Tuesday, February 12, 2013

Is Government the Problem?

Progressives or liberals believe that through collective action government is the solution – that is it is necessary to reach national goals. President Reagan countered that government is the problem. So which is it…The Problem or the Solution? And why does answering that question matter?

My answer is that it is a false question. It is sort of like having your mother-in-law living with you. She is there for the foreseeable future. If you let her, she will solve some of your problems while creating others. But she is there and you better figure out how to live with her. She isn’t going anywhere!

Government is like that. You would have an easier time getting your mother-in-law to move out than getting rid of your government. In the USA the government is a big mother. It spends a lot of money, it taxes, and it regulates. It is not going to move down the block. It is a waste of time arguing about whether it is the solution or the problem -- when it is both. The more important question is how to make it better.

Let’s start with a decision rule that applies to any institution. The government should solve problem X if (1) the private sector cannot solve X and (2) the government sector can solve X with reasonable efficiency. For example, let X be cancer. The private sector has not been able to eradicate cancer. So should the government try? While criteria (1) is satisfied many of us would wonder why it is that government could do a better job than scientists in pharmaceutical and biotech companies. Thus a government cancer program might not survive criteria (2).

Contrast this case to the famous case of the company emitting pollutants in a stream that another company uses in its production process. The very dirty water creates costs for this second firm who has to filter the water before using it. In the absence of any government pollution programs, the down-stream firm has costs that are not of their own making. Thus the costs and price of the downstream firm are made higher while the upstream firm has no liability. Thus a problem exists that is not solved by the market system. Enter the government. A pollution tax could be levied on the polluter that is in proportion to the costs incurred by the second firm. Thus government pollution regulation might be a solution for this problem if it reduces the amount of the pollution. This looks like a strong case for government action. 

Of course, much depends on whether the government would apply the correct solution. If the government simply closes the first plant or creates a pollution tax totally out of proportion to the harm – then society might be worse off with the government action.

Why do we care about these two decision rules? We care because it makes no sense to have a government that makes things worse. There are many problems out there. There are many ways these problems can be handled by the private sector. But in some cases, the private sector cannot get the job done. But just because the private sector can’t solve the problem does not mean the government should. Sometimes living with a problem might be better than solving it. Back to the cancer example. Cancer is a stubborn disease. Suppose a government official promises to spend $15 trillion per year to solve cancer? Government is going to raise taxes by $15 trillion per year to accomplish this? You would note that $15 trillion is about the size of the incomes earned by all Americans in one year. That’s a national cancer program that would be destructive. We can’t afford it.

You might say that our government officials are nice people and they would never intentionally waste the people’s money in this way. But then you would be forgetting many things about government. The first thing is that governments are as fallible as are the people who run them. For example, they might spend more on a problem than they initially intended because of human error.  Such a cost over-run in a private firm shows up in lower profits and will get attention quickly. But in government there is not such strong feedback loop for cost over-runs. There are no quarterly profit reports and no stockholders to get annoyed. In government a tally at the end of the year of all spending and taxes might find the government with an unexpected government deficit. At some point the voters might show their displeasure with this but nowadays that seems like a pretty slow and faulty system for cost over-runs.

Second, government officials answer to voters. We might even say that they cater to voters. Voters like the idea that government can provide them with things and they know that a benefit for them will be paid for by the country. If I want my street to be safer it is nice to think that the whole country will help me pay for that safer street. Unfortunately there is a fallacy of composition. If everyone wants a safer street they can’t have one. It would cost too much. So government creates a big problem for the politicians. They want everyone to know that the government is there to help so that they will get votes. But they know they can’t help everyone. This creates a queue for more government spending and a continual demand by voters for more government. It makes no sense for any single household to not participate in the demand for government growth. You are going to pay for it so you will want to get your share of the benefits.

The point is not to say that government is bad. The point is to show that once you set up a government and have it go about solving problems, then you have to be very careful or it will cost and grow more than expected. It takes strong vigilance. It is no accident that most economic calamities and pain often comes after rapid increases in government spending. It is also no accident that restraints on government spending, taxation, and debt are commonplace and that such restraints are often the advice handed to governments experiencing subpar economic activity. The Congressional Budget Office in the USA, the World Bank, the International Monetary Fund, and the Organization  for Economic Growth and Development are just a few of the policy advising bodies that regularly counsel counties to be careful about government growth.

Reagan was right when he looked back at the 1960s and 1970s and said government was the problem. But liberals are also right when they say that government can and should be the solution to pollution, poverty, security, and many other national problems. If they are both right then it shows that there is no free lunch when it comes to decisions about government spending and growth. It means that serious people in and out of government need to decide on the currently correct amount of government – program by program. This is about solving our problems with solutions that don’t bankrupt the country. It is about solving real problems based on real analysis and not on short-term vote getting. Isn’t it amazing when you watch our political leaders how far they are from this kind of rational behavior? 


  1. Rational behavior from the pols? Never.

    In the private sector managing a group of independent suppliers or sales people is sort the same as being a government. You want them to act as a team, share ideas, work together to win projects..etc. However, unless they see mutual benefit on how the system works then they will be more like managed cats.

    Wars used to do this for the public but I think that wore off after World War II and especially after the last two outings.

    Dr. D is right, If people see polluting streams and air are major detriments to their lives they will band together and ask the government for a fix to something the free market system either takes too long to correct or cannot do it effectively. On the other hand the government may be a not for profit and may not see the end value as being the same. The bad news is that it feeds on itself and does not make those rational decisions that Dr. D showed in his blog.....at least unless there is a large squeal from the public....and it takes a very large squeal to get the government to do it right.

    So on to the State of the Union science fiction story to be unveiled tonight. Government creating jobs and raising taxes to fund such creation. No mention of cutting spending. Nancy P keeps talking about balance. To the average non millionaire person balance means do not spend more than you earn and do not borrow any more than you can pay back with your debt to income ratio being less than 35%.

    The question is "what gets cut". There are lobbyist of all shapes and sizes working on behalf of their clients to influence almost every inefficient overpaying government agency or project. They are experts in using semi data to win their case and that of their client.

    We still need jobs but before the cannon is fired and the revenue thrown out the door, a lot of unbiased good research needs to be applied. The US is in a global battle for economic growth and in transition socially, morally and economically. Once the research has been organized, gathered and studied...only then can the government clearly see its role. The private sector is already moving because profits and the market system are forcing that on them...act quickly and smartly or die.

  2. Dear LSD. Obummer’s SOTU speech further demonstrated how out of touch he is, over his head, and way out of his league—unless one considers he’s just another lying, duplicitous, deceitful, hypocritical pol. He is and has been true to his upbringing, education, and work experience (or lack thereof)—which essentially is a collection of anti-free market, pro-govomit, socialistic, and collectivism proclivities.

    His SOTU initiatives amounted to another run on the Treasury to fund budget-busting no-value-added programs without any regard for the amount of debt it will add. Just expand govomit.

    His congressional supporters are no better and with their legislative advantage can block any bills to reduce spending—not the rate of spending—but actual spending. Nothing will improve on Cap Hill until earliest 2014 elections if the Senate goes R and Reid RIP. But even then POTUS can still veto bills ‘cause I doubt the ’14 election would result in an over-riding-veto majority. So now we gotta look to 2016, but I’m not hopeful—too much candy to hand out in the Candy Man’s goody bag.

    Don’t count on any meaningful decisions/solutions—jez keep on kicking that can down the road. Maybe that will be the best for those of us in the fiscal conservative camp because the Rs haven’t been able to even reach a compromise that is conducive to moderate fiscal discipline let alone major deficit reduction. Looking back 60 years any “compromise” the Rs agreed to has resulted in more govomit—not less.

    1. Reminds you of the guy who gets a "sudden" heart attack after many annual cautions by his physician that his diet of 12 ribeye steaks a week is not ideal.