Monday, 31 January 2011

The State of the Union and Obama's Game of Risk

Obama’s State of the Union address revealed a failure to understand the role that risk plays in the free market, meaning that his administration will only create unsustainable bubbles, and not successful businesses.

We are being told by the mainstream media that Obama’s State of the Union address was one in which he flexed his free market credentials.  The HuffPo’s Rachel Maddow even went so far as to describe the address as a “prayer to the free market”.  There can be no doubt that we were supposed to draw this conclusion - Obama spoke favorably of corporate profits, thriving small businesses, competition, innovation and even Google and Facebook (see how “hip” he is!)  Specifically, Obama spoke of how his administration was investing in small businesses trying to get off the ground.

However, pumping struggling small businesses with taxpayer’s dollars is not the same as being an advocate of the free market.  Despite what our left-wing friends will tell us, the free market is not so much pro-business as it is pro-consumer.  The reason we on the right advocate the free market is because it ultimately benefits the worker, the consumer and society as a whole, by creating wealth, jobs and delivering goods and services efficiently at low cost.

One of the ways the free market encourages the private sector to deliver such efficiencies is through the concept of risk.  The left sees risk as one of those bad and nasty things that they should “protect” vulnerable small businesses from.  Yet as Milton Friedman was so fond of reminding people - the free market is not just a profit system; it is a profit and loss system.  It is through the risk of loss, and the incentives and disincentives that it brings, which encourages efficiency and wise decision making.

In the free market, risk acts as a cleansing fire that burns away poor business ideas, as well as burning away inefficiencies and problems in good ideas.  This is because when the owner of a business bears the risks attached to failure, it encourages him or her to be as efficient as possible and to take care with decision making in order to minimize those risks.    To quote Thomas Sowell, “In a capitalist enterprise, the owner is an unmonitored monitor; self interest takes over from external monitors.”[i] 

Additionally, those wishing to start a business will be all the more careful about their business plan if it is their money that they are investing, as it will be they who will bear the consequences if the plan is not sustainable.  External investors in new businesses will also be careful how they invest their own money, and will either not invest in a bad venture at all, or will spend time examining the plan and pushing the owners to make changes before they take a risk and invest.  This means that the only businesses that start up are those in which people are prepared to risk their money.

The above is fairly simple economics, but for the left, risk brings to mind only negative images of scared small business owners and shattered dreams.  It is for this reason that Obama and similarly minded leftists have been quite happy to “minimize” the risk of starting up a business by providing loans and grants to small businesses that they deem to be politically expedient. 

The State of the Union address was therefore filled with examples of how government had funded the startup of various “green” businesses, such as the business owned by Robert and Gary Allen, who used their government loan to expand and to manufacture solar shingles.  Here in England we already have a whole rainbow of government grants and loans, such as the “Community Development Finance Initiative”, “The Carbon Trust” (if your business is “green”) and the “Mayor’s Economic Recovery Loan Fund” in London.
While these may sound lovely and compassionate, as well as being great ways of encouraging businesses to start up, they are not free market solutions, and are therefore misguided.  For what such loans and grants do is not to minimize risk, but simply to transfer that risk from the business owners and investors to the taxpayer.

This is unfair not only because the taxpayer is forced to bear the risk of loss without the prospect of profit, but also because they have become investors in businesses in which neither the owners nor private sector investors were prepared to put their money.

Also, although it may be wonderful for Robert and Gary Allen that they are selling their solar shingles in the short term, it may not be so lovely for them in the long term.  For if they had failed to attain investment through the usual private sector paths, they may have taken their ideas back to the drawing board and either jettisoned the ideas for better ones, or they may have ironed out the kinks in the current ideas to attract investors.  This would be better for their long-term prospects.

Such a grant is not good for the business (Robert and Gary may be working with a dud) nor is it good for the investing taxpayer – who gains nothing from the risky investment even if that business turns profitable.  The only group it benefits are Obama’s Democrats, who get to pat themselves on the back for encouraging green businesses and jobs, and who will then pat themselves on the back again when they “save jobs” by bailing out the industry after the green bubble they are creating by funding bad businesses eventually bursts.
Ultimately risk is seen by the left as bad as it discourages businesses from starting up.  This is inaccurate – risk only discourages bad or imperfect businesses from starting up.  Obama’s plan for more government funding for businesses is not a free market solution, and it is not pro-business.  All it will do is create unsustainable bubbles that will hurt efficiency, hurt workers, hurt consumers and hurt American society as a whole – and that is a risky plan.

[i] T Sowell, Basic Economic: A Citizen’s Guide to the Economy (New York: Basic Books 2000) p.75

1 comment:

  1. Here is my related reference for 2012 Obama's SUA. You can read it at (2012 State of the Union Address and How It Affects Those in Work Uniforms)