DRI-307 for week of 6-30-13: Paving the Road to Hell: A Short History of Bailouts

An Access Advertising EconBrief:

Paving the Road to Hell: A Short History of Bailouts

A versatile sports anecdote of obscure lineage pits a combative baseball manager against a first-base umpire. The manager conducts a prolonged, high-decibel – but utterly unavailing – protest against the umpire’s decision to call a runner out at first base. Upon returning to the dugout, the manager encounters a quizzical coach.

“Why waste all that energy?” the coach inquires. “You know he’s not going to change his call.”

“I’m not arguing about that call,” the manager replies vehemently. “I’m arguing for the next one.”

The story may be apocryphal, but its point is sound. Umpires are known to be influenced by their own nagging suspicions that they have blown a call, so much so that umpire schools teach pupils not to compensate for mistakes in subsequent decisions. The immediate aftermath of the play is the manager’s only window of opportunity to influence the umpire – about future plays, not the one argued about.

From the beginning, economists have argued against “bailouts” – the use of government (e.g., taxpayer) funds to rescue failing business firms. Although the arguments supporting bailouts pretend to be economic, the true motivation is invariably political. This suggests that economists’ opposition is futile. Yet the opposition continues, just as the bailouts themselves do.

Like the proverbial manager, economists are arguing for the next one. They know that the bailout process has a cumulative momentum. A bailout is not an independent, isolated event that stands or falls purely on its own merits. Each bailout establishes the precedent for the succeeding one. Moreover, each new generation requires a fresh introduction to the illogic of the bailout, as well as to the history of the process. Economists direct their arguments against past bailouts, but their true targets are the bailouts to come – the ones whose fate they can influence.

That is why a history of bailouts and the ghastly reasoning that inspired them is far from pointless. It is our only prophylactic against the flood of bailouts to come.

Penn Central (1970)

The Penn Central Railroad was created by the 1968 merger of two venerable American railroad companies: the New York Central Railroad and the Pennsylvania Railroad. A year later, the New York, New Haven and Hartford Railroad joined the party to form Penn Central Transportation Company. These railroads all shared common features, particularly their location in the northeast United States. The Northeast corridor was the most population-dense region of the country. Each of these roads specialized in short hauls of people and freight, in contrast to the mostly long-haul traffic carried by railroads elsewhere in the U.S.

The problem was that, while shorter routes made geographic sense, many competing means of transport had evolved by the late 1960s. Barges carried bulky, low value-to-weight commodities like gravel and sand. Trucks carried retail goods and foodstuffs, including refrigerated perishables. Buses and automobiles carried passenger traffic. This left specialized raw materials like coal and commuting passengers for the railroads.

The roads wanted and needed to lower freight and passenger rates to compete with rival industries. Alas, they were hamstrung by the Interstate Commerce Commission, whose regulations forbade rate changes without regulatory hearings. Ironically, the very regulatory body ostensibly created (in 1887) to prevent railroads from utilizing monopoly power now prevented them from behaving competitively. The erosion of railroad customer base to these competing transportation modes left the railroads with scads of excess capacity and no way to utilize it. This was a recipe for bankruptcy.

The theory behind Penn Central was that merger would allow the single entity to better utilize capacity by selling off abandoning track and rolling stock. Unfortunately, it succeeded only in building a bigger, bulkier and less efficient mousetrap. Penn Central declared bankruptcy in 1970 and was eventually declared unsuitable for reorganization. The federal government took over its passenger business and operated it under the name of Conrail.

Railroads in general and Conrail in particular were saved, not by government bailouts, but by the deregulation of railroads in the Staggers Act of 1980. This gave railroad companies the freedom and flexibility to act quickly and decisively to serve customers by cutting prices and dumping unprofitable lines of business. Unfortunately, the federal government continued to operate a nationalized passenger-rail transport system called Amtrak. Today, a completely deregulated railroad industry would undoubtedly serve the part of the U.S. where passenger-rail service remains viable – the Northeast. Instead, Amtrak continues to serve markets where the demand for passenger service is feeble and the costs of service are astronomically high.

Why in the world was Penn Central bailed out to produce Conrail? What crying necessity demanded it? What calamity would have accompanied an orderly bankruptcy and the demise and liquidation of the company? “None” and “none,” respectively, are the answers to the last two questions. Many upper-middle-class and upper-class Northeasterners traveled the commuter routes served by the roads, and the railroad unions wielded political clout in inverse proportion to the value created by their members for the railroads. (The term “featherbedding” was coined to describe the work practices of railroad-union employees.) The Republican (!) administration in power was powerless to resist the political temptation to “save jobs” and preserve a highly visible service catering to an influential elite.

Today, everybody has forgotten about Conrail. Nobody remembers the first great federal bailout of private business. Of course, it did not end in a huge fiasco. And today the railroad sector is a tremendous transportation success story. But the reason for success is the subsequent deregulation of railroads, and the remaining legacy of the bailout – Amtrak – continues to hemorrhage red ink and suck involuntary transfusions from taxpayers.

Great oafs from little acorns grow.

Lockheed (1971)

The longtime producer of jets had come to derive the bulk of its business from government contracts. This made it a creature of government, even though it technically operated in competition with other airplane manufacturers. The bankruptcy of British firm Rolls Royce – famous for its luxury automobile but also a proficient builder of engines – threatened the completion date for Lockheed’s TriStar L-1011 jet fighter. Default on this U.S. government contract would have put Lockheed under. To tide the company over, the U.S. Congress issued some $250 million in loan guarantees to Lockheed, over the protests of free-marketers.

This time, the rationale was somewhat different. Lockheed’s defense status allowed the company to wrap itself in the cloak of national security, a nuisance that probably destroys more GDP annually than any other economic pest. This required considerable chutzpah on Lockheed’s part, considering that America could still boast firms like Boeing and McDonnell Douglas even if Lockheed had padlocked its doors. But that didn’t stop the company from pointing to the dread specter of its 60,000 jobs that would be lost – gone forever! – if Congress did not ride to its rescue.

Sure enough, the TriStar made it to market. Fittingly, it was deep-sixed by competitors like Boeing’s BA747 and McDonnell Douglas’s DC-10. When the TriStar ceased production in 1983, Lockheed abandoned jet production (so much for our national security) and later merged with Martin Marietta to form Lockheed Martin.

Note, once again, that even though Lockheed did not default on its loans, the bailout was still exposed as a fraud. The pretext of protecting national security proved to be nonsense, the object of the loans proved to be superfluous and as for the jobs – well, the loan guarantees ended up saving a product that deserved to fail but didn’t immunize against an eventual loss of jobs, which went unnoticed anyway.

Chrysler (1980)

In 1979 Chrysler, the smallest of America’s “Big 3” automakers, turned in a then-gigantic $1 billion loss in net income and teetered on the edge of bankruptcy. Dynamic CEO Lee Iacocca heeded the newly evolving American tradition that, when the going gets tough, the tough go begging – to Washington for a bailout. Probably recalling Lockheed’s loan guarantees, Iacocca secured $1.5 billion in guarantees for Chrysler. In addition to the (by now) old chestnut that he was “protecting jobs,” old-hog Iacocca was able to root up a new chestnut – that America’s automotive vanguard had to be protected against the encroachment of foreign competition from Japan. This was a conveniently flexible argument. If there had been no competition from Japan, Iacocca would then have argued that Chrysler needed to be saved to make sure that Americans didn’t run out of cars. Now he could argue that Chrysler needed to be saved to make sure that America “won” the “car war” with Japan. The fact that “winning” by subsidizing an inferior product was the same thing as losing didn’t seem to occur to most people – certainly not to Congress – and Iacocca was hailed as a genius for his lobbying efforts.

President Carter signed the bailout legislation in January, 1980. His administration saved face by requiring Chrysler to raise its own financing for the loans. Iacocca could later brag that the company returned to profitability by 1983 and repaid its loans. No harm, no foul, right? What a triumph for bailouts! At least, that was the general impression conveyed. Yet American consumers paid for Chrysler’s comeback in the form of taxes and quotas levied on imports of Japanese automobiles. That price was very steep.

The biggest price, though, came later. The Chrysler bailout set the stage for the later bailout of General Motors and Ford. The precedent set by Chrysler made it easy – indeed, virtually inevitable – to bail out the “Big 2” when their time came. Not only was it that much harder to reject the same bogus “jobs” rhetoric Iacocca had advanced, but the mere fact that Chrysler had done it and gotten away with it set a psychological minimum standard for treatment of ailing corporate giants. Previous bailees had been either quasi-utilities like Penn Central or quasi-government firms like Lockheed. This was a straightforward case of corporate welfare. It was a line jumped, a Rubicon crossed, a rule broken. Things would never be the same again.

Long Term Capital Management (1998)

In the late 1960s, a group of investors that included Nobel-Prize winning economists formed one of the first hedge funds, named Long Term Capital Management (LTCM). The fund was designed to incorporate asset pricing and portfolio management principles embodied in tools like the Capital Asset Pricing Model developed by William Sharpe. The most striking notions employed by LTCM were those involving portfolio risk.

LTCM designed highly risky portfolios that included long-term fixed-income instruments and currencies. It was precisely the long terms that produced the high risk, since the interest-rate risk of fixed-income securities increases with term to maturity. Currency risk likewise increases with the holding period. The high risk produced very high rates of return. So far, there was nothing remarkable about LTCM’s activities or methods. But the firm was able to offset most of the high risk through a hedge position, whose value was specifically designed to move inversely to that in the risky portfolios. Alternatively put, it was supposed to move directly with interest rates. The general idea behind this hedge investment was simple in concept but hard to achieve in practice: to rise in value when LTCM’s risky portfolios were falling in value, thus offsetting the otherwise-high risk LTCM was running. This made it possible for LTCM to earn spectacularly high profits in good times and break even (more or less) in bad times.

The hedge investment was a short position in U.S. Treasury securities. When worldwide interest rates rose, LTCM’s risky portfolio value would plummet. But LTCM’s managers knew that investors would bid down the prices of Treasury securities and, as a result, their effective yields (interest rates) would rise. Only this higher yield would make Treasury bonds equally satisfactory to investors when world interest rates had risen. The fall in Treasury-bond prices would make big profits on LTCM’s short position to offset the losses on its risky portfolios. And so it went for about 20 years until 1998.

That was the year of the Russian government default. Suddenly the world’s investors abandoned risky investments altogether. They embarked on a “flight to safety.” At that point, the U.S. government’s Treasury bond was still the prototypical riskless asset. So investors bought Treasury bonds, driving up their price and driving down their effective yields (interest rates).

Whoops! Now LTCM was losing boatloads of money on both sides of its trades. In no time it was going down for the third time, financially speaking. And its owners, having kept their eyes open for the preceding 20 years, did what any red-blooded American financier or CEO would do. They ran to the federal government for a bailout.

LTCM was not a railroad. It was not a defense contractor. It was not a car company. It wasn’t even a bank. It was just an investment company whose investment strategy had blown up in its face. Now its investors and owners were suddenly staring insolvency in the face. Except, in this case, they decided to stare Fed Chairman Alan Greenspan in the face instead. And Greenspan blinked. Acting through its New York branch, the Fed passed the plate around Wall Street and collected $3.8 billion in funds with which to salvage the firm’s investments while delivering the firm into the hands of its rescuers.

And what was the rationale for this unprecedented act? Basically, to prevent turmoil in the markets. LTCM was so big that the Fed was afraid that its failure would scare investors to death. Note that there was now no pretense of saving jobs, defending national security, preserving the sanctity of motherhood or the recipe for Mom’s apple pie.

LTCM was a hedge fund whose investors were people of considerable means. The whole idea behind the tight regulation of the investment business is to make sure that investors and investments are suitable for each other and risks are borne by willing individuals who can afford to lose the money. And now… the Fed said we couldn’t afford to let them lose the money! Why? Because the knowledge that one firm had failed would drive this group of rational investors to collectively commit irrational acts. The Fed intervened massively in capital markets to reverse the outcomes of legitimate trades because their subjective reading of collective psychology told them it was the thing to do. And they arbitrarily commandeered private resources to do so, without statutory or judicial warrant.

The Bailouts of the Great Recession and the Financial Crisis (2007-2010)

For most people, the steps taken by the federal government during the Great Recession and the Financial Crisis of 2008 seemed unique and precipitous. But our history of bailouts shows their roots extending far back in history.

The nationalizations of General Motors, Fannie Mae and Freddie Mac were preceded by the nationalization of Conrail. The bailout of GM came after the bailout of Chrysler. The bailout of a financial firm like LTCM paved the way for future bailouts of AIG, Goldman Sachs Hedge Fund and others. The numerous bank and near-bank bailouts in the Financial Crisis were the grandchildren of the Continental Illinois bailout.

The ostensible legacy of the Great Depression was that particular markets needed tight regulation. Financial markets needed it to insure that all parties had the information needed to make rational voluntary exchange possible. Banking needed it because the principle of fractional-reserve banking allowed banks in the aggregate to exert an undue influence over the supply of money through credit creation. In good times, this could facilitate inflation and the creation of bubbles. In bad times, this could cause disaster when bank runs and bank failures have a downwardly cascading effect on the money supply.

Our history of bailouts, however, indicates that bailouts began forfirms in specialized sectors like railroads, defense and banking, but gradually spread to mundane sectors like manufacturing and investment. It comes as no surprise, therefore, that today programs like TARP offers bailouts to a substantial sector of the American population. Homeowners make up a majority of U.S. households and it is not hard to envision a day when a mortgage will come with a guarantee against foreclosure.

The ultimate guarantors of a bailout are taxpayers. The government can obtain funds to bail out a business firm from only three sources: tax receipts, borrowing and money creation. Taxes reduce the real income of taxpayers. Borrowing requires the repayment of principal and interest; thus, it reduces taxpayer real incomes unless it funds the creation of a productive asset. Money creation reduces the value of taxpayers’ money holdings, which is tantamount to a tax.

When everybody bails out everybody else, the process is self-defeating. It becomes impossible and purposeless to sort out gainers and losers. Only the brokers, politicians and bureaucrats, are net gainers. Since the expenditure of resources necessary to produce the bailouts far exceeds the gains enjoyed by these groups, economists frown on the whole process. Far better to allow market to allocate resources and pass judgment on how well or how badly business firms use them to satisfy consumers. Of course, anybody who wants to voluntarily contribute their own resources to compensate losers in the competitive process is welcome to do so. When people act voluntarily, we can presume they gain more than they lose from their actions.

But when government meddling takes the form of bailouts, there is no such presumption.

DRI-271 for week of 1-13-13: How (Not) to Help Orphans

An Access Advertising EconBrief:

How (Not) to Help Orphans

The current issue of Great Britain’s venerable weekly The Economist contains a revealing anecdote about Vice President Joe Biden – revealing not merely about Biden himself but about economics, politics and their interaction.

The anecdote is recounted by one of the magazine’s American correspondents, whose byline is “Lexington.” The column identifies Biden as chief mediator between the Obama administration and the Republican opposition. Lexington finds Biden suited to that task, citing his 40-year Congressional career mostly spent brokering deals and schmoozing colleagues. It is not Biden’s fault that “America’s problems are larger than the deals that a vice-president can cut.” It seems that, according to Lexington, “small-government conservatives – backed by the Tea Party and allies on the airwaves and online – have raised the political costs of dispensing political pork and favours.”

Since it is not clear why this is a bad thing, it would seem that The Economist’s left-wing bias is showing. This is confirmed when Lexington cites “an old Senate belief cherished by Mr. Biden: that fellow politicians may be wrong but are rarely bad. Mr. Biden likes to recall his shock as an angry young senator on learning that a seemingly heartless Republican foe of disability rights, Jessie Helms, had adopted a disabled orphan.” Lexington’s point is that this experience chastened Biden and made him tolerant of Republicans, willing to oppose their policies but not to question their motives.

Lexington is wrong on both counts. Biden is bigoted, not tolerant. The episode reveals his intolerance of the right wing. But that is the least of its importance.

Helping the Disabled

Even as the current Economist was hitting the newsstands, the tolerant, conciliatory Mr. Biden was floating proposals for his boss to suspend the Second Amendment rights of Americans via executive order. In so doing, Biden was displaying the same callous insensitivity he displayed toward Jesse Helms in assuming that Helms’ opposition to federal disability “rights” legislation reflected a persona animus toward the disabled as a class.

Today, thanks to research by Arthur Brooks of the American Enterprise Institute, we know that right-wingers like Jesse Helms provide the bulk of charitable assistance in America. Left-wingers tend to consider their tax payments as their contribution to charity. We also know that federal-government welfare programs have become a monstrosity, mushrooming in number and size while failing to make a dent in the problems they were ostensibly intended to solve. The latter conclusion is now shared by many on the left as well as practically everybody else.

The notion that opposition to big-government is “heartless” implies that compassion is expressed impersonally, indirectly and ruthlessly by taking money from some people and giving it to others, rather than personally and directly by immediately benefitting those who need help. This not only prejudges the motives of the opponent, it takes for granted both the good will and the efficiency of the government. In other words, it was not only bigoted but dumb.

Biden’s opposition to Helms was simply the reflexive action of a man not given to reflective thought. His numerous verbal gaffes committed while Vice President reinforce this interpretation. Biden’s status as the Obama administration’s designated dealmaker does not bespeak any innate sense of empathy for his opposite numbers across the aisle, any more than a used-car dealer need feel kinship with his customers.

Jesse Helms vs. Joe Biden

Lexington’s anecdote has much more revealing economic implications. Contrast the two types of problem-solving approach illustrated. On the one hand, there is the “Jesse Helms” approach. Orphans are in trouble. They need help. Helms sees them. He responds immediately and directly – by helping orphans.

Now compare this with the “Joe Biden” approach. He sees orphans in trouble. He responds by – well, he “responds” by setting in motion a lengthy, ponderous, indirect process that just may, if all goes well, after many months or even several years elapse, succeed in helping some orphans, to some vague and indeterminate degree.

Is this comparison unduly pejorative? Does it prejudice the case against the Biden approach? No, this would seem to be a pretty dispassionate summation of the history of federal-government welfare programs over the last five decades, when balanced against the efforts of the private sector. The Congressional legislative process is indeed protracted, beginning with bill introduction, committee study and submission to the full chamber, followed by reconciliation and eventual passage by both houses. This alone often takes up the better part of one legislative session. Sometimes bills are held over into the next session; sometimes they linger on for years.

When the aid-to-orphans bill passes, does that mean the problem is solved? Certainly not. It means that government machinery is formally set up. It may take months or even years for the resulting program to become operational. After it does, the program may operate indirectly through pre-existing state and/or local programs. The federal program may generate related programs, exhibiting a form of political cellular mitosis.

The programs themselves are intended to help orphans, but they do not provide the form of direct help that Jesse Helms provided. That is, they do not take in orphans and provide them with those things the lack of which makes them orphans in the first place; namely, a loving, caring, compassionate home and family. They may provide institutional shelter in the form of a state-run home. They may provide real income, mostly in the form of in-kind assistance. This second-best form of care will be dispensed by bureaucrats and tied to all kinds of strings and rules. These rules are ostensibly designed to insure that the taxpayer funds bankrolling the program are wisely spent. But the result of this bureaucracy is invariably a system that works poorly and is disliked by the social workers who administer it, the recipients of its largesse and the taxpayers who fund it.

Ah, but surely private charity comes with its own constraints, its own delays, its own bureaucratic drawbacks and roadblocks? For example, Jesse Helms almost surely had to undergo a suitability test in order to adopt; running that gauntlet took time and effort. True enough, but the example of Father Flanagan and Boys’ Town in Omaha, Nebraska shines a glaring light of contrast on the difference between government welfare and private charity. Starting with nothing but a handful of homeless and impoverished boys and his own determination, Father Flanagan built Boys’ Town into a self-sufficient city of self-governing boys that has attracted orphans like a magnet for nearly a century.

It is true that the sunk costs of enabling legislation and setting up programs have already been expended; the welfare system is already in place. But instead of time take to pass new laws, we have to factor in time and expense of re-authorizing and financing programs already in place. Indeed, the crisis posed by public debt alone is reason enough to abandon the fiction of the “compassionate” Biden and the “heartless” Helms. It is not only that the Helms approach works and the Biden approach fails. The Biden approach is drowning representative government in a sea of debt throughout the world.

Roundabout Production

Even if we stipulate that the “Biden approach” has failed dismally in this particular case, can we say that this is a general result? That is, should we apply this lesson not merely to welfare programs but in all situations involving private vs. public assistance? And does it have even broader applicability?

“Helms vs. Biden” illustrates a lesson in the economic theory of production. To drive home the lesson in general terms, consider the example of fishing – a productive activity man has undertaken throughout recorded history. The most primitive production process is also the most direct: wading into the water and catching fish with bare hands. This requires skill and patience as well as access to shallow water holding fish.

A somewhat more productive process involves building a net, which improves the catch-per-unit-of-time. The first net builders had to take time off from fishing or hunting, which required them to build up a store of food to support themselves while net building. In turn, this required reducing their food intake for awhile prior to the investment period. This was an early historical example of the economic process of saving (dietary stricture and food stockpiling) and investment (net building).

More productive still is to construct rod and line to supplement the net. Yet more productive is to build a boat to enlarge the geographic range of fishing. These broaden the time frame of the production process considerably since they require much more time spent on investment and fishing itself. But the huge improvement in physical productivity in terms of potential catch makes the time spent worthwhile.

In the last half-century, fishing has become a production activity analogous to farming. Businesses have purchased infant fish and/or breeding stock and ponds, lakes or defined oceanic territory in which to raise colonies of fish for commercial harvesting. Obviously, this is the most protracted and costly of all fishing production processes, as well as potentially the most productive and lucrative.

The economic term of art that describes this continuum of production processes is “roundaboutness.” The most direct production processes are those that translate inputs into consumption output the quickest. Successively less direct processes take more and more time and involve more and more steps, but tend to gain more productivity with each increase in time and stages. The great Austrian economist of the late 19th and early 20th century, Eugen von Bohm Bawerk, described this by saying that roundabout production processes tend to be more productive.

Bohm Bawerk also found roundabout processes to be more characteristic of capitalism. Owners of capital (the machines and goods-in-process vital to the productivity of longer processes) can borrow to finance their own investment in these longer processes. They pay workers the discounted value of their marginal product for the work they do and use the premium above the discount to repay the borrowing. Thus, everybody can benefit from the enhanced productivity of roundabout production. Interest rates are reflected in the borrowing and in the discounting process that produces the premium.

Capitalism comes into the discussion because roundaboutness cannot be properly evaluated without the existence of prices and interest rates. It is tempting to view the productivity of roundabout production as an immutable physical law, but sometimes the good being produced is a service that has no physical yield. Now we have no alternative except to evaluate that yield in monetary terms using its price as a multiplicand. Even more compelling is the fact that a larger quantity of physical output in the future is not necessarily preferable to a smaller quantity today; it depends on the time preferences of individuals and their rate of preference for consumption today versus consumption in the future. A sufficiently high rate of preference for consumption today could override the possibility of more output in the future and tip the balance in favor of the simplest and most direct production process rather than a more roundabout one.

Another factor that might argue against roundabout processes is scarcity of inputs used in those processes. Thus, input prices have to figure in the evaluation, too. And interest rates reflect the intensity of consumer time preferences as well as the scarcity of funds made available by savers for investment purposes. Thus, interest rates are key to the calculation of costs and benefits for roundabout processes.

In a pure capitalist economy, roundabout processes are used only when they are profitable. That is the same as saying that they are used only when the value created by their higher productivity exceeds the value lost to their higher investment cost. Thus, under capitalism we are doubly blessed. As consumers, we benefit from the ofttimes greater productivity of roundabout production without having it jammed down our throats when it is not beneficial on net balance. The safety factor is the presence of the profit motive. When roundabout production is too costly, it will be unprofitable and firm owners and managers will veto it.

Government and Roundabout Production

Government is roundabout production to the max. The very existence of the legislative process itself gets government started in a roundabout direction. Stages of production increase every time a new level of bureaucracy is created. The difficulty of interacting with bureaucrats and repeating budget authorization procedures annually maintains and even increases the temporal distance between the consumer and the good or service being provided by government.

Unlike production in a pure capitalist economy, however, government production possesses no inherent internal check on roundabout processes. There is no profit motive; thus, there is no easy way to tell how much recipients like the service being provided. The absence of profit means that there is no check on costs incurred; indeed, the value of government services is traditionally gauged according to the value of the inputs used in providing them! In other words, the more we spend on government, the better off we are supposed to be. The polite way of describing this state of affairs is to say that the incentives are perverse.

Nobody has any reason to spend money carefully since bureaucrats are rewarded by overspending their budgets (with bigger budgets and larger departments) and for increasing the size of their departments (with promotions, larger salaries and more impressive titles). Government employees are the inputs into the roundabout production of government services; those production costs are income to them. Thus, the higher costs soar, the better they like it – no matter how economically inefficient this might be. True, government employees pay taxes, too, but they pay only a tiny fraction of the costs of their services while reaping all the wage, salary and fringe benefits.

To make matters worse, the demand side of the market is least amenable to roundabout production for goods and services provided by government. Welfare payments, disaster relief, military goods and services, “social insurance” and medical care for the aged and impecunious are things typically desired with the highest degree of immediate urgency. That is, they are areas where time preference is presumed to be very high and the wish for current consumption is at its greatest. Thus, even where productivity gains from roundabout production might be available, it is by no means likely that recipients of government aid would consider those gains to be “worth the wait” in the economic sense. Judging from the high level of dissatisfaction commonly expressed with government production, it is probable that neither consumers of government nor taxpayers are getting their money’s worth.

In summary, then, roundabout production has proven to be an economic triumph in free capitalist markets, where it has spurred tremendous improvements in productive techniques and living standards. And it has proven disastrous when used by government to produce goods and services. The difference between the two outcomes is the presence of the profit motive under free markets and its absence in government.

Why Has “Biden” Triumphed Over “Helms”?

Over time, various rationales have been advanced for the “Biden approach” and against the “Helms approach.” Originally, the “Helms approach” was seen as a “do-nothing” approach. The presumption – sometimes tacit, sometimes explicit – was that unless government adopted its roundabout approach, nothing would be done to help the poor, sick, orphaned, old, infirm, stricken, et al. We know now that this is not true and was never true. Even in past centuries, much voluntary effort was expended to help those in need. The reasons why this effort looks skimpy to modern eyes is twofold. First, real incomes in general were much lower and less was available for every purpose – charity included. Second, much activity was carried out informally within the boundaries of the family, neighborhoods and churches, without ever being recorded. Today, the omnipresence and scope of government has diminished the importance of the family and reduced the importance of the voluntary private sector.

The problem with the “do-nothing” presumption is that it contradicts the other premises of the welfare state. Much is made of the fact that we “voluntarily tax ourselves” to enable government to undertake its work. Of course, if this were really true, taxation would be superfluous and wasteful. The purpose of taxation is to coerce the unwilling; they are being taxed, not those who voluntarily surrender their income to the state. If people are unwilling, they presumably have a good reason. Either way, there is no reason to preserve a status quo that has broken down. Let the willing contribute to charities of their choice. This gesture will undoubtedly recruit many who are now unwilling to allow government to waste their money but would willingly give money if allowed to supervise, evaluate and find-tune their contributions.

Of course, somebody must be lobbying strongly in favor of the current system. It is the administrators, managers and employees of the 180 or so federal agencies that make up the welfare system. Welfare started out as an ostensible benefit for the poor but has now become a kind of dole for those who operate the system rather than its supposed beneficiaries. Most of these people earn higher salaries and larger employment benefits than they would otherwise earn in the private sector. Thus, they have a very strong motivation to preserve the status quo even though they are themselves taxpayers.

There is one more group – a small one – whose self-interest is identified strongly with the “Joe Biden approach.” That is the relatively small number of politicians who gain a large number of votes from their staunch of this system. And it is this group whose resistance to change has kept that system in place.

Meanwhile, what of the orphans themselves, disabled or otherwise? In a voluntary society, they could choose where to seek assistance just as the rest of us could choose whether and how to render it. The problem would be getting those who need help together with those willing and able to help. Today, the one thing available to all in profusion is information. It is impossible to believe that the voluntary efforts of a free people would accomplish less than the self-interested efforts of a badly motivated, poorly informed government.

That is the crowning irony of “Biden vs. Helms;” the Helms approach empowers the poor while the Biden approach renders them relatively powerless. The best way to help orphans is to keep government away from them.