“What has always made the state a hell on earth has been precisely that man has tried to make it his heaven.”  - Friedrich Hölderlin

Can an entire economy really be managed to ensure prosperity for all? 

Around the globe governments are overheating from activities designed to prevent a recession.  The medicines range from bailouts and money printing to lavish government spending. 

The unbridled hope is that through these interventions the government will induce people into acting a certain way and thereby make economic life better for the whole population.  The fact that these policies may have not only unintended consequences, but likely unimagined consequences, has not yet been thoughtfully considered.    

We find it fascinating that the debate centers on what mix of medicines the government should administer.   For us, the most interesting questions are: Will the medicine work?  Will it have its desired effect?  Can we really eliminate the negative consequences of economic decisions?

The answers to these questions depend on one’s view of economics itself. 

To some, economics is viewed as an empirical science, similar to chemistry or biology.  It is a discipline governed by unchanging laws and underpinned by assumptions of how people should behave.  To others economics is the combined result of individuals’ choices.   

Amongst those that view economics as a science, grand mathematical models and projections are often constructed and used to forecast and explain economic activity.  At the heart of these models are the assumptions that individuals have “perfect information” and will act “rationally”.  Based on these models the various bailouts and spending plans are formulated and presented as a solution to the current economic problems. 

Coming from a family of scientists, I can tell you that what are often called the “laws” of economics” certainly do not behave as what we normally think of as laws of nature.  For example, in physics the theory of gravity can be empirically tested by dropping an apple from a table.  Each and every time the apple will drop and hit the floor, (ceteris paribus) thereby proving the theory of gravity. 

Economics; however, deals with people’s behavior.  The supply and demand for goods/services are governed not by some unchanging law but by the decisions people make regarding buying and selling.  Moreover, these decisions do not always conform to the assumptions of perfect information and acting rational.   

I don’t know about you my friends, but my wife continually reminds me that she is the only person that possesses perfect information.  We have also seen people in our lifetime that appear to act irrationally and against their own self interest.  Ever witness a housing bubble by any chance? 

But hey who are we to judge?  We can’t identify the quality of information that people possess or what is in someone else’s self interest anymore than the US Treasury Department can.  The only small difference is that we don’t have the power to reallocate the resources of an entire economy. 

On the other hand, there are those who view economics more organically and less presumptively.  The economy is viewed as an amalgamation of individual choices regarding buying, selling, investing, saving, etc.  These choices may be made rationally, irrationally, intellectually, emotionally, etc.  All of these choices have consequences; some positive and some negative. 

From this standpoint, it is hard to see how exactly the bailouts, inflation and government spending can be relied upon to ensure people act in a certain way.   

Indeed, these interventions often do not have their desired effect.  For example, the loose monetary policies of the past several years were designed to “get us through” the tech bubble burst, 9-11, and various other crises.  Did anyone expect the result to be a speculative bubble in real estate, fueled not by savings, but by securitization and an alphabet soup of financially engineered vehicles?  Did anyone expect the entire banking system to be nearly vaporized as a result?  

Rather than more experimentation based on faulty assumptions, the economy simply needs to be cleansed.  Mal-investment must be cleared from the system through failures and bankruptcies.  The market will reallocate capital and resources to those more competent in managing them.  Providing more money to those who have already failed will not only encourage future failure, it will delay the healing process. 

Failure has gotten a bad name anyway and unfairly so in our opinion.  Failure is part of life’s natural feedback loop.  Individuals and businesses make various economic decisions and assess the results which are then used in future decisions.  The astute even learn something from the failure of others.

Without failure there can be no success.  If we eliminate one, we also eliminate the other.  In my own life I have learned that the greatest failures have often been the beginnings of my greatest successes. 

Perpetual prosperity for all is a concept not of this world.  For such an ideal we look to the theologians.  It’s fairly certain; however, that if we continue trying to predetermine economic outcomes and erase bad decisions, we will have prosperity for none. 

Until next week,

Michael Bechara, CPA

Managing Director

Granite Consulting Group Inc.