Market Analysis

Government’s Very Un-Invisible Hand

On average, government subsidies don’t yield the intended results—and maybe even have completely the opposite impact. What would yield results? Freer markets.

Few—anarchists and maybe some extreme libertarians aside—would disagree government plays an important role in society. Well-run governments lay the ground rules and ensure they’re enforced. And they provide certain essential services—generally in the realm of public good—like police, firefighters, and military. But the list of things better left alone by government is arguably a lot longer.

Question: Why do cell phones keep shrinking in size while multiplying exponentially in power? Simply, competition and profit-motive. Technology firms’ sense of self-preservation motivates them—as it does all firms—to ensure they’re always a step ahead, providing the latest “must-have” technology while earning profits and providing consumers the most bang for their buck.

Not so with governments—which not only lack competition, they’re also not profit- or value-driven. If they were, the very existence of Amtrak right now wouldn’t be possible. Though running at a loss for nearly the entirety of its 40 year history, taxpayers (or rather, politicians) have yet to defund it—quite the opposite: The government favors increasing its funding. In fact, Amtrak’s creation was born out of government’s perceived necessity for passenger rail service, though it was largely government policies which killed private railroads in the first place—a somewhat mind-boggling example of government’s inefficiency and a lesson in the unintended consequences of government intervention.

If government could effectively determine who should optimally provide which goods and services—though I’m not sure how they would—that would be one thing. But the reality is those decisions have proven to be better left to markets—the wisdom of crowds of self-interested people making millions of selfish decisions based on myriad reasons no one group of even very smart people could pray to understand. But politicians’ decisions are more often based on (surprise, surprise!) political considerations—how best to allocate dollars to earn the highest political return.

Another ongoing yet potent example of the government trying to outsmart the wisdom of crowds is the US energy policy debate. Most folks generally agree fossil fuels are needed in the here and now and at affordable prices, which leads some to call for greater government involvement in opening land to exploration. Still others believe we need less fossil fuel reliance and more “clean” energy. There’s merit in both camps to an extent, but I won’t weigh in on their arguments’ factual merits here. The more important question is: How do we effectively and affordably get the energy we need both today and tomorrow?

Well, the government wants to have it both ways, so it hands cash to oil and clean energy companies in the form of government subsidies, hoping to indirectly keep conventional energy prices down with the former, while encouraging alternative energy development with the latter. Meanwhile, government regulates the energy industry in myriad ways—which, combined with subsidies, can detract from free-market forces’ determination of winners and losers. So you may ask: Do these subsidies at least yield results that outweigh the impact of government involvement? Let’s examine using a thought experiment within alternative energy.

Since the government can’t effectively single out companies to subsidize, it offers blanket subsidies—but that just holds back some companies that might be independently competitive in an open market. Consider two companies, both engaged in, say, solar power technology using different systems. One works really well—so well it actually makes not only scientific but also economic sense. The other works scientifically but isn’t economical. Government subsidizes both, which creates a problem: Two sources of supply—one inefficient, one efficient—competing for the same customers. But the efficient one effectively loses business because the inefficient competitor stays afloat through subsidy. Without subsidy, inefficient competitors are forced to either further innovate to increase competitiveness or fail. Either way, an overall plus for society and innovation. I know what you’re thinking: How is an inefficient competitor’s failure a plus?

If inefficient competitors fail, more business would likely be directed to the efficient producer, creating growth. Its success would probably encourage others to enter the market as competitive suppliers—prices to consumers would likely fall, to stay afloat in a more competitive field, industry productivity and/or efficiency and/or innovation would likely increase and on balance, society would benefit. Creative destruction at work. Government subsidies hinder that process and actually can create severe distortions—possibly making the hypothetically competitive alternative energy company a modern-day Pennsylvania Railroad.

Moreover, from an investment standpoint the existence of government capital can affect the behavior of private investors. In the short term, government subsidies can create winners and losers (see above for the pluses and minuses of that). But at the same time, private investors can (rightly or wrongly) perceive government’s investment as a crutch—and fear what might happen if the crutch is removed. That fear can negatively impact the subsidized industry’s access to private capital.

Consider what’s happening with shale oil: Natural gas industry deregulationin the 1970s and 1980s incentivized entrepreneurs to pursue shale oil development as a potential future energy source. The resulting innovations have us on the verge of a potential shale oil boom. Which begs the question: How much more innovation are we sacrificing because of government trying to shape the market?

The reality is there will be winners and losers, as with all innovative endeavors. But that just means consumers should benefit overall as the best products and latest technologies eventually win out. That creative destruction will ultimately solve the conventional versus clean energy contest may seem unfathomable today, but it’s happened throughout history (and continues to this day). And we’re all better off for it. Adam Smith’s metaphor for the phenomenon whereby markets allocate resources to the most productive uses was the invisible hand. And I’d argue it’s infinitely preferable to government’s very visible—and generally overly heavy—hand.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.