Saturday, June 27, 2009

When Government Determines Winners, We All Lose

A recent article in the Economist entitled "No Exit" chronicles the dangers of government officials selecting the economic winners and losers, but President Obama and his administration continue to promote a carbon emission caps by claiming it will usher in a new era of technological development and high tech jobs. The administration has bailed out the automobile industry in an attempt to preserve manufacturing jobs and prevent a further decline in employment, yet new claims for unemployment benefits continue at a pace of over 600,000 new claims per week. Most recently the U.S. International Trade Commission has ruled in favor of a complaint by the United Steelworkers Union that accuses China of dumping low cost tires in the U.S. market and disrupted domestic supplies. By embarking on a path of industrial policy-making and government intervention, the U.S. will distort the efficient allocation of capital and artificially support failing institutions. If the Obama administration hopes to avoid the lingering stagnation experienced by Japan over the past two decades, it will end its interventionist policies and allow competition and free markets to determine the most efficient allocation of resources.

The Economist reports that "As Japan struggles with its deepest recession since the war, the government has established a mechanism to give financial help to poorly performing firms, companies are being encouraged to provide support to their weaker suppliers, and banks are being asked to do their bit, too.... The problem is that keeping ailing companies on life-support holds back healthier firms and harms the economy overall. That is true everywhere, but Japan provides an extreme case that illustrates the dangers of coddling weak companies.... Banks are being pressured by the government to roll over existing loans and make new ones, and firms encouraged to extend credit and maintain business relations. The government’s recent stimulus measures give failing firms taxpayers’ money. A plan approved in May allocated ¥2 trillion ($21 billion) to prop up (indirectly) troubled companies. Pioneer, an electronics firm, Elipda, a chipmaker, and Japan Airlines are among the first to look for government support.... Weak firms need to exit the market, either by going bust or being sold to another firm, or the whole business environment gets stifled. Japan has far too much capacity in many businesses—eight mobile-phone makers, for instance, few of which make much money. This squeezes prices and margins, thus denying better-run firms the surplus capital they need to hire talented people, buy competitors or invest in research and development. It also locks up resources, both human and financial, that could be used more productively by stronger firms. Before the downturn, Japanese companies’ return on equity averaged around 10%, about half the level of American firms."

They conclude that "As governments around the world come under pressure to bail out everything from retailers to travel companies to automotive firms, Japan’s experience—a downturn followed by years of stagnation—serves as a reminder of the importance of destruction in capitalism. Instead of continuing to prop up struggling companies, Japan and other countries need to let them go under, so that new, better ones can be created."