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Saturday, December 01, 2012


Soft Budget Constraint

I was unable to find a good publication that related to something that caught my attention in chapter eight of Power and Prosperity so I figured it best to just discuss it.

The subject is the emergence and implications of a “soft budget constraint” within an autocracy in which the government owns the means to production, and therefore, allocates resources to producers (Olson, pp. 147-148). The basic idea is that a firm’s actual productivity does not have an effect on the resources it receives. Whether or not a firm is successful enough to cover its costs, it will continue to receive the same amount of resources. It is easy to see the major failure of a system that works in this way: in a free market system, a firm that is unable to cover its costs will eventually fail. By not allowing this natural outcome to occur, weak players are given an advantage while strong players are faced with a disadvantage.

Although in a free market economy within a democratic system of government (like that of the U.S), firms are not simply given a stock of resources with which to work, similar types of inefficiencies have been observed throughout history when government has stepped in to offer a helping hand to businesses that have proven to be negligent enough to have a severely imbalanced budget. The mere existence of government bailouts gives an advantage to the weak and a disadvantage to the strong, resulting in the same distortion referred to in the book: firms that do not cover their costs are not required to stop using resources.

When the government itself is the source of huge quantities of deficits, meaning that it has done a very poor job of balancing its budget, not allowing it to fail almost seems to be another violation of the natural order of success and failure. I was listening to 740AM here in Colorado Springs and a caller (probably a Liberal) asked the host why Republicans are so opposed to letting us go over the fiscal cliff, given that it would essentially force the government to fix its spending problems. The host’s response was that he personally is not okay with the idea that we go over the fiscal cliff, because it was designed as a punishment for not coming up with a solution and absolutely everyone suffers from this punishment. Although the consequences of going over the highest level of the fiscal cliff are sickening to think about, I think the caller had a good point, especially if you take into consideration not only the self-correcting philosophies of a free market system, but also Thomas Jefferson’s argument that governments occasionally need to be refreshed, mentioned in another of Olson’s books The Rise and Decline of Nations. It seems that if the country goes over this cliff in the worst possible way it may bring about the threat of a revolution in the most general sense of the word. Letting our government come severely close to failure or even actually failing may allow for a sort of “mini-revolution”. Don’t get me wrong, I do not enjoy the idea of this country being taken over by another, but if there was a real threat that it may happen, because our own government got itself into so much fiscal trouble that we are no longer able to finance spending through borrowing from other countries, essentially leading to bankruptcy, it just may be enough to slap some sense into the people we elect to run this country. Then again, given the logic of collective action, it might not work out that way. Either way, I think from the angle of market efficiency, that caller had a good point, despite the fact that he is likely an advocate of ObamaCare.

Works Cited

Olson, M. (2000). Power and Prosperity. New York: Basic Books.

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