Why Republicans support limiting government

Why do conservatives support limiting government? Continuing with our excerpting of Congressman Jim Saxton’s Joint Economic Committee research report (see part one here), what follows below is the meat of Saxton’s argument.

I am not calling for boring economic speeches to be given every day by every Republican member of Congress. What I am calling for is that every Republican member of Congress reach out to serious communications professionals so what is explained below and in part one can be heard – and learned by – more Americans.

For years I have been saying that it’s time for private sector marketing, public relations, media and advertising professionals to be brought in to help Republicans disseminate good information. Right now what we have is a vacuum. It’s being filled by silly “hope and change” rhetoric.

What Saxton provided in this report is an example of the fact that at least some of our leaders know what to say – they just don’t know how to say it succinctly or connect with a larger audience. It’s time they learn.

Don’t tell me it’s not possible. This is the information age – and people are bombarded with a ton of news and data on a daily basis. What they don’t get enough of is good information.

Oh, and by the way, the same applies regarding state policy and economics.

Here is the Saxton argument. It’s a tad long but a decent summary nonetheless. It’s worth reading if only to experience an example of intelligent and informative writing from a Republican politician.

Information problems. The knowledge necessary to allocate capital efficiently is widely diffused throughout the global economy and costly to obtain. It is impossible for any one person or organization to acquire and to update constantly all of the information necessary to allocate capital efficiently in a complex economy.

Prices reflect the collective judgment of global markets on all available information. Under the market allocation of capital, price signals from changes in interest rates and share prices allow households and firms to coordinate their investing and lending activities and rapidly adjust their behavior to reflect changing conditions or prospects.

Under the political allocation of capital, however, policymakers or government bureaucrats substitute their judgment for the collective judgment of global financial markets expressed through prices. Because of the high cost and extreme difficulty in obtaining and constantly updating information, this substitution necessarily ignores some of the information incorporated in market prices. With less than complete information, politically determined credit and investment decisions are less efficient than market determined credit and investment decisions.

Unresponsiveness. A constitutional republic such as the United States places many restraints both legal and practical upon policymakers and bureaucrats. These restraints necessarily slow the response of policymakers or bureaucrats to changing conditions or prospects.

It takes time for policymakers to perceive funding needs. Congress must enact enabling legislation to allow a political allocation of capital. Normally, federal agencies must then devise implementing regulations before decisions can be made. While laws and regulations can be amended, change is often slow. In contrast, market participants have no such time constraints.

Bias against entrepreneurship and innovation. Extending credit and making investments involves risk. Loans may not be repaid, and the value of equity investments may dwindle. To reward lenders for assuming risk, riskier loans bear higher interest rates. Likewise, riskier equity investments require higher expected rates of return.

Entrepreneurs experience a high rate of failure. While only a small number of new firms grow into large prosperous multinational corporations, the rewards for investors in these few are enormous. Under the market allocation of capital, venture capital firms can provide funds to promising new firms with innovative products or breakthrough technologies because the vast returns from investing in the next Microsoft or Starbucks can offset many failed investments.

Under the political allocation of capital, neither policymakers nor bureaucrats receive large returns from successful investments in new firms. Instead, policymakers and bureaucrats that extend credit to or make investments in new firms that ultimately prove unsuccessful may suffer from press derision and public ridicule. As a result, policymakers and bureaucrats may lose their positions.

The differences in the balance between risk and returns in private firms and in government bias the political allocation of capital against funding entrepreneurship in emerging industries producing new goods and services using innovative technologies, and toward funding existing firms in established industries producing known goods and services using conventional technologies. Thus, the political allocation of capital discourages entrepreneurship, slows product and process innovation, and retards the development of new technologies.

Bias for constituents. Under the separation of powers system with legislatures whose members are elected by separate constituencies, the public expects individual lawmakers to respond to special needs of their constituents, while the public expects the chief executive to defend general interests.

Under the political allocation of capital, the natural tendency of legislative policymakers to serve the special interests of their constituents may cause such policymakers to direct or at least to influence the flow of credit and investment to their constituencies.

Struggling firms that have trouble raising funds in capital markets often seek funding from government. Because of constituency bias, many policymakers may support extending credit or investing funds to struggling firms that employ the constituents of policymakers to avoid layoffs or facility closures.

Layoffs and facility closures are never popular, but such restructuring is often necessary for struggling firms to recover. To secure governmental funding, however, firms may make popular commitments that are often not in the long term interests of the firm or its shareholders. For example, firms may commit to maintain their current level of employment, to keep inefficient facilities open, or continue to produce unprofitable products.

Resource diversion. The political allocation of capital encourages firms to devote management time and firm resources to lobbying activities to secure funding from policymakers or bureaucrats.

At a minimum, this distracts entrepreneurs and firm managers from their business. Firms may redirect resources from product innovation and process improvement toward lobbying activities. As dependence on government funding increases, the diversion of attention and resources may become severe. Such diversions retard product innovations and process improvements. Over time, diminishing productivity gains slow real income growth and reduce real GDP below its potential.

Corruption and crony capitalism. Finally, the political allocation of capital may foster corruption. When policymakers and bureaucrats make credit and investment decisions, entrepreneurs and firm managers may be tempted to bribe policymakers and bureaucrats to secure funding for their firms or to prevent their rivals from securing funding. Both policymakers and bureaucrats may seek to exploit the considerable economic power that they are exercising when they allocate capital.

Thus, policymakers and bureaucrats may seek bribes from entrepreneurs and firm managers.

In a number of countries, the political allocation of capital has led to crony capitalism, in which politically connected firms receive favors from the central government in exchange for various types of bribes to policymakers and bureaucrats. Under crony capitalism, politically favored firms are largely immune from competition with less well connected firms. This discourages both domestic entrepreneurship and foreign direct investment. By diminishing the incentive to innovate, productivity gains lag, reducing real GDP growth over time.

Conclusion. While the severity of the financial crisis may justify some of the recent federal interventions, these interventions, if not reversed once the crisis has dissipated, may retard the efficient allocation of capital in the United States and thus diminish its long-term growth prospects.

Private firms and households make their credit and investment decisions based on economic criteria. While federal policymakers may incorporate economic criteria, federal policymakers must necessarily incorporate political criteria into their decision-making. This fundamental difference between decision-making in private financial institutions and markets and decision-making in government inevitably fosters certain biases in the political allocation of capital and creates the opportunity for corruption that reduces long-term economic growth.”