustenance to the growth of the metastasising state

If we are launch a critique of the welfare state we must first attempt to define it and to distinguish it from other categories of government activity. Such a task is not an immediately clear cut one as, fundamentally, all government expenditure sustains the welfare of its beneficiaries. If the government launches an invasion of a foreign country, spending on military grade weaponry, aircraft and whatever else will very much contribute to the “welfare” of armaments manufacturers yet we wouldn’t ordinarily classify this as part of the welfare state. Similarly, if the government decides to build a new road or railway line we wouldn’t usually describe this as providing “welfare” to the construction workers who undertake the leg work (although certain “job creation” schemes that simply pay people to carry out pointless work could be classified as welfare).

Whether or not a particular government outlay is classified as part of the welfare state is therefore defined more by its purpose rather than by its effect. The purpose of a foreign war is usually to gain control of valuable resources (even if it is veneered with an alternative justification such as spreading freedom and democracy). The purpose of building a road or railway is to “improve” the country’s transportation and communication networks. None of these projects is designed to provide some kind of comfortable lifestyle to those who undertake them (and, ignoring the possibility of benefiting favoured lobbyists and donors, to the extent that a government has a particular purpose in mind and wishes to achieve it efficiently it will have a desire to remunerate its suppliers as little as possible rather than as highly).

Welfare spending, on the other hand, is markedly different. Its purpose is always couched in the language of providing some kind of “help”, “care”, or “assistance” to the citizenry, as if the government is a giant nanny who appears with an equally giant milk bottle whenever one’s own teat runs dry. Given this, then, we can attempt to define the welfare state as that portion of government activity which is devoted to the sustenance of either the existing lifestyle of a particular citizen or to a lifestyle that is thought to be the minimum that is equitable in terms of wealth and income. The welfare state therefore provides a cushion or relief from events that may intercede in that lifestyle so, for example, if you get sick, the government will provide you with either free or subsidised healthcare; if you lose your job you will be entitled to unemployment benefit; and if you have baby the government will give you some money so that you are able to take care of it and give it an “adequate” upbringing. Granted, this definition if the welfare state is not precise and it will overlap with many other types of expenditure – few government outlays have a single purpose, even if some of these purposes are not made public – but we can be satisfied that it is reasonably accurate.

In spite of the fact that the welfare state is a moral issue and that its proponents believe that its existence is justified by the fact that the able should take care of the less able (“from each according to his means to each according to his needs”) it is arguable that the strength of its cause derives more from a misunderstanding of economics and that an amelioration of these misunderstandings is likely to weaken the foundations of the welfare state most effectively. Rather, therefore, than elaborating on the fact that the welfare state is, in a genuine free market, a morally unjustifiable confiscation and redistribution of property from its owners to non-owners respectively, let us concentrate mainly on a proper realisation of the economic effects of the welfare state in order to find the source of its undoing.

The type of welfare spending that we will focus on specifically is the bailout of the banks. This selection may appear surprising as surely most supporters of the welfare state are flat out opposed to bailing out the banks? And yet if we look closely, the qualities of bankers’ bailouts fits our definition of welfare spending all but perfectly. The financial services industry was accustomed to its business of expanding credit during the boom years and ploughing them into ultimately unsustainable malinvestments; its practitioners were richly rewarded for doing so and could afford big houses, expensive cars, private schools for their children, exotic foreign holidays, and so on. Metaphorically, they became accustomed to a lifestyle of gambling and partying fuelled by the punch bowl of monetary expansion. Following the inevitable crash that revealed the extent of the malinvestments and the huge losses that would ensue, the bailout of the banks was designed precisely to prevent the liquidation of this crumbling economic structure so that the banks could keep on making loans, keep on making profits from those loans, and so their top employees would not lose the lifestyle to which they had become accustomed. It was meant to refill the punch bowl and to keep the music playing so that the party would never end. The difference, therefore, between bankers’ bailouts and what we typically regard as the welfare state is simply a matter of degree, not of kind. They each provide a taxpayer funded cushion for their respective beneficiaries that insulates their lifestyles from the effects of either their own choices or from events that are beyond their control. Indeed, the collapse of the financial services industry as we know it would also have seriously curtailed the ability of governments to retain their accustomed lifestyle of borrowing and spending. To that extent, therefore, the bank bailouts were an exercise in self-preservation. The only perceived difference between bank bailouts and the welfare state is that the beneficiaries of the former were “rich” and not “poor”, which, it must be understood, is itself a misrepresentation. Many of those affected by a collapse of the financial services sector would not necessarily have been multi-millionaires as any insolvencies and downsizing is likely to have hit those lower down the pecking order first such as local branch managers and tellers before it hit those in the penthouse offices.

We have outlined this description of bank bailouts because every single argument that welfare statists use to oppose them are, in fact, the very same arguments that apply to their conception of the welfare state. We will therefore take each of these arguments in turn and show just how both bank bailouts and the welfare state, which are both a form of welfare spending, are economically destructive.

The first argument against the bank bailouts used by its opponents is that it creates moral hazard. In other words, if the banks can privatise their gains yet socialise their losses it provides an incentive to carry on and, indeed, augment the very destructive activity that was the source of the problem in the first place. All of this is true and we can have no quarrel with it. Yet it applies equally to the welfare state as well. Proponents of the welfare state imagine that if the government throws money at all of the events that manifest themselves as pitfalls in one’s own lifestyle then these pitfalls will simply go away. However if the government simply pays for a problem when it occurs then it creates as much of a moral hazard as the bank bailouts because all you have done is simply lowered the cost to individuals of bearing these pitfalls – and lowered cost leads to a swelled demand. If you pay people when they get sick, there will be more sickness; if you pay people when they are unemployed there will be more unemployment; if you pay people when they have children people will produce more children that need a roof and need feeding. The welfare state is not the solution to the problems it seeks to resolve; it is, rather, a fertiliser for their growth and proliferation, just as bank bailouts are a fertiliser for the growth of credit expansion, malinvestment and repeated boom and bust cycles.

The second argument against bank bailouts, related to the one we just outlined, is that it shoves the cost of the bad decisions of the bankers onto the shoulders of everybody else. Yet isn’t this precisely what the welfare state does? Welfare statists imagine that nearly every unfortunate circumstance in which people find themselves is not the product of their own making and that they are therefore blameless and should be (patronisingly) pitied – in short, that people do not bear any responsibility for their own circumstances. However, this is not the case with many of the issues that the welfare state attempts to address. As was argued in a previous essay on universal healthcare, the majority of medical ailments from which people suffer are not the unfortunate result of a random, illness lottery but are, rather, directly related to their environment and lifestyle – particularly diet, exercise and consumption of alcohol, tobacco and narcotics. If, therefore, people choose to pursue a lifestyle of eating gluttonously, exercising little and smoking and drinking heavily with this resulting in sickness, then if the government picks up the tab this simply forces the cost of these bad decisions onto everyone else. People, in most cases, choose to have children, or at least to engage in the intercourse that results in children – it isn’t a random, spontaneous event that appears out of nowhere to inflict itself upon people’s lifestyles. To the extent, therefore, that people cannot afford to raise these children properly and the government intervenes then the cost of other people’s bad decisions is again shovelled onto the shoulders of everybody else. But even those aspects of the welfare state that are not necessarily the fault of the individuals concerned – such as unemployment – is usually the result of government anyway. Low employability is caused not only by inadequate state education, but also government interference in the labour market such as minimum wages and excessive regulations that cause the cost of employment to exceed that of the productivity of the lowest skilled workers. Why, therefore, do welfare statists propose a government solution to what is a government created problem? Why not just get rid of the government created problem?

The third argument against bank bailouts is that they perpetuate what we might call a crony “corp-tocracy” where taxpayers’ money is siphoned off into the hands of the government’s favoured millionaire chums. Yet this is precisely the result of the welfare state also. Although the nominal beneficiaries of the welfare state are individual people, someone has to be paid in order to carry out the work of the welfare state. Not only does a welfare state require the creation and sustenance of a vast, leeching bureaucracy to administer it all but particular parts of the welfare state have to be contracted out to individual specialists. For example, public housing schemes need to find construction companies, hospitals need to find doctors and they need to purchase medicines from drug companies. The interests of these suppliers to the welfare state is to ensure that their compensation for carrying out their tasks is as high as possible; indeed, one of the reasons why the welfare state is such a burgeoning expense is because the disconnect between the consumer that pays and the supplier that is paid results in spiralling costs for the services of the latter, with the result that the majority of welfare spending goes not to the individual people but straight into the bank accounts of large corporations and contractors. Moreover, the welfare state is not usually a fixed pool of services that are provided by the government, but includes also private organisations and charities that lobby the government for money in order to solve the particular societal “problems” and grievances that they happen to have identified. Much of this money is simply wasted, as suggested by the recent collapse of Kids Company, a UK children’s charity, around a week after it received a £3 million grant from the government. Indeed, in the UK – when the chief executives of high profile charities are paid six figure salaries and they have been chastised for “aggressive” funding raising strategies that were recently attributed, at least in part, to the death of a pensioner – the substantive difference between a charity on the one hand and a corporation on the other is becoming increasingly questioned.

The fourth argument against bank bailouts is that they distort the economy, shovelling excess funding into the financial services sector and expanding their profits at the expense of other industries. Again, nothing about this is untrue and, indeed, as “Austrian” economists we would make an even more detailed case about how the resulting credit expansion distorts the consumption/investment ratio in order to result in unsustainable malinvestments across the entire economy. Yet the welfare state distorts the economy also, only in a more incremental and pacing manner. In the first place, the increased incentive caused by the welfare state to exacerbate the very problems it is supposed to solve, such as sickness and unemployment, reduces the capacity of the labour market and thus shrinks the extent of the division of labour that would otherwise have been possible. Second, the burgeoning cost of the welfare state caused by an artificially inflated demand for welfare requires more and more resources to be confiscated by the government in order to fund it. Thus, the areas of the economy that are devoted to providing welfare are swollen at the expense of other areas of the economy which must correspondingly shrink. Third, this is compounded by the fact that a large, government pot of gold encourages rent seeking behaviour, which in the case of welfare means (as we stated above) large numbers of special interest groups lobby the government each with a claim that they have identified some societal affliction that is ripe for resolution by government spending. Governments are eager to attract this kind of attention for more government spending means not only more power and prestige but also provides another outlet with which to bribe citizens with their own money when making election “promises”. The result of this, again, is that the total portion of the economy that is devoted to welfare spending is artificially inflated compared to what consumers would otherwise prefer.

The final argument against bank bailouts that we will consider is that they create a feeling of bitterness and resentment in the general population, a fissure of hate, contempt and distrust between the bankers and the people whom they supposedly serve. Again, all of this is true. However, it applies just as readily to the welfare state. Its proponents usually justify the imposition of the welfare state by stating that it is morally good for us to care and look after one another as if we are all one big family. This may be true enough, but the welfare state does not create that situation. In order to become a morally better person I have to choose to care and to look after my fellow man – I have to decide to do it voluntarily. I am looked upon with admiration because in spite of all of the personal luxuries I could have spent my money on, I willingly deprived myself of them and was happy to give the money to a person in need. The welfare state, however, does not give me any choice in this regard – it just forces me to do it regardless of what I want. The action, therefore, is not as the result of any personal sympathy or empathy for the plight of the less fortunate, nor of any aspiration to moral heights. Instead, the void left by an absence of sympathy and empathy is likely to be filled by bitterness and resentment as my hard earned money has just been confiscated from me to go to people who I believe may not deserve it, particularly if it goes to some cause that I may disagree qualifies for welfare spending (such as breast enhancement surgery on the NHS or unemployment benefits to those who are just workshy). The welfare state therefore creates the opposite of any charitable feeling whatsoever and destroys any notion of brotherhood or family. When this is coupled with the welfare state’s encouragement of the afflictions it seeks to solve then the result is a society with a lower, rather than higher, moral standing. This is exacerbated by the interdependent relationship between bank bailouts on the one hand and the welfare state on the other. Bank bailouts mean that the banks take the money of the taxpaying public and plough it into assets so that the income of anyone who owns these assets – i.e. the bankers themselves – is swollen while the incomes of those who do not stagnates. The resulting price inflation lifts the affordability of assets such as houses and basic necessities, such as food, out of the grasp of those on low incomes. The consequence is another artificially swollen demand for welfare to give ordinary people somewhere to live and something to eat. Thus, the poorest in society demand increased taxes on the rich – i.e. the very bankers who were bailed out – in order to fund increased welfare spending. The result, therefore, is a toing and froing of mutual theft, a circle of robbery where bankers demand taxpayers’ money to continue their casino operations, after which everyone else demands some of it back to ameliorate the resulting effects. Far from being a moral and harmonious society all we end up with is hating each other and trying to grab whatever we can out of each other’s pockets.

What we can see from this brief comparison of the welfare state to bank bailouts, therefore, is that there is very little qualitative difference between the two and that the arguments that are used to oppose bank bailouts apply just as easily to the welfare state. The amelioration of welfare demand is achieved not through the redistribution of a fixed pool wealth but through the raising of real incomes by increasing the productive output per person. In order to achieve this we need to eliminate both the bank bailouts and the welfare state so that we can return to a genuine economy where everyone serves each other rather than engages in mutual plunder. The rich would have to earn their wealth by directing and increasing the productive capacity of the economy to best meet the needs of the consumer; the poor earn their money by providing the labour to bring about this direction, with their wages being able to buy more and more goods as a result of the increased output. Not only would this create a more prosperous society where poverty has truly been consigned to the history books, but the vanquishing of hatred, resentment and antagonism would create a morally superior one too.

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Libertarianism – A Utopian Ideal?

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Libertarianism – and any sort of more general freedom from government as advocated by anyone with a pro-free market leaning – is opposed both ethically and economically on a number of substantive grounds. The proposition that without government we would have inequality, destitution for the masses, rampant greed, and so on is a familiar charge. A further point of opposition is that libertarianism, and the drive towards it is simply utopian or idealistic and that libertarians are hopeless day dreamers, lacking any awareness of how the world “really” works. It is this objection that we will attempt to answer in this short essay.

There are two different basic guises of the argument that libertarianism is utopian. The first is that a libertarian world will simply never come about; that government is so entrenched in the world and people are so inherently statist that any hope for a libertarian society will founder upon the rocks. In the first place we might as well point out that libertarianism is a normative theory; just because we live in a society overwhelmed by statism does not mean that things should be that way. The current situation may make it harder to achieve but it does not undermine libertarianism as an ethical theory. But if we ignore this we do have to recognise that much of the fight for freedom will be an uphill struggle – as it always has been in history. The present author does not expect a libertarian world to appear within his lifetime. But from a strictly practical point of view this fight is a lot less “utopian” than many other goals such as the fight against poverty or against disease. These things require positive action and endless patience to wait for enough wealth to accumulate in order to provide some alleviation. Indeed even the most popular ideal in the world today – the so-called spread of democracy – requires armed invasions, active peacekeeping, the setup of institutions for which to hold to elections and the willingness of the population to get off their backsides and vote. This is assuming, of course, that such an ideal is genuine and not simply a veneer for power and control over resources. Freedom, however, only requires negative action – the abstinence from violence against the person or property of another person. Every single individual in the world has the physical ability to bring this situation about right now with no effort whatsoever. Freedom could practically be achieved much more quickly than wealth, democracy, inequality, happiness, fulfilment or any other ideal that one could care to mention. This does of course suffer from the drawback that people need a passion for liberty and a willingness to cease their promotion or tacit acceptance of the ruling regimes. Inducing recognition of the illegitimacy of government on a wide scale is a formidable task for libertarians, especially as it is so radical. But what is truly utopian, however, is the belief that the current situation of debt, spending and kicking the can down the road can ever continue. At the birth of social democracy, Western nations had accumulated several generations’ worth of capital that had raised the standard of living by a significant magnitude. This provided a seemingly inexhaustible fund for politicians to bribe voters, showering them with goodies in the form of retirement benefits, welfare payments, nationalised industries, publically owned infrastructure, and so on in return for their votes. Because politicians like to spend and spend without raising current taxes, much of this spending was fuelled by borrowing, with the productivity of accumulated capital enabling tax revenue to service this debt. The borrowing and inflation has benefitted the bookends of society – the poorest who receive the majority of the welfare payments and the very rich whose assets survive the inflation by rising in nominal value – as well as the baby boomer generation, which has received most of the lavish benefits without having to pay for them. The profligate waste disguised a slow but relentless capital consumption until now productivity can no longer provide for the burgeoning level of spending. Governments today are struggling to even service the interest on debt through tax revenues, having to borrow more just to pay down previously accumulated debt. Particularly now as the aforementioned baby boomer generation has begun to retire, leaving behind it a decimated workforce supporting a heavy generation of retirees, this situation is likely to only get worse. There are three possible options available – to default on the entitlements; to default on the debt; or to print enough money to pay for everything. The first option would cause mass social unrest, the second would cause financial markets to collapse and the third would cause hyperinflation of the currency. This is an unpleasant but soon to be necessary choice. It is precisely because the paradigm of social democracy, its welfare state and social justice no longer appear to be working that liberty (and “Austrian” economics) are beginning to be viewed as viable alternatives. As suggested previously, the view (and hope) of the present author is that this will be a relatively bloodless and un-revolutionary process, taking effect through the simple circumvention of government by people who simply want to live their lives and maintain their standard of living. Regardless of their precise knowledge of the virtues of liberty, a libertarian world will come about by people seeking to assert their individuality. That seems a lot less utopian than desperately attempting to prop up the current, zombie-like system.

The second guise of the argument that libertarianism is utopian is the proposition that non-aggression is counter to human nature and there will always be people who seek to murder, rape and steal. Or, even worse, a free society will just create a society of looters and murderers and the peaceful and harmonious world that libertarians envisage will simply never appear. With government, however, peace is maintained (enforced?) and we have a controlled and orderly redistribution subject to democratic oversight and this is far more in keeping with the nature of humans. First of all, freedom is the raison d’être of human nature and not its antithesis. Undoubtedly it is true that the political means of achieving wealth through theft and redistribution, as well as the abdication of individual responsibility through devotion to a leader, are powerful and attractive propositions that may form part of human nature. But this is simply a part of the universal law of human action that seeks to minimise individual cost and maximise individual benefit. People seek to promote government action because they think it will promote what they want while forcing others to shoulder the burden. They want government to enact their ideas and their plans and for everyone else to march in time. They seldom consider the fact that they may be suffering the costs of implementing somebody else’s plan. As soon as government ceases to serve this function in the opinion of individuals, it will be dropped. It is, therefore, individual freedom and not an automated, robotic adherence to the government that is in keeping with human nature. Second, bearing this in mind, it is far from clear that society would simply disintegrate into murderous chaos if government was abolished instantly. While there may be a transitory period of restlessness, people will soon take steps to privately protect and defend their property, with these private means replacing the monopolistic provision of the state – as happened recently in the riots in Ferguson, Missouri, when police were ordered to stand down. Moreover, there is no reason to believe that the division of labour and social co-operation would suddenly be obliterated overnight. People engage in these things not only because it is the most productive form of organisation but also, and perhaps more importantly, because the number of people willing to commit private murder and theft would still be in the minority. The majority of people abstain from these acts not because the government is preventing them from doing them but because they are evil. Abolishing the state will not change this view. If any proponent of government was to suggest otherwise then it is permissible to ask him what he would do if government vanished suddenly. Would he be among the looters and plunderers? And if not, why should anyone else? Third, libertarians have never made the claim that the world will be completely eradicated of aggression and we do not assume that, once governments and states are abolished, evil people will suddenly vanish from the face of the Earth. Indeed, libertarians do not even have to prove that a world of liberty will be absolutely flawless and totally free of evil and violent people; it simply has to be better than any other option. What we are firmly opposed to is the legitimisation of aggression when it is carried about by an elite group called the government; that if we recognise acts such as murder and theft as immoral and evil then they shouldn’t be done by anyone. In other words, libertarians oppose the legalisation of aggression under any circumstance, applying simply what resides in everyone’s understanding of basic morality to those who are in government. The fact that illegal acts will still be done is fully acknowledged; but allowing a legitimate channel for the initiation of violence dilutes this basic moral understanding and serves as a vehicle for evil acts such as murder and theft rather than for their prevention. In any case, even if libertarians strove for a world of the complete, de facto eradication of all aggression, private and public, then what would be wrong with that? It is not likely, for example, that rape will ever be completely eradicated whatever legal regime is put in place and any person who sets out to achieve such a total banishment would certainly be “utopian”. But we would hardly dispute the honourable nature of his goal, nor would we castigate his efforts to achieve it. Governments themselves participate in causes even more utopian than this, such as the seemingly endless “War on Drugs”. Doubtless many of us would love to have a world free from substance use but, regardless of the ethics of either drug use or the attempts to prevent it, from a strictly practical point of view it is hopeless to attempt to regulate with the force of law what people desire to put into their own bodies.

Libertarianism will never create a perfect world; but it will create a world that is most in step with the fact that humans think, feel, desire, choose and act as individuals. Undoubtedly, according to some “higher” ideal, the human race is flawed but any practical and sensible political theory has to account for humans as they are, warts and all. It is for this reason that libertarianism, as opposed to its statist and collectivist rivals, is one of the least utopian theories.

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Economic Myths #10 – Taxes Benefit “Us”

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During the revelations that large corporate entities such as Amazon, Google and Starbucks were arranging their affairs so as to pay as minimal tax as possible on profits earned in the UK, the indignation from the general public seemed to centre on the belief that the “lost” government revenue was somehow a “lost” benefit to the average citizen. After all, won’t lower tax revenues result in fewer hospitals and worse schools? Indeed tax avoidance (together with the deliberate blurring of the legal and moral distinction between that concept and that of the explicitly illegal tax evasion) has become a favourite topic of heavily indebted governments as they attempt to balance their books without reducing their profligate spending. The speech of Danny Alexander, Chief Secretary to the UK Treasury, to the Liberal Democrat Party Conference this Autumn is typical of their hubristic attitude but now with a somewhat chilling veneer:

Liberal Democrats have led the crackdown on tax avoidance. The investment I announced at this conference in 2010, is now bringing in an extra £7bn. We are now insisting that tax dodgers pay the right tax up front – they will only get any money if their scheme is later proved in the courts to work. And we are using psychologists and behavioural economists in HMRC to get the money quickly. Tax dodgers beware – we know where you live, we know how much you owe, and now we know how you think. Your behaviour is unacceptable, and we are coming for our money.

Part of the vitriol of the general public is explained by the fact that people want some kind of tax equality and don’t want to be shouldering the burden of public expenditure themselves when others appear to be shirking their alleged responsibility. Indeed many of the cries for reform all appear to be in the direction of making people their “fair share” of taxes – an amount that is, conveniently, never quantified but always means more. Yet the core focus appears to be that life will somehow be worse off without Amazon and Google paying tax in the UK.

All of this is nonsense. Profits that are retained by private shareholders do not magically “vanish” from the economy. Rather, they are reinvested in productive enterprises that create capital in order to churn out more products that people want to buy at lower prices. Fewer profits retained by investors means fewer capital goods and fewer products on the shelves. If that money disappears into the hands of the government, it is not invested prudently in productive business. Most of it vanishes into the pockets of favoured government contractors to spend on wasteful projects – with very little resulting in marked improvements for the average citizen. This government demanding more money is the same government that, in 2012-13, wasted £1.2bn on subsidising foreign farmers through the Common Agricultural Policy, £20.6bn on public sector fraud, £3.0bn on benefits to people who don’t need them, £145m on “ghost patients” on the books of GP surgeries, £300m on unused medicine, and £113m in subsidies to trade unions1. Every pound that is taken by government to be spent on these wasteful ends is one pound less that can be invested in genuine, private enterprise that must produce products that people wish to buy. Which category of spending – public or private – are we really worse off without?

Some of the more extreme rhetoric – that the likes of Amazon and Google have “blood on their hands” because of all of those patients in hospitals who cannot be treated because of the lost tax revenue – is akin to a sick joke. What about the lives saved because government was not able to use Amazon’s tax revenue to throw bombs at civilians in the Middle East? Yet even if we ignore this the prevailing attitude is that these companies should be punished for setting up businesses, creating jobs and producing stuff that people want to buy – and right at the time when we are at the depths of a deep, government-induced economic malaise when we should be celebrating what little success there is. In any case, every company has to pay tax somewhere even if it is at a lower rate in an alternative jurisdiction. If Google pays tax in Ireland then what is wrong with that? To the rejoinder that this means a foreign government and foreign public services are benefitting from profits earned in the UK, well doesn’t the £11bn foreign aid budget do the same thing?

Increased taxes on the people that take risks to provide us with jobs and produce goods and services that improve our lives do not make things better for “us”. It only benefits the government and those recipients of its bloated, wasteful spending. Fewer taxes and vastly reduced spending would be far better for all of “us”.

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1The Taxpayers’ Alliance, Bumper Book of Government Waste 2014. From the same report: £32K was paid by a council to compensate a man who slipped on a berry in a churchyard; £1K was spend on a council officer to investigate a picture taken of the mayor looking at her phone during an Armed Forces Day ceremony; £4K was spent by a council on a whisky tasting event for international golfers; and £70 was spent by the Forestry Commission on a bunny outfit.

Capital – The Lifeblood of the Economy

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It is the gravest deficiency of mainstream economics that it fails to understand the necessity, role and structure of capital in the economy, a failure that permeates through to lay debates concerning production, income, wealth and redistribution. This essay will explain why this deficiency will lead to economic ruin unless its errors are comprehended and corrected.

Production

It is self-evident that everything desired by humans that is not the free gift of nature at the immediate point of consumption must, in some way, be worked for. By “worked for” we mean that the human consciously strives to devote means to bringing about an end that would not otherwise exist. The benefits of air, for example, must be “worked for” in the sense that the body has to contract the diaphragm to inhale. But to the extent that this is not a conscious process, that the human does not knowingly have to divert resources to meet this end means that air is, to all intents and purposes, a free good. Very few, if any, other goods meet this criteria and the environment of the first human that walked on the Earth was one of unrelenting scarcity, a complete and utter dearth of anything necessary, enjoyable or desirable for that human being’s existence.

An isolated human, therefore, has to work to produce his goods. The extent of his success determines his productivity or, to put it more starkly, his income. If, at the start of the day, he has nothing and he labours to produce three loaves of bread then by sunset we may say that his productivity, or his income, is three loaves of bread per day. Productivity does not rise proportionally with effort. It may be possible to achieve a high level of productivity with relatively little effort or, conversely, to waste ones efforts on boondoggles that turn out to be a complete failure. While it is generally true, therefore, that harder work will begat a greater level of productivity it is not necessarily true – humans must direct their efforts in the most appropriate way to enable the greatest productivity, not necessarily in the hardest way.

Let us take, then, the first human on Earth who has nothing except air to breathe and nature’s gift of his body which empowers him with the ability to labour. Let us say that, at this point, his wealth, his accumulated stock of produced goods, is zero. It will be the task of his existence to increase this level of wealth. How does and how should he go about this?1 Let us say that his first desire is to find firewood to burn and keep warm. So on the morning of day one of his existence he has no logs to burn and his wealth is zero. Off he goes on a brief expedition and, using only the body that nature has given him, he returns in the evening with three logs. His productivity, or his income for the day, is therefore three logs. We may also say that his wealth has increased from zero to three logs. However, he then makes the decision to burn all of the three logs to keep him warm for the night. His act of burning the logs is his consumption. He has used the three logs as consumer goods to directly yield him a satisfaction in his mind. However, with the arrival of morning, he is in exactly the same position that he was in on the previous morning – his stock of wealth is once again zero. So off he goes on another expedition and returns again, with three logs. Once again his income is three logs and his wealth has expanded by three logs. But again he burns them overnight, meaning that yet again his stock of wealth on day three is back to zero.

It is therefore the case that one’s stock of wealth is directly related to the amount of it that is consumed. The more of one’s produced product (income) that is consumed, the less overall wealth one has.

Let us say that, within a week, our human grows weary of collecting three logs every single day only to see them vanish again overnight. He wants to increase his wealth. What can he do? It should be self evident that the only thing he can do is to reduce his consumption; if, he wants to be wealthier at the start of tomorrow than he was at the start of today he needs to reduce his level of consumption by abstaining from burning one or more logs. Let us say that he decides to burn only two logs and sets aside one. The following morning, therefore, his wealth is now one log, whereas the previous morning it was zero logs. He is now wealthier today than he was twenty four hours ago, this increase of wealth being owed to the fact that our human he has engaged in an act of saving2. With his saved wealth he can do one of two things. The first possibility is that he can hoard it. If he hoards it then all this means is that, while his wealth will increase as his act of hoarding continues, the human’s consumption of the wealth that he is accumulating daily is merely delayed. This method of saving does not, in and of itself, permit wealth to grow and from this perspective serves little purpose. If all else is equal, he might as well burn the third log today and enjoy the extra warmth rather than leave it lying around for a future date3. However, the second thing that he can do is to take his saved logs and invest them. To invest means rather than consuming his wealth directly the human takes it and uses it as a tool of production of further goods. This must be the result of a transformation of the goods into such a tool. Let us say that the human saves enough logs to invest in the production of a wheelbarrow and that, for one week, he labours to construct the wheelbarrow. The finished wheelbarrow is now a capital good – a good used in the production of further goods. The aim, in this case, is for the wheelbarrow to be used to transport logs that will then, in turn, be burnt as firewood. Let us say that with the aid of the completed wheelbarrow he is now able to bring home six logs per day rather than the initial three. By aid of the capital good he is therefore able to increase his production of other goods. His wealth therefore increases by more than it would have done so without the aid of the capital good.

What, therefore, are the inherent qualities of this act of saving and investment? What, in particular, will induce the human to engage in it? There are several aspects to note:

  • It requires abstinence from direct consumption of the good that will be transformed into a capital good;
  • The abstinence is for a period of time, that is the time taken to transform the goods into capital goods that yield further goods for consumption;
  • In order to justify the period of abstinence, the yield of goods from the capital goods must be higher than it would have been without the capital good.

This final point is of crucial importance. For what will determine the human’s propensity to save/invest on the one hand and his propensity to consume now on the other? The answer will be his willingness to trade the period of waiting in which the capital good will be constructed against the increased quantity of goods that will result. He will start to save at a point when the increased quantity of goods yielded is more valuable to him than the utility gained from direct consumption now of the capital good. He will stop saving when consuming now will yield him more utility than waiting for an increased quantity of goods in the future. This propensity to wait is called his time preference. If time is relatively more valuable to him than an increased quantity of goods then he has a high time preference. If the increased quantity of goods is relatively more valuable than the waiting time then he has a low time preference.

Increasing Capital – the Structure of Production

The consequences of the increased yield of consumer goods – in this, case, from three logs per day to six logs per day – and the resulting increase in wealth means that our human yet again has to face the same choice as he did with his original stock of wealth – to consume or save (hoard/invest). Only now, however, he has to make this choice with an increased quantity of goods. What will be the possibilities?

  • He could choose to consume and save at the same rate as he did previously, that is one saved log per two consumed. Out of a total of six logs he will, therefore save two logs per day and consume four;
  • He could choose to consume at an increased rate and save at a reduced rate. One day of doing this would be to save the same quantity of logs as he was before (one) and consume the remainder (five); however, he could also increase the quantity he saves while decreasing the rate, for example by saving one and a half logs and consuming four and a half.
  • He could choose to save at an increased rate and consume at a reduced rate, for example by consuming the same quantity of logs as he did before (two) and saving the remainder (four); however, he could also increase the quantity he consumes while decreasing the rate, for example by consuming three logs and saving three.

The precise consequences of each choice are unimportant, merely that each will occur at a different rate depending on what is chosen. It should be self-evident that more saving will begat more capital goods and more consumption but only after the period of waiting; more consumption will mean more goods can be enjoyed today at the expense of relatively fewer in the future. But in practice, we might add, it tends to be the case that the wealthier a person becomes the more he tends to follow the third scenario, specifically by increasing the quantity he consumes while decreasing the rate. The rich, for example, consume a much greater quantity of goods than poorer people do but as a proportion of their wealth they consume less. This will have important consequences as we shall see when we consider the effects of taxation and redistribution below.

However, let us assume that, whatever choice the human makes, there will be a rate of saving that permits investment to continue. What will happen now?

As the level of production is now dependent upon a capital good, the rate of saving must, at the very least be able to maintain this capital good. Capital goods are not consumed directly but they are consumed in the process of production through wearing down. While no new wheelbarrow will need to be produced, of course, a level of saving that permits its parts to be repaired or replaced will be necessary. If the human is not able to maintain his capital goods what happens? It means that he is using it for the purposes of production the results of which are consumed to the detriment of repairing and replacing the capital stock; in short he is engaging in capital consumption. It should be self evident that if the capital is lost, production must decline and so too will the standard of living. The dangers of capital consumption will become clearer when we discuss it below4.

However, let us assume that our lone human is able to maintain the existing capital stock and also has enough further saving that does not need to be used for this purpose. What will happen? He will, of course, invest in further capital goods to increase his production of consumer goods. Let us say that, satisfied with the utility gained from and his ability to maintain his wheelbarrow, he decides instead to invest his logs in the production of tools. Let us say that he fashions from a log directly an axe handle. But the axe head cannot be made out of wood. He must acquire and fashion metal in order to complete the axe. Aren’t the saved logs useless for this purpose? Not at all; for while the saved logs cannot be used directly in the production of the axe head, they can be used indirectly in order to sustain our human during the production of the axe head. In short, let’s say he goes on an expedition far from home in order to acquire the material to fashion the axe head. He takes the saved logs with him and burns them at night to keep him warm. To the extent that the venture is successful and he returns from the expedition with the material to fashion the axe head, then the consumption of the logs has been compensated by the acquisition of the axe head. The axe head can then be used to fell entire branches or even trees which can then be transported in the wheelbarrow for our human to consume. Let us say that, once again, his output doubles as a result of the introduction of the axe, meaning that he now takes home twelve logs each day.

What does this addition of another capital good – the axe – demonstrate? In the first place, it once again demonstrates the requirement of waiting during the production of the additional capital good, waiting that must be sufficiently offset (in the valuations of the human) by the resulting increased level of production. But there are two more crucial aspects:

  • That, in terms of providing for the human’s needs, it is relatively less important to stress the amount of capital he possesses as compared to its precise structure. The new capital structure is intricately woven and the stages are dependent upon each other. For example, if he had two axes and no wheelbarrow, he could fell a lot of trees but would lack the means to transport them. If he had two wheelbarrows and no trees then he could transport a lot of logs but he wouldn’t be able to fell enough trees to fill and use two wheelbarrows. As we can see therefore, capital growth manifests itself as increasing the stages of an intricate production structure through the passage of time. Any interference with the precise structure of capital would be as detrimental as capital consumption; in the complex economy a corollary would be all of the world’s factories, tools and machines, consisting only of tractors. It would not be hard to see that, in spite of the overall level of capital being very high, the specific glut of tractors and corresponding shortage of absolutely anything else would lead to a very severe degree of impoverishment;
  • That the logs used in discovery and fashioning of the axe head, by not being used directly as a capital goods, were used as a fund to produce a capital good. The majority of capital investment is, in fact, the use of a fund of saved products that are consumed in the production of other products and these latter products are the capital goods. In the complex economy we can see how wages, for instance, which are consumed by workers are paid out of saved funds in return for their production of goods which are either sold or used as capital goods (or both if the buyer uses them as capital goods), just in the same way that the logs were consumed in production of the axe head.

This method of saving and investment in capital goods is frequently termed in “Austrian” literature as “roundabout” methods of production; that an increase in capital leads to a longer production structure with multiple stages (in our case hacking of logs off the trees with tools, collection of logs in the wheel barrow, followed by consumption). However a more appropriate description would be that increased saving and investment in capital goods results in a process of production that takes more time for a greater quantity of produced products.

Further Increases in the Structure of Production – The Source of Wealth

This outline of a simple economy consisting of our lone human and two stages of production should illustrate how that human can further increase his wealth. Assuming he continues to save at a rate above that which permits him to maintain the existing capital goods (the wheelbarrow and the axe) he can continue to expand the stages of production of logs or begin to invest in the lower stages of production of other goods. He might, for example, use one log to build a fishing net to catch fish, thus increasing his quantity of fish to add to his wealth. He then might be able to use quantity of saved fish and saved logs to sustain him in building a boat which permit him to catch and even greater quantity of fish. It is this process of capital accumulation, its maintenance and its regulation into a particular structure that is the cause of the increase of wealth. Relatively speaking, the more capital that our human has, the more tools, equipment, machines, etc. that he fashions by abstaining from the consumption of the goods that make them (and by waiting for them to be completed), the wealthier he is.

It should not be difficult to abstract from this simple illustration the workings of a complex economy. The only substantial differences are the existence of the division of labour and the resulting necessity of trade which serve as the most complicating factor in trying to visualise the complex, growing economy. For in such an economy people, on the whole, do not produce goods for their own consumption but rather they concentrate on the production of a specific good (or service) which they then trade in return for other goods. The other goods, of course, are never traded directly but with the aid of a medium of exchange, money, so that you sell the goods that you produce for money and then take money to buy the goods and services that you want to consume5. Each and every single day, then, any person who goes to work engages in production of a produced product. If you are a baker you produce bread, if you are a butcher you produce meat, if you are a fishmonger you produce fish. But no one butcher, baker or fishmonger directly consumes his own product, rather he trades it for money which he then uses to buy the goods he wants. So the baker, for example, may sell bread to the fishmonger who will pay for it with money. The baker may then use the money he receives to buy meat from the butcher. From the point of view of the economy as a whole, the situation is no different from that of the economy with the lone individual. We will remember that, in the latter situation, if our loner produced three logs per day and burnt (consumed) three logs per day then on the morning of the following day he is in exactly in the same position regarding his personal wealth as he was the previous morning. If, in our complex economy, the butcher, baker and fishmonger produce, respectively, on one day three cuts of meat, three loaves of bread and three fish, then if after trade these are all consumed by somebody at the end of the day, then tomorrow the economy as whole will be in exactly the same position as it was at the start of the previous day. If, however, some of these products are saved then tomorrow the economy as a whole will be wealthier than it was at the start of the previous day6.

Saving and investment in the complex economy will not, of course, take place in the form of hoarding the physical products like it did in the simple economy. Rather, let’s say that that the baker sells three loaves of bread to the butcher and receives in exchange for them money. His saving takes place in the form of saving money rather than goods directly. His investment will come in the form of spending this money on goods that are used for investment – i.e. are transformed into capital goods – rather than for consumption. For example, let’s say that he takes his saved money (we shall call it £100) and buys fish from the fishmonger. In exactly the same way as the logs sustained the lone human in constructing the axe head, the fish provide sustenance for the baker while he increases his capital at his bakery – let’s say he invests in a new oven. The fish, therefore, provided a fund which was used to construct a new capital good, the oven which will produce more consumer goods. In his own mind, however, the baker will not reckon in terms of fish, ovens, or the extra amount of bread that is produced as a result of the oven’s construction. Rather, he will say that he has an investment of £100, an investment whose return will be measured not by the physical quantity of extra bread produced but by the increased money he will receive from being able to sell the extra bread. It is this extra money that, in his own mind, compensates him for the waiting time in constructing the capital good. If we say, for example, that he invested his £100 at the start of the year and by the end of the year his sales had increased by £10 then we may that the return is 10% per year. This return is known as interest, the compensation for the waiting time between the point of saving and the point that the increased quantity of consumer goods is available for consumption (and in this case, when the baker has the money from the increased sales).

Another possibility is that rather than expanding his existing business the baker creates a new one; or he could lend the saved funds to somebody else to invest in their business. Let’s say that he lends the money to a new entrepreneur, the candlestick maker. The candlestick maker has himself also saved £100. for his new business and so, together with his own saving and the money lent to him by the baker, he has a total investment in his firm of £2007. The candlestick maker will then take that money and spend it on the fish (or other goods) that will sustain him in producing the capital goods needed for his new candlestick business. Let us say that this business is successful and, at the end of the year, the resulting sales means that the value of the business has increased from the initial £200 to £220 – the original £200 capital and £20 return on that capital as a result of increased sales. This £20 will be divided between the baker and the candlestick maker depending on the terms of their investment, but overall the firm has received interest of 10% per annum.

We have, of course, left out of this simplistic calculation the fact of depreciation – the wearing down of the capital goods during their use in production. Suffice it to say here that at the end of the year the original amount of saving reckoned in money terms will be less than £200 owing to the depreciation of the capital goods in the venture. More on this can be read here].

Another aspect we have deliberately ignored is entrepreneurial profit and loss. The rate of return that any one person needs to receive to induce him to save and invest is the interest return – the compensation for waiting. We have assumed in all of the illustrations above that any saving and investment will for sure result in the return that is expected. But this is never the case in real life – the actual return may be greater than, less than, or equal to what was expected. In all cases, then, the actual return will consist of:

Interest + Profit/Loss8

Going back to our original lone human, he may find that his wheelbarrow actually is only enough to bring him an extra two logs per day whereas he originally wanted three. His return will therefore consist of an interest return of three logs and a profit/loss of negative one log. Or, he may be delightfully surprised to find that his wheelbarrow is enough to bring in four logs per day in which case he will earn interest of three logs and profit/loss of one log. Or, the most disastrous of all outcomes would be that he finds the wheelbarrow is a complete hindrance and, in fact, means that he is able to harvest fewer logs than he was with his bare hands! Let’s say he can only bring home two. In that what is earned is interest of three logs and profit and loss of negative four logs. The real loss that he experiences is much higher than the nominal loss of logs – four and one respectively – as, at the time he decided to save and invest, he needed a return of three logs to justify the waiting time. Although he only appears to lose one log by erroneous construction of the wheelbarrow his actual loss is much greater because of the waiting time he endured. In our complex economy, profit and loss takes the form of having to anticipate that other people will want to purchase the additional produce that is enabled by the capital good. If the actual selling price of the final goods is more than what was needed to induce an entrepreneur to save and invest then this represents an entrepreneurial profit. If it is less than he suffers an entrepreneurial loss9.

It is not necessary for the reader to dwell too much on the intricacies of profit and loss in order to understand the role of capital in increasing wealth. An elaboration is offered here merely for the sake of a degree of completion. Interest, however, is vital in understanding the role of capital. It must be emphasised again that people will begin to save and invest in capital goods when the resulting outlay of consumer goods is higher than what could be produced without the capital goods, and this outlay must be sufficient to compensate for the waiting time in which the capital goods are constructed. In short, people must make a choice between having fewer goods to consume today or more goods to consume at a future date. The number of additional goods that a person wants to appear at the future date to induce saving is his interest return. Whether this return actually appears or not and to what degree determines his profit and loss. But it is this desire to consume more in the future, to abstain from consumption today for a lot more of it tomorrow, that enables the economy to grow and for wealth to expand. There is no other way than by saving and investment in capital goods.

In the complex economy, of course, everyone can be savers and investors and we do so in a multitude of different ways and through different channels. Anyone who earns a wage and then spends a portion of it on his monthly outgoings (i.e. consumption) and uses the remainder to, say, deposit in a savings account, or to buy bonds or shares is investing in capital goods and increasing the capital stock of the economy. If it is saved in a savings account, the bank will lend that money to companies who will use it to invest in the capital goods, the return on which will enable the bank to pay interest to the depositor. If stocks or bonds are bought then money is advanced to a company directly. The crucial aspect is that by saving money, you are not consuming. By investing it you are turning those goods that could have been consumed today into capital goods that will produce more goods to be consumed in the future.

Having therefore examined in some detail the role of capital in wealth accumulation and raising the standard of living, let us proceed to analyse some aspects of Government interference that will affect the rate of saving and investment.

Taxation

Taxation is the deliberate confiscation by the Government of that which has been produced. It must be emphasised that all taxation, whatever name it is given, however one may attempt to justify it, must be a taxation of produce. There must be something that has been produced that the Government can come along and take. In our example of the lone human, the Government would have come along and taken some of his logs, i.e. confiscated his produce directly. In the complex economy the Government tends not to confiscate produce directly but rather money which it then spends on produce, i.e. the produce that the taxed individual could have bought is diverted, by way of money, to the Government.

From our analysis of saving and investment above we also know that there are only two types of produce that can be taxed – that which is produced today (income) and that which was saved and invested (capital, or wealth). There is nothing else that can be taxed and all taxes are either taxes on income or on wealth. What are the implications and results of each? Let us deal with the material effects first of all. If the Government taxes income, that is, the presently produced product, we know from our analysis above that it can do so up to a point which still permits enough saving to maintain the existing capital stock. If it does this, the present level of production can continue as the capital goods will keep functioning. However, for the remainder of the produce that is confiscated, there will be less saved in the hands of private individuals and entrepreneurs to invest and increase the capital stock. Capital growth, therefore, will be retarded. And even if the private individuals would not have saved this income but would have consumed it, it is still the case that they have suffered a loss from the fact that the produce is directed towards Government ends rather than their own. The important point is, however, that taxation retards the ability of private individuals to grow capital and increase production and, hence, the standard of living must either stagnate or improve less quickly.

It is no answer to this charge to assert that Government might take this money and spend it on allegedly “important” capital projects such as roads, schools, hospitals, and other spending on what they like to call “infrastructure”. As we noted above it is not the capital stock that is so important but rather the capital structure. For the invested capital must take a form in which it meshes cleanly with the rest of the existing capital and its produce supports the production of goods further down the chain of production. It would, for example, be useless to bring a fishing net to a cattle ranch. The only way to determine whether capital contributes to the capital structure is through the pricing, profit and loss system – that capital that is successfully producing generally needed products to create further products will turn a profit for the enterprise. But how does Government, devoid of the need for profit and loss, know that, say, a factory or a road must be built? What if it diverts its taxed resources to building a grand factory but there are no machines to put in this factory? How does it know how large the factory should be, what it should produce, etc.? No Government has any method of gauging these criteria. Our lone human, we noted, needed in his capital structure an axe to fell trees and a wheelbarrow to transport the logs. Having instead two axes or two wheelbarrows would have been of no use to him. Precisely the same is encountered when Government produces roads when there are no cars, hospitals but no operating equipment, tractors but no plough, railway locomotives but no wagons. Such was frequently the case in the former Soviet Union where buildings and machinery frequently were lying incomplete because a crucial part had received underinvestment and hence was simply missing. It is true, of course, that the capital structure that remains in private hands will adapt to the capital that Government has forced upon it. If a Government produces a road, for example, it becomes more economical to increase the production of cars in order to fill it. But all this means is that private investment has been forced to adapt to what the Government has produced whereas these Government projects are frequently sold to the public as being necessary to “boost the economy” etc. Instead the capital structure has been twisted and distorted from the form that it would have taken had it been left alone and the structure that is in fact produced is serving ends that are relatively less valuable than those that would have been served in the absence of the Government interference. As Bastiat would put it, the Government may be able to point to its wonderful roads that are full of cars (that which is seen), but what is not seen is all that was not produced as a result of this diversion of funds10. It is for this reason that, economically, all Government spending must be regarded as waste spending.

However, what if the Government initiates an even higher level of income taxation, a level that does not permit enough saving to main the existing capital stock? Then, disaster will strike. For now the existing capital stock will start to wear down and cannot be replaced. As the capital structure collapses, production will decline and so too will the standard of living. Production processes will become shorter and less roundabout as the produce that could have maintained them is siphoned off into Government consumption. The situation is exactly the same as if the lone human consumed the logs that should have been diverted to maintaining his wheelbarrow. He enjoys, for the moment, the additional consumption of the log but at the expense of a severely reduced level of consumption in the future. But when the Government taxes income at such a level the private citizens do not even get to enjoy this temporary upswing of consumption, merely the bureaucrats and politicians whose lifestyles it is supporting.

Within this category of taxation of income we may place all of the everyday taxes from which people suffer – income taxes, sales taxes, excise taxes, corporation taxes, capital gains taxes, dividend taxes, VAT, etc. Anything that is a tax on productivity or newly produced good is a tax on income.

Finally, we consider the horror of horrors – when Government doesn’t tax the presently produced product but instead directly taxes the existing stock of capital. Within this category fall inheritance taxes, property taxes and wealth taxes. The results of such action should be obvious as it deliberately sets about consuming the capital stock. It dismantles the factories, machines and tools and diverts them towards Government consumption and even if the Government diverts them to “investment” then this will simply be of the same kind of Government “investment” that we just outlined with regard to income taxes. Wealth taxes are the most ruinous and destructive, attacking the very means of production and leading to a rapid decline in output and the standard of living. The situation is precisely analogous to our lone human chopping up his wheelbarrow and using it as firewood – there is a temporary increase in enjoyment today that must be offset by a very rapid decrease tomorrow.

It is at this point that we should consider all “soak the rich” taxation rhetoric and practice. For it is usually the point of view of politicians and the non-rich that the wealthy provide an inexhaustible slush fund that can be plundered and pillaged to serve whatever “needs” might be desired. Earlier we noted that there is a tendency (although not strictly a necessity) that as income increases the proportion of that income that a person devotes to consumption decreases and the proportion that is devoted to saving and investment increases. Therefore, while the rich consume more in terms of quantity than a poorer person, as a percentage of their overall income they consume far less. A person earning an income of £1 000 per month might consume £800 worth and save £200, a consumption rate of 80% and a saving rate of 20%. However a person earning £10 000 per month might consume £3 000 and save £7 000 – a consumption rate of 30% and a saving rate of 70%. So while the rich person is visibly consuming more in terms of quantity he is saving and investing a very great deal more. This saving and investment is obviously channelled into capital goods, goods which are used in the production of consumer goods that other people can buy. By increasing the supply of consumer goods the prices of these items drop and so they become more affordable to everyone else and the general standard of living increases. To the extent that the “rich become richer” through this process it is only because they invest in those capital goods that produce the wares that are most eagerly sought for by the masses. Indeed the only way to really become rich under conditions of free exchange is to abstain from consumption and divert your savings to that which people most want to buy11.

If the Government therefore sets about taxing the rich to what extent can it do so? It should be clear from our analysis that it can tax the proportion of the rich person’s assets that comprise his consumption spending. If this is done then what the rich man would have spent on fine dining, chauffeurs, exotic holidays etc. is simply diverted to Government spending. The capital structure remains untouched. But the amount of consumption spending by the rich is extremely limited; indeed if all of it was to be confiscated and distributed to the world’s poor there would barely be enough to give everyone a handful of pennies. Therefore, if taxes on the rich are to be increased then they must start attacking the saved wealth of the rich, that is the capital structure. In short, factories, machines, and tools – the very things that were churning out affordable products that the masses wanted to buy – are liquidated and diverted to Government uses, either to Government consumption or to a form of investment that, as we noted above, must necessarily be less valuable than that which existed before. The very worst thing that can be done is to tax the capital stock and distribute it in welfare for then the saved wealth of society is quite literally transferred from those who saved and invested it to those who consume and destroy it. With fewer machines and tools there will be less production, with less production there will be fewer goods, with fewer goods there are higher prices and with higher prices there is less that everyone is able to buy.

We might conclude this section, therefore, by saying that from the point of view of the standard of living, all taxation will retard its level or growth. However, that form of taxation which decays the existing capital stock is the most destructive. Wealth taxes, inheritance taxes, property taxes and their ilk should be firmly resisted.

It is not sufficient, however, to merely consider the material effects of a policy of taxation, wherever it may fall. We also need to consider the psychic effects. It is self-evident that all taxation is a confiscation from one set of persons and a distribution to another set of persons. Those who have had their goods confiscated must be producers; those who receive in distribution must be (relative) non-producers. Indeed, usually some kind of non-productive status is what qualifies a person as a recipient of welfare spending – poverty, illness, disability, etc. It is an axiom of human action that all humans devote their energies to that which has the most benefit for the smallest cost. We endure the toil of labour because the loss experienced in doing so we deem to be worthwhile for the value that is gained as a result. The same is true of consumption and investment. Each has its own benefits and costs. The benefit of consumption is the enjoyment that it provides to the mental faculties; its cost is the labour expended in production of the article to be consumed and that, once it is consumed, it is gone forever and cannot be devoted to an alternative or additional use and further needs must be met by increased production. The benefit of investment is an increased yield of consumer goods in the future; its cost is the pain of having to deny oneself the consumption today of the goods that will be added to the capital stock.

If there is any change in the relative proportions of these benefits and costs it follows that certain activities will become more attractive (i.e. more valuable) and others will become less attractive. Yet this is precisely what the effects of taxation are, effects that fall heavily upon the impetus to produce, consume, or invest. We noted earlier that a person will start to invest at the point that the increased quantity of goods that results from the investment is sufficient to compensate him for the waiting time necessary to produce the capital good. Yet if the fruits of this productivity are taxed it means that the yield is reduced. To the individual saver and investor, the benefit of saving and investment has declined, but the costs remain the same – he must still expend the same amount of labour and must endure the same amount of waiting time but only now for a smaller yield. The value, therefore, of investing will, to him, decline and consumption will become relatively more attractive. There will therefore be less investment and more consumption, lower output and the standard of living will decline. It gets worse, however, when we look to the recipients of taxed income or wealth. For in a world where there is no tax, the enjoyment of consumption must be outweighed by the costs of production and the incentive to invest. Only if the value of consumption is higher than the toil of production and the yield from investment will consumption be carried on. But if one now receives an income free of the necessity to produce, both of these costs are removed. For now, why should one labour to produce when he can simply receive the benefit – the enjoyment – for free? And why should he invest when he can simply demand another article from the Government once he has consumed the first? And even if he did invest his income from other people’s taxes, this will simply be taxed away anyway. Why bother?

In short, therefore, taxation reduces the relative value of production and investment. It increases the relative value of consumption. There will therefore be less production and investment and more consumption, the stock of capital will decline, output will decline and the standard of living will lower also.

Regulation

Regulation is, in common social democratic discourse, deemed to be a necessary tempering (or tampering, one might say) of the otherwise capitalist economy, the wise overlords stepping in and ensuring that people do not compromise “safety”, “quality” or whatever in their supposedly lustful pursuit of profits. We will leave to one side any discussion of the fact that regulation is itself a service that consumes scarce resources and that the benefits of a regulation must be offset by its cost – hence it is a market activity just the same as any other. Rather, we shall focus exclusively on the effects of Government (i.e. forced) regulation upon saving and investment in the capital stock.

The effect of a regulation is to ban a certain activity from being carried on by otherwise free individuals; an example would be a restriction on to whom a certain product can be sold, perhaps by age or income. Or, it can take the effect of a requirement to do so something, usually before something else can be done. For example, it may be required to provide a list of ingredients or a nutritional breakdown on an item of food before it can be sold. However sensible they may seem the effect of regulations is to limit the ends to which capital may be devoted.

Let us first of all consider regulations that take the form of bans. As we noted above the incentive to save is dependent upon the fruits of production that are the result of the investment. In a free market a person can invest in whatever he thinks people will want to buy. By advancing goods and services to meet people’s ends he earns a return. The public could, for example, in the saver’s estimation be demanding more of goods X, Y and Z. He will invest in the line of production that he believes will yield the highest return. But what happens if the Government then intercedes with a regulation? It is effectively saying to the investor “you may invest in goods X or Y, but not in good Z”. In other words, an entire avenue of investment opportunity is closed off even though both the public and the investor may wish to trade the good Z. What then happens if Z was the most profitable investment? Then, by having to invest in the relatively less profitable X or Y, the value of saving and investing to the investor will reduce. Therefore, there will be less saving and less investment. Indeed he might even decide that the profit opportunities afforded by X or Y to be insufficient to reward him for the waiting time between the act of saving and the receipt of returns. He may just decide to consume entirely that which he would have invested. The amount of capital investment therefore decreases and so too does the standard of living. But even if he does invest in X or Y this is not what the buying public are demanding – they want Z and no extra amount of X or Y will compensate for this loss.

However, the more common type of regulation is of the second kind – that a product may be invested in but there are regulatory requirements that must be met before one can do so. Let us take the typical type of regulation on which the Government feels itself qualified to pronounce judgment and that is health and safety. If the public demands food, for example, it may be perfectly happy to buy food that comes without any detail of ingredients or nutritional breakdown. The Government then decides that people aren’t giving enough thought to their health (probably as a result of them being able to get free healthcare, which has been dealt with in detail here). So the Government then steps in and says to the investor “OK, you can invest in food but to do so you must provide a list of ingredients, a nutritional breakdown and, with every sale, you must provide a free fact sheet of how to live healthily.” The effects of such an edict should be clear – for every article that is now sold, the investor must spend additional money on analysing every article of food for its ingredients and nutritional content and must spend even more money further on producing the factsheet. Yet the public are not demanding these things so they will not be willing to pay any more for the articles that are purchased. The effect of this regulation, then, is to increase the amount of capital that is needed to produce the same return. Or, to put it another way, the same amount of capital produces a lower return. So once again, then, the value of investing to the investor is lowered and there will be less of it. By heaping on to production artificial, deadweight costs that serve no one capital is simply consumed purposelessly. It is conceivable that regulation may cripple an industry so much that it deters all investment and investors will simply stop producing the regulated products altogether. In practice what tends to happen is that regulation forces out the smaller investors, the upstart companies, while the big players are able to absorb the added costs. The economy is then left with a few key providers in each sector who are able to raise prices and lower quality as a result of this insulation from competition.

Regulation is therefore one of the most powerful ways in which capital investment can be restricted, possibly even more so than taxation.

Uncertainty

The final aspect of Government intervention into saving and investment we will consider is that of uncertainty. Whereas before we were analysing the effects of known Government policies on taxation or regulation, here we will look at what happens when someone simply doesn’t know, or cannot be sure of, precisely what the Government will do.

Rothbard describes succinctly the role of uncertainty in human action:

[A] fundamental implication derived from the existence of human action is the uncertainty of the future. This must be true because the contrary would completely negate the possibility of action. If man knew future events completely, he would never act, since no act of his could change the situation. Thus, the fact of action signifies that the future is uncertain to the actors. This uncertainty about future events stems from two basic sources: the unpredictability of human acts of choice, and insufficient knowledge about natural phenomena. Man does not know enough about natural phenomena to predict all their future developments, and he cannot know the content of future human choices. All human choices are continually changing as a result of changing valuations and changing ideas about the most appropriate means of arriving at ends. This does not mean, of course, that people do not try their best to estimate future developments. Indeed, any actor, when employing means, estimates that he will thus arrive at his desired goal. But he never has certain knowledge of the future. All his actions are of necessity speculations based on his judgment of the course of future events. The omnipresence of uncertainty introduces the ever-present possibility of error in human action. The actor may find, after he has completed his action, that the means have been inappropriate to the attainment of his end.12

It follows from this excerpt that an increased degree of uncertainty leads to an increased possibility of error – that there is an increased likelihood that the scarce goods used in attainment of the end will, in fact, not attain the end and will be wasted. And, as Rothbard highlights, part of the composition of this uncertainty stems from future human choice, in our case the choices of the Government actors.

We noted above that the effect of Government taxation and regulation is to render less valuable the act of saving and investment to the individual. If he knows that he will be taxed and regulated to nth degree then he can, at least, factor this in to his calculations and act accordingly. If, however, the Government creates an aura of uncertainty – that an individual investor may find his fruits taxed or regulated not necessarily to the nth degree but may be to the n + 1st degree, or the n – 1st degree, or to a whole other range of possible degrees, then this weighs heavily on his mind in deciding whether to save and invest. Indeed heaping on uncertainty effectively increases the psychic costs of an action. The greater the degree of uncertainty and the more likely it is that his decision to invest will result in error (the error in this case being that he will suffer a more crippling degree of taxation or regulation than he would prefer) the more costly it becomes. Hence, the relative attractiveness of consumption increases. Indeed, consumption renders neutral this uncertainty – if something is consumed then the Government, for sure, can’t come along later and attempt to tax it away. There will, therefore, be more consumption and less saving and investment. The capital stock will not grow as fast and neither also will the standard of living.

Uncertainty, often labelled “regime uncertainty”, has been an important factor following the 2008 financial crisis and the subsequent malaise. Precisely because nobody knows precisely what the Government will try next, whether it be stimulus, taxes, regulations, capital controls, inflation or whatever, nobody is willing to take the risk to save and invest. Indeed, in the US, the huge increase of excess bank reserves – i.e. banks simply holding onto cash – following the expansion of the monetary base is at least partly explained by the phenomenon of increased uncertainty.

Conclusion

What we have realised through our analysis, therefore, is that capital accumulation is the source of increased wealth and an increased standard of living. Where there are strong private property rights to this capital and its fruits then capital accumulation will, all else being equal, be encouraged. Where these rights are compromised by taxation and regulation, they will be discouraged. Further, as our discussion of uncertainty entails, it is not sufficient that these rights are left uncompromised today but there must also be an expectation that they will not be compromised in the future.

We have not said much about Government-induced credit expansion that leads to business cycles. The effect of credit expansion is to divert goods away from consumption and to invest them in more roundabout production processes. This looks, on the face of it, as if the Government is doing a benevolent thing – it is causing us to increase the capital stock! But as we noted above, the return on capital must be sufficient to justify the waiting time. If people are not willing to endure this waiting time then investment cannot occur. Indeed credit expansion is forced saving and investment in an increased capital stock. When the credit expansion halts it is not possible to continue this diversion of goods into building and maintaining this capital structure; rather the latter now becomes fully dependent upon the consumption/saving preferences of consumers. But these preferences are not sufficient to carry out the level of investment required. The capital structure is revealed as malinvestment and must be unwound. Tragically, the Government, in ignorance of what we have learnt here about waiting times and the necessity for a precise capital structure that meets the needs of consumers, responds to this series of events by trying to boost consumption, even though it is not consumption that needs a shot in the arm. If anything, there needs to be more saving and investing so that at least some of the projects that were embarked upon during the credit expansion can be justified.

All in all the effects of Government upon capital accumulation and the creation of wealth are a disaster. All that is needed for these things to occur is private property and free exchange and Government, if we are to endure at all, should concentrate on guaranteeing these institutions.

1Strictly it is a necessity of human action that it seeks improvement to the current condition. Therefore, simply moving an object out of one’s way or to where one would prefer it to be is an act of “production” and an increase in “wealth” from the acting human’s point of view. But for the sake of simplicity we will discuss production, income and wealth as alluding to driving towards an increase in the number of material, tangible goods that the human can enjoy.

2Here we may briefly consider what the purpose of increasing wealth is. Excluding the possibility that someone gains utility simply from owning a lot of stuff, it can only be to consume in the future. The ultimate aim of all production is consumption, if not by yourself then by your heirs. Production that does not eventually result in consumption gains nothing. This is important for understanding what the human does with his saved wealth.

3We must add emphatically that hoarding is not unproductive and typically takes place in times of uncertainty – when one does not know whether he might suddenly need to call upon extra resources – or to cater for a known period of un-productivity, such as storing food for the Winter.

4Technically speaking if the level of “saving” is insufficient to maintain capital then there is a net dis-saving. As Mises puts it: “The immediate end of acquisitive action is to increase or, at least, to preserve the capital. That amount which can be consumed within a definite period without lowering the capital is called income. If consumption exceeds the income available, the difference is called capital consumption. If the income available is greater than the amount consumed, the difference is called saving. Among the main tasks of economic calculation are those of establishing the magnitudes of income, saving, and capital consumption.” Ludwig von Mises, Human Action, Scholar’s Edition, p. 261. However for the purposes of this essay we shall define income as the produced product and saving as the portion of the income that is not consumed, regardless of whether the rate of saving is sufficient to maintain the capital stock.

5Money as well as being the medium of exchange is also is the facilitator of economic calculation without which a complex economy could not exist. Money is also a good in its own right but there is not space here to dwell on the fascinating reasons how and why it comes into existence. Interested readers should consult Ludwig von Mises, The Theory of Money and Credit.

6A word of extreme caution in necessary when discussing the economy in the aggregate. Simply because we say that x amount of produce is consumed or y amount of produce is invested does not mean that it does not matter precisely who is consuming and who is investing. For it matters very much to the particular individuals concerned. If, for example, the baker purchases three cuts of steak from the butcher with the intent to consume all of them but the fishmonger steals them and consumes two but saves one, even though the fishmonger has “saved” one steak that would have been consumed by the baker we can in no way say that the economy is “better off”. The loss of utility of steak consumption to the baker cannot be compared or measured against the gain of utility to the fishmonger who consumes two steaks and saves one. Similarly if a slave is forced to labour to produce bread in the bakery and he gets nothing in return we cannot say that the economy is better as a result for there has been a very real loss to the slave in spite of the bread produced. We can only assume that there are gains in utility when there is voluntary exchange and any analysis of the economy as a whole which results in conclusions of one state of affairs being “better” or “wealthier” than the other must be made under the assumption of voluntary production and exchange.

7Whether someone is a stockholder or a lender to a firm or enterprise is a legal difference, not an economic one. They are both advancing saved funds to further the firm’s ventures but on different terms.

8There is also the possibility of additional compositions of return that we will ignore here. See Murray N Rothbard, Man, Economy, and State, Scholar’s Edition, pp 601-5, although it remains doubtful whether some of these can be distinguished conceptually from existing categories of return.

9Calculated profit and loss in the complex economy is measured against the societal rate of interest which is determined by the societal time preference rate. The societal interest rate is the price at which all willing borrowers can borrow money and all willing lenders can lend it and the success of failure of an enterprise will, by and large, be judged against this rate.

10Claude Frédéric Bastiat, That Which Is Seen and That Which Is Not Seen.

11Capitalism, in contrast to socialist and Marxist myths, has always been a system of production for the masses, of increasing the outlay of basic, everyday items that are sold inexpensively to everyone. Very little of capitalist production is devoted to luxury production for the rich.

12Rothbard, p.7, (italics in original).

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