Credit Diverts Production   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.


I love this one because it really gets to the nitty-gritty about some economic habits we’ve fallen into in this country … or should I say, been manipulated into.

Hazlitt could simply have said “beware of government grants”, but he recognized that his readers were probably not all that smart. He knew he was dealing with farmers who receive agricultural credits.

In the eyes of most Congressmen the farmers simply cannot get enough credit … supplied by private mortgage companies, insurance companies or county blanks is never “adequate”. Congress is always finding new gaps that are not filled by the existing lending institutions, no matter how many of these it has itself already brought into existence.

Image result for image of government subsidiesCongress keeps finding “credit deficiencies” to repair. This, by the way, still exists, but it is also applied now to homeowners. Faith is these government policies springs from two acts of shortsightedness. One looks only from the standpoint of farmers who borrow and the other thinks only of the first half of the transaction.

All honest borrowers assume they must repay all loans. Credit is debt. By increasing the volume of credit, you are increasing the burden of debt. If we would keep our eye on the concept of debt rather than mislabeling it “credit” we might not be so tempted.

Hazlitt set aside the ordinary loans farmers received through private lending institutions and focused instead on government-provided and government-guaranteed loans. He also set aside farm subsidies for later discussion. Here, Hazlitt concentrated on the capital loans that farmers use to buy the farm, tractor and other equipment.

At first glance, the case for this type of loan may seem a strong one. Here is a poor family … with no means of livelihood. It is cruel and wasteful to put them on relief. Buy a farm for them, set them up in business, make productive and self-respecting citizens of them; let them add to the total national product and pay off the loan out of what they produce.

Aren’t you enriching the whole community through this loan? Yes and private institutions offer these loans all the time, but there is a qualitative difference between a private loan and a government loan. A private lender risks his own funds or the funds of his depositors, who earn interest on allowing the private lender to risk their funds, while being guaranteed the banker will make good from his own funds if the money is lost. When people risk their own funds, they are careful in their investigations to determine the borrower’s ability to repay the loan.

If government operated on the same strict standards, there would be no good argument for its entering the field at all.

Image result for image of government subsidiesBut the government operates on different standards. It makes loans to people who can’t get them from private lenders. Government lenders will take risks with the taxpayers’ money that private lenders will not take with their own money. There is therefore a higher rate of losses in government loans than in private loans but the apologists for public loans will contend that this is offset by added production.

The argument holds water so long as we only look at the borrowers and not the ultimate source of the funds — that taxpayers who have been deprived of their income.

What is really being lent is not money, which is merely the medium of exchange, but capital. What is really being lent is the farm or the tractor itself. These are limited items. The farm or tractor being lent to A cannot also be lent to B.

The real question is, therefore, whether A or B shall get the farm.

We must then look at the merits of A and B. A is the person who would get the farm if the government did not intervene. The local banker knows him and his record. They know he’s a good farmer and an honest man. They consider him a good risk, a man who has accumulated enough cash to pay one-fourth of the price of the farm. They loan him the other three-quarters because his character and prior track record has earned him the banker’s trust. Sometimes things go wrong, but generally people of good character repay their loans, thus bankers are willing to loan money to A.

But the government goes into the lending business with a charitable frame of mind because it is worried that B cannot get a loan from private lenders because he doesn’t have credit with them. He lacks savings, he’s not an impressive farmer … maybe he’s even drawing welfare now. This loan will make him a productive citizen. Government can help with that.

Maybe. Sometimes people of good character fall on hard times, but in general people selected by these government standards are poorer risks than people selected by private standards. More money will be lost by loans to them. People who were previously not as efficient or trustworthy do not suddenly change their character when they are given a loan, which explains the mortgage collapse of 2008. That’s a verifiable fact. But what we don’t see, is the other half of the equation – the effect on A.

Because B has a farm, A is deprived of a farm. A may be squeezed out entirely because interest rates rise as a result of government operations or because farm prices increase as a result of them, or because there are fewer affordable farms available to those using private loans.

[T]he net results of government credit has not been to increase the amount of wealth produced by the community, but to reduce it, because the available real capital (consisting of actual farms, tractors, etc.) has been placed in the hands of the less efficient borrowers ratehr than in the hands of the more efficient and trustworthy.

The proposal for government-backed business loans applies to other businesses too, where the argument is that government “ought to assume the risks that are ‘too great for private industry.’ Bureaucrats are permitted to take risks with the taxpayers’ money that nobody would ordinarily make with their own funds.

This policy leads to favoritisim, cronyism, and out and out bribery. There are recriminations everytime the taxpayers’ money is thrown away on enterprises that fail. Think Solydra. This increases the demand for socialism because “if government is going to bear the risks, why should it not also get the profits?.

What justification could there possibly be … for asking the taxpayers to take the risks while permitting private capitalists to keep the profits.

Hazlitt asked his readers to focus on just one consequence of loans of this type — they waste capital and reduce production. They throw available capital into dubious projects, into the hands of people who are less competent or trustworthy than those who otherwise would have used the capital in a more productive way.

Private lenders want to get their investment back, so they weigh the prospects of profits against the changes of loss. Sometimes that doesn’t work out, but they make fewer mistakes than government lenders because the money is their own (or they are responsible to pay it back to the actual investors), whereas government lenders have an unlimited supply of taxpayers’ money.

The proposal for government loans to private individuals or projects … sees B and forgets A. … It is one more illustration of the fallacy of seeing only a special interest in the short run and forgetting the general interest in the long run.

Now, Hazlitt turned to subsidies. Government lends or gives to business only what it has already taken away from another business. When the New Deal proponents bragged about “bailing business out” with the Reconstruction Finance Corporation, the Home Owners Loan Corporation, etc, the government was not providing any financial help to business that it had not previously taken from other businesses. Government doesn’t create anything of its own. It’s funds all come from taxes. It taxes successful private businesses and individuals to support unsuccessful private businesses.

This is not good for the country as a whole.


Posted January 17, 2017 by aurorawatcherak in economics

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One response to “Credit Diverts Production

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  1. Pingback: Introduction to “Economics in One Lesson” | aurorawatcherak

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