Freeman

ARTICLE

To Deal With A Crisis: Governmental Program or Free Market?

SEPTEMBER 01, 1986 by ROBERT HIGGS

Robert Higgs is the William E. Simon Professor of Political Economy at Lafayette College, Easton, Pennsylvania. He is the author of three books and a number of articles in the professional journals of economics, history, and economic history,

Emergencies are inevitable. History is replete with them, and the future will certainly bring new ones. During the past century, Americans have suffered the un-anticipated shocks of great strikes, wars, depressions, and various lesser crises. It is instructive to consider now, while relative calm prevails, how past crises have been dealt with.

In the twentieth century the usual method by which Americans (and many others) have dealt with crises, namely, by creating emergency governmental programs, has resulted in permanent losses of economic freedoms and permanent impairments of economic institutions. If we can learn from our past mistakes, perhaps we can avoid such unfortunate developments when we must cope with a crisis again,

Above all, we need to understand that the choice is not between a governmental program and an unchecked calamity. Rather, the choice is between remedial actions taken by governmental officials, who can wield coercive powers, and remedial actions taken by private citizens, who must confine themselves to voluntarily accepted arrangements. In either case, something will be done. The critical questions have to do with the effectiveness and long-run consequences of the actions taken.

Suppose a crisis strikes: for example, foreign supplies of oil are drastically reduced. Industries using oil as a raw material must reduce their rates of production. Workers are laid off; their earnings decline or disappear. Oil- related industries and businesses dependent on the patronage of the laid-off workers feel the impact. They too must cut back. Economic decline spreads like ripples from a stone tossed into calm water. Something must be done. But what should it be?

Some are likely to propose, indeed to insist, that the government “do something.” An emergency program could assign the available supplies to the users governmental officials consider most important, perhaps hospitals, police, fire departments, farmers. The authorities could undertake to restore the domestic equilibrium upset by the foreign shortfall. They might, for example, compel refiners using domestic off to give up some of their supplies to refiners dependent on foreign sources. Of course, some method of compensation would have to be devised; someone would have to administer the rules to insure compliance; and someone would have to make adjustments to unforeseen changes in domestic patterns of demand and supply. In short, a governmental program to “do something*’ about the import cutback would probably lead to the creation of pervasive rules, a large administrative corps, and a suppression of free-market arrangements over a substantial part of the economy.

But what choice do we have? Given the dire consequences of the import shortfall, how could we refuse to acknowledge the need for a governmental program? Is there really any workable alternative? Would not catastrophe result from the absence of an emergency governmental response? The short answers to these questions are: There is an alternative way to deal with the crisis; a governmental program may not be needed; a market-oriented response probably will work; and people left to work out their own salvation will not simply surrender to despair and disaster.

The essence of many crises is shortage: the quantity supplied of something—oil, opportunities for employment, soldiers—falls short of the quantity demanded at the prices prevailing in the market. But markets, if prices axe free to adjust, naturally tend to eliminate shortages. In fact, the very existence of a shortage tells us that the prevailing price is too low. When the price rises, two things happen. First, demanders reduce the amounts they want to buy. Second, suppliers increase the amounts they want to sell. Given a sufficiently large price increase, a new equilibrium results in which the quantities demanded and supplied are the same. The shortage disappears. This adjustment process is exactly what is meant by “the workings of the laws of demand and supply.”

Sometimes, however, the process does not appear to be working. Prices quickly rise, but little else seems to happen. Complaints arise that sellers are enriching themselves by “ripping off” the buyers. Political pressures may be exerted to keep the prices from rising further or to force them back to previous levels, on the grounds that price increases, even if they eliminate the shortage, only transfer income from buyers to sellers while doing nothing to restore the amounts of the good previously available in the market. But wait.

Laws of Demand and Supply

The laws of demand and supply have two parts. The first law of demand says that, other things being equal, people want to buy less when the price is higher. The second law of demand says that the longer the time for adjustment, the greater is the reduction in quantity demanded for a given increase in price. Similarly with supply. The first law of supply says that, other things being equal, people want to sell more when the price is higher. The second law of supply says that the longer the time for adjustment, the greater is the increase in quantity supplied for a given increase in price.

The message is clear: be patient. The market will restore an equilibrium, and conditions will steadily improve. With sufficient time, suppliers will bring forth more of the good in short supply or good substitutes for it. Demanders will find increasingly satisfactory ways to do without the good in reduced supply, often by substituting other goods for it.

In an emergency, however, many people do not want to wait for the second laws of demand and supply to come into play. Markets, we are often told, work too slowly. An emergency governmental program is said to have the important attribute of speeding the process of adjustment. Undeniably, coercive programs often work more quickly. But is this aspect of their operation, really an advantage?

Unfortunately, coercive programs “save time” only because they compel wastefully hasty adjustments. They do not save valuable resources. Rather, they redistribute the costs of adjustment in comparison with the responses determined by voluntary arrangements in free markets.

Suppose, for example, that in an oil crisis created by an import shortfall the government orders domestic oil producers to bring forth immediately larger deliveries of oil than they would supply voluntarily in reponse to the higher price of oil (assuming the government allows the price to rise freely in the market). Does not the government’s order hasten the process of adjustment, and is not such a speedup desirable?

To see what happens, consider why the oil producers do not supply the governmentally ordered amount voluntarily. When the price rises, they of course want to increase the amounts they supply. But an increase of amounts supplied can be brought about by various means, for example, by drawing down on inventories stored in tanks, by increasing the rate of pumping from established wells, by drilling more wells on known underground reservoirs of oil, by searching for new oil fields, by extracting oil from shale, and so forth. Each source can be tapped, but in the short run it is wasteful to draw on those that require more costly development, that is, more research, planning, reorganization of facilities, and reallocation of resources. It may make good economic sense to proceed with additional exploration and the development of new oil fields, for example, but to make these options yield oil quickly is possible only at extraordinarily high costs—for hiring and training inexperienced workers, bidding the use of materials and equipment away from other industries, paying employees higher wages to get them to work overtime. In the very short run it is economically justifiable to bring forth only the extra oil available in existing inventories in storage tanks. Later the other sources of additional supply can be tapped at a measured, and therefore cheaper pace.

Coerced haste only makes waste. Faster adjustments are more costly, and someone must bear the additional costs. The government can compel a faster adjustment, to be sure, but no valuable resources are saved because of the compulsion. Rather, someone is compelled to bear costs of adjustment that are not worthwhile. To satisfy the government’s requirement, resources are shifted from socially more valuable uses to socially less valuable uses. The government gets a faster reallocation of resources not because its emergency programs “save” anything but only because its coercive power allows it to impose wasteful reallocations on the private owners of labor and capital. Society makes a faster adjustment at the cost of becoming, all values considered, worse off.

Emergency governmental programs, then, offer exceptional opportunities for those who would substitute their own values for those ordinarily guiding the allocation of resources in the market. When the cry of emergency goes up, the public’s resistance to governmental takeovers comes down. Hence, aspiring redistributors of income, collectivist planners, and do-gooders at other people’s expense all rash in to exploit the unusual opportunity for replacing market processes with governmental controls. But whatever one may think about the immediate desirability of an emergency governmental program, one must recognize that the program is almost certainly only a beginning; and what follows in its train may be far less desirable.

Unintended Consequences

At the very start one often gets something he doesn’t want along with something he does. Because governmental programs are created by politicians who seldom give their assent gratuitously, proponents of a governmental program of type X may be able to marshal a majority in favor of it only by adding a governmental program of type Y. For example, when Congress passed the National Industrial Recovery Act—a paradigmatic emergency program—in 1933 to restore business profits by establishing cartels in every industry, provisions were included to promote collective bargaining and establish wage-and-hour rules in the labor markets. The labor provisions bought the acceptance of the act by congressmen responsive to the interests of labor unionists and thereby insured its passage. When the Supreme Court overthrew the NIRA in 1935, Congress immediately re-established (and even strengthened) its labor provisions by passage of the Wagner Act. In this instance, as often happens, the original emergency program had attached to it, as the outcome of a political “horse trade,” a governmental program that persisted long after the original program had disappeared.

Emergency programs frequently don’t work as they are intended to. Governmental officials attempting to control the market discover that it is a moving target. As George Shultz and Kenneth Dam have written, “To every government action the private sector reacts or accommodates, and the government further reacts as the private economy ‘talks back’ to the government.”[1] The government tries harder and harder to outwit the people subject to its controls. The people try harder and harder to anticipate what the controllers will do next. Although the process may result in a stand-off, it consumes ever more resources on both sides. For example, when the Reagan administration in 1984 announced new import restrictions on steel, “steel-making nations around the world began shipping more steel to the United States to establish higher benchmarks from which their steel export limits would be set,” thereby bringing about the opposite of what the program was designed to achieve.[2] Naturally, domestic steel producers and labor organizations called for a stronger program to deal with this unforeseen development. American farmers subject to acreage controls have been playing a similar game since 1933.

Creation of an emergency program usually leads to the entrenchment of the connected special interests, both governmental and private. Everyone knows that “infant industries” granted tariff protection never mature to the point where they are willing to give up the “temporary” protection they sought in the beginning. Trackers who got protection from free-market competition during the Great Depression are still fighting to maintain their privileges against those who seek to deregulate the industry. Farmers are perhaps the most notorious. While the number of farmers has declined greatly and the typical farmer’s income has risen dramatically since the 1930′s the bureaucracy at the U.S. Department of Agriculture has become vastly larger. And the farm “crisis” seems ever with us, no matter how often the government undertakes to deal with it.

The farm programs also illustrate how emergency governmental programs, when maintained long after the events that prompted them, can lock the government into an almost inescapable position. The benefit of governmental subsidies comes to be expected by all parties. Hence it is “capitalized” into the value of farm land. Current farmers, who must bear the higher cost of land use, get no extra benefit by operating land subject to the subsidies—all the benefits were captured by those who owned the land at the time the new subsidies were first announced. But should the government discontinue the subsidies, current farmers would be hurt; the value of their wealth would fall. Naturally they fight to maintain the existing programs. The only way the government can rectify its initially bad choice of policies is by harming innocent parties, which seems manifestly unfair. Thus the programs go on and on even after almost everyone has recognized their ineffectiveness, inequity, and waste of resources.

Of course, no matter how the programs work out, the administrative corps tends to grow. If there are far fewer farms to serve, well, the people at the Agriculture Department can find other things to do, like operating the food stamp program or distributing pamphlets to urban gardeners or studying the international commodity markets. The U.S. Department of Energy grew out of a so-called energy crisis in the 1970s, yet today, when oil prices have plummeted and no one even claims the existence of an energy crises, the Energy Department thrives with thousands of employees and a budget of billions of dollars.[3]

Suppressing Flexibility

Ultimately the most unfortunate aspect of emergency governmental programs is that they suppress or crowd out flexible, creative, voluntary market responses to the crisis. When the energy programs of the 1970s controlled the prices of petroleum products and allocated the products among different classes of users and different areas of the country, the market could not work. Indeed, every aspect of the controls, especially the so- called entitlements program that was developed to make the controls “fair” to different classes of refiners, was socially perverse. Consumption and imports were encouraged; domestic production was discouraged. William E. Simon, the famous energy “czar” of the early crisis period, later declared that “There is nothing like becoming an economic planner oneself to learn what is desperately, stupidly wrong with such a system.”[4] Economic history is full of successful market adjustments to shortages of all kinds: coal was substituted for wood; steam engines for animal and water power; an ingenious assortment of machinery for human labor; the list is virtually limitless. Yet such adjustments hinge on the I presence of market incentives and the economic liberties that permit voluntary rearrangements to emerge.

The first and second laws of demand and supply cannot come into play unless shortages are allowed to express themselves in the form of price increases and surpluses are allowed to express themselves in the form of price decreases. Ultimately the most damaging aspect of emergency governmental programs is that they prevent the fundamental forces of the price system from doing the job that they, and only they, can do while preserving our economic freedoms.

Having witnessed decades of episodic crises, Calvin Hoover wrote: “At the time of economic crisis . . . critical extensions of governmental power are likely to occur . . . . [T]here is likely to be an insistent demand for emergency action of some sort and relatively little consideration of what the permanent effect will be.”[5] The outcome is almost always the same. As Clinton Rossiter observed, “No constitutional government ever passed through a period in which emergency powers were used without undergoing some degree of permanent alteration, always in the direction of an aggrandizement of the power of the state.”[6] In American history these observations are undoubtedly valid.[7]

Yet the pleas persist. Even in the early 1980s, hardly a time of genuine national emergency, there have been calls for emergency governmental programs to deal with unemployment, mortgage interest rates, re-regulation of the air-lines, oil, and of course, the farmers,[8] Apparently the rhetoric of crisis still promises a positive political payoff, no matter how visibly grasping the special interests who mouth it.

The government will be less likely to use its powers in the service of these special interests if the general public keeps calm. When we hear the claim that a crisis is upon us, we are justified in remaining skeptical, for the serviceability of a genuine crisis to those who would set aside the free market has led them to attach the crisis label to almost all their pleas. Even when a genuine crisis occurs, we might well consider whether the best way to deal with it is simply to let the market work. By considering all costs and benefits and all consequences in the long run as well as the short run, we shall be less inclined to place our trust in emergency governmental programs. []


1.   George P. Shultz and Kenneth W. Dam, Economic Policy Beyond the Headlines (New York: Norton, 1977), p. 8.

2.   “Foreign steel still flooding U.S., ‘Voluntary restraint’ on imports makes little impact,” Easton (Pa.) Express, May 10, 1985.

3.   U.S. Bureau of the Census, Statistical Abstract of the United States: 1985, 105th ed. (Washington D.C., 1984), pp. 311,324.

4.   William E, Simon, A Time.for Truth (New York: Berkley Books, 1979), p. 50.

5.   Calvin B. Hoover, The Economy, Liberty, and the State (New York: Twentieth Century Fund, 1959), pp. 326- 327.

6.   Clinton L. Rossiter, Constitutional Dictatorship: Crisis Government in the Modern Democracies (Princeton: Princeton University Press, 1948), p. 295.

7.   Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (New York: Oxford University Press, in press.)

8.   Dennis Farney and Rich Jaroslovsky, “Reagan, Democrats Seeking Compromise To Produce an Emergency Jobs Program,” Wall Street Journal, Feb. 10, 1983; “Senate unit OK’s $5 billion housing program,” Seattle Trines, April 22, 1982; “House OK’s bill to aid housing industry, Measure would pump $1 billion into mortgage-interest sub-sidles,” Seattle Times, May 12, 1982; Dennis Farney, “House Sustains Veto on Mortgage Subsidy Aiding Reagan Bid to Stem ‘Bailout’ Bills,” Wall Street Journal, June 25, 1982; “Airline Unions Ask For ‘Re-Regulation’ of Ailing Industry,” Wall Street Journal, Oct. 5, 1983; “Analysts see oil-shortage problem if emergency powers lapse,” Seattle Times, Sept. 9, 1981; “Oil Emergency Rules End as World Supply, Price Outlook Eases,” Wall Street Journal, Oct. 1, 1981; “Senate Self-Embarrassment” [editorial], Wall Street Journal, Oct. 12, 1981; “House Votes President Oil-Embargo Powers,” Wall Street Journal, Dec. 15, 1981; “Return to Rationing?” [editorial], Wall Street Journal, March 16, 1982; “Reagan Vetoes Bill To Give President Powers in Oil Crisis,” Wall Street Journal, March 22, 1982; “Senate upholds veto of bill on oil-crisis action,” Seattle Trines, March 25, 1982; Andrew H. Malcolm, “In Farm Crisis, the Land Itself Becomes a Liability,” New York Times, Oct. 9, 1983; “FmHA to make emergency loans to farmers in ‘84,” Easton (Pa.) Express, Dec. 28, 1983; “House Panel Clears Measure to Expand Credit for Farmers,” Wall Street Journal, March 18, 1983; “House panel orders more farm emergency help,” Easton (Pa.) Express, Sept. 22, 1983.

ASSOCIATED ISSUE

September 1986

ABOUT

ROBERT HIGGS

Robert Higgs is a Senior Fellow in Political Economy at The Independent Institute. He is also the Editor at Large for The Independent Review, the Institute's quarterly journal.

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