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-335 for week of 9-30-12: The Economic Concept of the ‘Free Lunch’

An Access Advertising EconBrief:

The Economic Concept of the ‘Free Lunch’

“Give me liberty or give me death!” “54-40 or fight!” “What do you want – good grammar or good taste?” “Where’s the beef?” “There’s a sucker born every minute.”

Aphorisms, slogans and catch-phrases decorate the American idiom like Christmas-tree ornaments. They punctuate our points, intensify our insults, amplify our arguments and rationalize our rituals. They often start life as political or advertising jingles, only to outlive their original inspiration to become part of the language.

Economics has left its mark on our idiomatic heritage. Its most famous contribution has been: “There’s no such thing as a free lunch.” Although both the phrase and the concept date back to the 19th century, the line didn’t hit its stride until the 1940s, when a few economists revived it. Just as these origins would lead you to expect, the slogan contains a hard core of imperishable truth.

The Literal Free Lunch That There’s No Such Thing As

Today, children at K-12 public schools (and many private schools) commonly eat at least two meals at school. These meals are planned and paid for, wholly or partly, by government using taxpayer funds. Current programs evolved from the original federal program of “free” school lunches provided to poor elementary schoolchildren, begun in 1946. Today, some 31 million children receive subsidies, which go to those in families with incomes up to 185% of the poverty-level income. (Some children in wealthier families also receive subsidies, particularly for after-school snacks.)

Debate over the wisdom of the program attracted the attention of economist Milton Friedman, who reoriented the focus of the debate with his famous declaration: “There’s no such thing as a ‘free lunch.'” Before wasting time arguing about whether it was morally or constitutionally justifiable for government to provide free school lunches, Friedman maintained, we should first acknowledge that the lunches weren’t “free” in the true economic sense.

In the first place, somebody was paying for them. Sure, neither the children nor their impecunious parents were effectively plunking down cash in payment, but the foodstuffs were nevertheless being purchased by somebody. But even this wasn’t the ultimate point. Suppose, for example, that government had simply ordered private-sector firms to supply food to school cafeterias as an act of charity. That still wouldn’t make the lunches truly free.

The food was grown or raised. It was prepared and packaged. It was transported to the schools. All this required the use of resources – human labor, natural resources like land and water and chemicals, capital goods of various types. These resources had alternative uses, which meant that alternative output was sacrificed in order to produce the food and make it available. The sacrifice of that alternative output was the true economic cost of the food. Even if the school lunches carried no nominal price to their consumers, they still carried a real economic cost in the form of a foregone output. This is the only meaningful concept of the word “cost” – the highest-valued alternative foregone in production or consumption.

Friedman objected to free school lunches – not because he lacked compassion for poor schoolchildren but because he had compassion for children, their parents and everybody else. He wanted to see resources used as efficiently as possible, thereby making everybody as happy as possible.

The General Fallacy of the Free Lunch

To maximize happiness, we should use resources where people value them the most. To do that, we need to place a market value on the output produced using the resources, then let people compare that to the personal value they get from consuming those things. People will increase consumption for so long as their personal value exceeds the market value, finally arriving at their stable, ongoing consumption point when the two values coincide.

But school-lunch programs misled consumers by presenting them with a false picture of the market value. By presenting children and parents with a false market value of zero, the school-lunch programs encouraged poor children to consume far more food than they would have otherwise. (Some qualifying children pay a flat fee of $.40 for a lunch, but this does not alter the logic of the case.) Indirectly, parents were deceived as well, since they would otherwise have reacted to market-value prices of food by economizing on the lunch-money budgets they allocated to their kids.

Over time, free lunches for poor children have gradually metamorphosed into free or subsidized lunches for many schoolchildren in both public and private schools. Is it any wonder, then, that we have gradually developed a nationwide problem of childhood obesity pari passu with the escalating phenomenon of “free” and subsidized school lunches (and breakfasts) provided by government?

The inefficiency of free school lunches extends far beyond the current epidemic of child obesity. The fact that children consume too much subsidized food is complemented by the fact that producers produce too much. Indeed, agricultural subsidy programs for certain crops are the mirror image of the consumer school-lunch subsidies. One original rationale for the school lunch program was to complement agricultural price-support programs by liquidating or reducing crop surpluses.

Consumer subsidies artificially present a price that is too low; agricultural price supports artificially hold the price too high, creating a surplus. Production and consumption are driven beyond the point where the true personal value placed on the goods produced and consumed equals the opportunity cost of producing them. Instead, the opportunity costs exceed the value; the subsidies make us poorer.

The “us” in the last sentence includes nearly everybody, even the schoolchildren. By subsidizing the children with cash instead of lower lunch prices, they could consume alternative output that would make them better off overall than do the lunch subsidies. (Obviously, the cash subsidies would enable children to meet their varying individual nutritional needs.) There are only two possible net losers from abolition of food subsidy programs. Farmers might not gain enough from consumption of the additional output produced to compensate for capital losses on the value of their agricultural land. The other loser-candidates are the people in government whose incomes are directly dependent on the programs.

Milton Friedman’s position is now clear. Now we know why there is no such thing as a free lunch. But why did government insist on giving us something that made us worse off? And why do we insist on receiving it?

The Lure of the Free Lunch

Government’s behavior is conditioned by our responses, so the two questions above are not independent. The disconnect between tax collections via withholding on wage and salary income and provision of free school lunches means that taxpayers have traditionally failed to add up all the various government expenditures and gauge their personal value against their cost. Instead, they have said to themselves: “This individual subsidy is such an insignificant pro rata fraction of my total tax bill that it is not worth the time it would take me to mount an effective protest against it – which would only end up making me look selfish and insensitive, anyway.” Food consumers – parents of schoolchildren – say to themselves: “All I can be sure of is what I see in front of me – a free lunch for my kids. Refusing it won’t get me a cash subsidy. Maybe I’ll consider voting for somebody who makes that proposal – if anybody does.” But nobody does – and the subsidies are enacted, and grow ever larger and more inclusive.

The incentives offered government by these programs are utterly perverse. The beneficiaries of the subsidy – more specifically, the parents of the schoolchildren – represent a huge pool of potential votes. So politicians have an obvious incentive to propose and approve the program. Administering the program requires a large staff of bureaucrats and a much larger army of low-level employees. The larger the program, the more money bureaucrats make. This is an obvious incentive for bureaucrats to lobby for the program’s approval and enlargement. The low-level employees are getting secure government jobs; they are another obvious source of potential votes for politicians.

The longer this process goes on, the more entrenched and secure the program becomes. The more tenacious and vehement are its defenders – farmers, bureaucrats, politicians, government employees, even many ill-informed parents and schoolchildren. The more established the program becomes in the government budgetary process, where programs are routinely extended from year to year with an allowance for increases in prices and population. Any decrease in this routine increase is referred to as a “budget cut,” belying the fact that the actual spending on the program has risen.

The Free Lunch Pretext

The reader will have noticed at least two outstanding ironies in the foregoing explanation. First, the “solution” to the original problem of poor schoolchildren suffering inadequate nutrition ended up making practically everybody worse off – including the schoolchildren. Second, an actual solution that would have solved the initial problem for a fraction of the actual cost – a cash subsidy – exists but is spurned by the ostensible problem-solvers.

This seeming irony is explained by the fact that the problem-solvers are not really trying to solve the problem posed. The provision of the supposed free lunch is only a pretext. It is only an excuse for doing what politicians, bureaucrats, lobbyists and other enthusiasts for big government want to do; namely, expand the power and reach of government. The schoolchildren themselves are only pawns, convenient fronts and poster-children, a sympathetic public face for a most unappetizing enterprise.

Any doubts on this score have been expunged by the recent shift in emphasis by the federal school-lunch program. The Obama administration, supported by allies in academia, regulatory agencies, leftist think tanks and municipal authorities like Mayor Bloomberg of New York City, has proposed mandatory menu standards for school lunches in the Healthy Foods Act. The Act drastically modifies calorie, fat, carbohydrate and salt content of K-12 school lunches. Calories have been set between 650 and 850, depending on the age of the students.

The purpose of these modifications has been to preserve the free-lunch pretext of using government subsidies and mandates to help schoolchildren while really serving the interests of big government. Whereas the free-lunch pretext was to alleviate the effects of poverty by making lunches “free,” the pretext here is curing obesity by making healthy eating mandatory.

And as before, the real purposes are left unstated. The regulatory standards will require more and bigger government to formulate and enforce. They will absolve government from blame for the childhood obesity epidemic in the familiar way – by making government look as active as possible. This entails spending as much money as possible, which in turn serves the interests of bureaucrats, lobbyists and government employees.

Washington, D.C. is an official irony-free zone, but inhabitants outside the beltway may appreciate the irony that the same federal government now purporting to cure childhood obesity was a key contributor to it. The artificial underpricing of school lunches were one substantial contributor to child overnutrition. The new learning on obesity reveals another government link to obesity and to other worrisome trends – early- and late-onset diabetes.

In the last decade, research into Type II diabetes has confirmed a relationship hinted at by doctors such as Robert Atkins, whose low-carbohydrate diet gained tremendous popularity in the 1970s and 80s. Obesity is not always, or even primarily, the simple outcome of excess calorie intake relative to energy expended. Nor is it necessarily conducive to treatment via low-fat and low-calorie diets.

Many people suffer a double whammy of blood-sugar fluctuation and weight gain. Blood-sugar spikes occur when carbohydrates – particularly simple carbohydrates such as sugars – are ingested and enter the bloodstream quickly. This process drives blood sugar levels above the safety zone, causing neurological damage that eventually leads to peripheral neuropathy and other symptoms of Type II diabetes. Meanwhile, the spikes trigger a bodily alarm that releases insulin into the blood stream. The insulin restores the blood sugar level to normal, but causes the carbohydrates to be stored as fat molecules. These later produce arteriosclerotic plaque in the veins and arteries, causing heart disease – the common ultimate cause of death among diabetics. (The primary difference between Types I and II diabetes is that Type I sufferers cannot produce insulin, which must be supplied externally to prevent diabetic shock and coma.) And the fat storage produces weight gain – another commonly observed symptom of diabetes.

The new nutritional approach is to minimize carbohydrate intake and/or combine carbohydrates with substances like fiber, protein, fat and acid – all of which retard the quick release of carbohydrates as metabolized sugar in the bloodstream. Far from being the villain in obesity, fat plays a beneficial role by providing taste in food, preventing food cravings and satisfying hunger by filling you up. This fat doesn’t make you fat because it doesn’t accumulate in the cells; protein and fat are the primary source of energy and are burned by the body. Thus, meat is a dietary staple, along with fish. Fruits and vegetables are encouraged as long as they are high in fiber – whole fruits like apples with the skin on for fiber and nutrients, and vegetables like broccoli and beans.

How did the federal government figure in this nutritional revolution? Just prior to the emergence of the Atkins diet, the federal government’s nutritional recommendations followed the conventional thinking that carbohydrates should be the primary source of energy. White bread and potatoes were healthy and wholesome; fruit juice was wholeheartedly recommended; meat was highly suspect and eggs were virtually verboten due to their high cholesterol content. As noted cardiologist Dr. Arthur Agatston has ruefully pointed out, today we know that the reverse is nearer the truth.

Nobel laureate Milton Friedman once compared the behavior of politicians and bureaucrats to leaders of a flock of ducks flying in V-formation. Periodically, the leader looks back to discover in confusion that the formation has deserted him and is flying away. Immediately, he scrambles to catch up and get back in front of the V, where he can pretend to be the leader once again.

Today, the public has flown away from government leadership with the help of doctors like Atkins and Agatston. The flock of commercials on television advertising treatments for the symptoms of peripheral neuropathy testifies to the prevalence of Type II diabetes. The ubiquitous sight of restaurants and grocery stores nationwide offering foods catering to low-carbohydrate diets – sweet-potato fries, unsweetened iced teas and the like – shows that the free market moves faster to meet the needs of consumers than do federal regulatory agencies. Federal agencies are scrambling to get back in front of the nutritional V by imposing standards to make up for the obesity crisis that they played an important role in causing. It remains to be seen whether government standards will ever again regain the prestige they once enjoyed, or whether they will increasingly come to be recognized as pleas for special interests.

Economists vs. the World

The foregoing makes it clear why special interests embrace the free lunch pretext. It explains why the general interest – in this case, taxpayers and schoolchildren – cannot or will not mobilize sufficiently to overturn the current status quo. But why do so many people actively oppose reform? That is, why does the general public so often oppose efforts to end, let alone mend, subsidy programs like school lunches, food stamps and agricultural price supports?

Recall the arguments mobilized above against the free lunch. The one question never debated by economists is virtually the only question the general public considers worthy of argument. That is: Should the federal government give lunches to poor schoolchildren?

Economists don’t ask the question because they generally stipulate an answer. Given the assumption that “we” (e.g., the government in its capacity as executor of the collective will) have already decided to help schoolchildren who are too poor to afford adequate lunches, what is the most efficient way to do that job? Economists stipulate this answer because most of them are leftist in sympathy and owe their living to government employment. But that is misleading. The answer to the economic question (“what is the most efficient way to do the job?”) is purely a function of analysis, not of ideology.

There are at least three sensible answers to the general public’s question (“Should we or shouldn’t we subsidize poor schoolchildren via the government?”). 1. Government should subsidize poor schoolchildren in the most efficient way possible. 2. Government has no legal or moral authority to subsidize schoolchildren while private citizens have the legal authority but no special moral duty to do so. 3. Government has no legal or moral authority to subsidize schoolchildren but private citizens have both legal authority and a moral duty to do so. And no matter which one of these sensible answers you select, the current “free lunch” system is horribly wrong.

That is the unique contribution made by economists to the debate – the realization that the free lunch is a sham and a delusion that makes a bad situation much worse, rather than better. And unless you accept the likelihood that government can be persuaded to reform itself, economic analysis also tells you that you’re probably wasting your time selecting alternative 1. So, the choice is between alternatives 2 and 3 above.

Alas, the only issue that receives much public airing is “compassion for kids.” Ostensibly, free-lunch supporters are compassionate while opponents are hard-hearted and insensitive. In reality, the issue of compassion is a non-sequitur. Everybody, whether compassionate or hard-hearted, should unite in opposition to free lunches.

Yet the major issue is not a moral one. If you believe that bad parents or freeloaders are a burden on society, then you support alternative 2 above. If you believe that the only important question is how to improve the lot of poor children, then you favor alternative 3. But nobody should support what we have now and nobody should defend free school lunches or any of the other subsidy programs. Not only do they make most people worse off, they don’t even help the poor schoolchildren they were supposedly designed to benefit.

The widespread support that these programs do command is the strongest kind of proof that economists have failed in their primary mission – to teach basic economic logic to the general public. We cannot even persuade people to defend their own economic interests.

There Is No Such Thing as a Free Lunch

There is no such thing as a true, legitimate free lunch in the economic sense. There is only the pretext of a free lunch, which buys time for authorities to pretend that one exists. And the special-interest beneficiaries of the free-lunch pretext are very different than the supposed beneficiaries of the ostensible free lunch.

Having outlined the concept, we will devote the next EconBrief to an exploration of more expensive free lunches.