Central Planning and Government Failure

  • Chris Edwards
September 1, 2015
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The driving force behind market economies is that voluntary exchanges are mutually beneficial. Millions of buyers and sellers pursuing their own interests engage in billions of exchanges, each creating value on both sides. This process generates market prices, which help guide people and businesses toward the best uses of their efforts and resources.

Markets spawn prosperity by integrating production and consumption across the nation and around the globe. Markets thrive on diversity and innovation, and they generate cooperation between people with different values, goals, and lifestyles.

The federal government does not work this way. Rather than voluntary exchange, it uses coercion to pursue its ends. As a consequence, government decisions are based on guesswork, and its actions tend to create winners and losers. Furthermore, failed government policies are not weeded out because they are supported by compulsory taxes, not voluntary revenues.

The government is also inferior to markets in the generation and use of knowledge. The government creates unintended side effects when it intervenes because it cannot know all the personal preferences and complex relationships in our dynamic society. While markets work by gathering information from the bottom up, the government often fails by imposing its plans top down on the nation.

Decisions Are Guesswork

Federal agencies impose more than 3,000 new regulations each year, and total accumulated regulations span 168,000 pages.1 The government spends almost $4 trillion each year, and it distributes subsidies and benefits through more than 2,300 programs.2 Needless to say, the government is making a vast number of decisions affecting all aspects of our lives.

In making all these decisions, the government is flying blind. Regulations are top-down requirements for action or restraint, not efforts at finding voluntary agreement. Federal spending relies on compulsory taxation, not customer revenue. Because government activities are based on coercion, not mutually beneficial relationships, we cannot be sure that they generate any net value.

There is no system of supply and demand, prices, and profits to inform policymakers if their activities create more benefits than costs. So policymakers may believe that their interventions make sense, but that is usually wishful thinking based on guesswork.

Consider the purchase of aircraft. In the private sector, an airline chooses the number of planes to buy on the basis of demand for air travel, which is aggregated from individual preferences expressed in the marketplace. By contrast, when the Pentagon buys aircraft, the number chosen is decided by political factors and guesswork regarding threats. No market generates information about the benefits of a threat reduction.

More broadly, no reliable mechanism exists to help the government make efficient choices across alternative uses of funds. Would fighter jets, farm subsidies, or food stamps be the best use of added funds? In markets, tradeoffs are made with the help of prices. If the price of air travel goes up, consumers reduce their air travel and increase their automobile travel. But in the government, decisions on allocating its vast budget are not based on solid metrics.

In theory, government decisionmaking could be aided by cost-benefit analysis.3 Experts could try to tally up all the monetary and nonmonetary costs and benefits of proposed actions, and the government could choose those options with the highest returns. Since 1981, federal agencies have been required to perform such analyses for major regulatory actions.4 However, these analyses have often been of low quality because of a lack of accurate data and the use of dubious assumptions.5 Furthermore, experience shows that regulatory cost-benefit analyses are often biased in favor of the predetermined answers that government leaders favor.6

With spending programs, there is no broad requirement to perform cost-benefit analyses.7 To the extent that they are performed, they show similar shortcomings as regulatory analyses. The Army Corps of Engineers, for example, has long performed cost-benefit analysis on projects. But outside experts have complained that the agency's analyses are biased in favor of project approval.8 Investigations "have repeatedly caught the Corps skewing its analyses to justify wasteful and destructive projects that keep its employees busy and its congressional patrons happy."9 One Government Accountability Office report found that some Corps' analyses were "fraught with errors, mistakes and miscalculations, and used invalid assumptions and outdated data."10

Perhaps federal cost-benefit analyses could be insulated from politics and made more rigorous. If so, the technique could be used for more spending decisions within agencies.11 However, it is unlikely that such analyses would ever be used for broad allocation decisions by Congress, such as divvying up the budget between defense, housing, transportation, and other categories.12

In sum, decisionmaking in the market is a reality-based system rooted in individual preferences and trade-offs. By contrast, government decisions are based on guesswork, which is one reason why there is so much failure in Washington. It is also why there is so much bickering in politics—everybody has an opinion about how to spend and regulate, but nobody has hard data.

Funding Guaranteed

In markets, individuals and businesses often make bad decisions. But if they continue down the wrong path, their resources get depleted. A business making misguided investments will be punished by financial losses and may face bankruptcy. About 10 percent of all U.S. companies go out of business each year, which is a remarkably high exit rate.13 But losses and business failures prompt the beneficial reallocation of resources to more promising activities.

If government leaders are no more skilled than business leaders, their efforts will also have a high failure rate. But government activities that create no value can live on forever because the funding comes from a mandatory source: taxes. In theory, federal policymakers could rigorously analyze programs and then reallocate spending based on informed judgements about the successes and failures, but that usually does not happen.

How about successful activities? Businesses that do a good job serving customers will earn high profits, at least until the profits are eaten away by competition. The quest for profits guides businesses toward generating net value. In government, there is no such guide. Federal subsidy programs may attract many recipients, or "customers," but that is not an indicator of success—or net value creation—because it does not take into account program costs.

People might assume that government has an advantage in tackling society's problems because it is a powerful institution that can use coercion. Actually, the fact that government has a compulsory revenue stream is a huge weakness that leads it astray. In markets, strong feedback mechanisms prompt rapid adjustments when failures arise, but in government there is usually too much inertia to make needed changes. To a large extent, government failure is baked into the cake because its misguided actions are not self-limiting the way that private actions are.

Winners and Losers

People in markets generally act in their own self-interest in pursuing their goals and trading with others. At first blush, that seems like an anti-social bias, but the opposite is true. In his 1776 classic, The Wealth of Nations, Adam Smith described how people in markets acting in their self-interest end up promoting the broader public good. An individual "intends only his own gain, and he is … led by an invisible hand to promote an end which was no part of his intention.… By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."14 People who work hard and allocate their resources to benefit themselves end up supporting overall prosperity. Their personal actions are socially beneficial.

Economist F. A. Hayek expanded on Smith's observations. He noted that in markets people "are induced to contribute to the needs of others without caring or even knowing about them."15 And he said people "following their own interests, whether wholly egotistical or highly altruistic, will further the aims of many others."16 Markets are a win-win proposition for participants, a positive-sum game.

It is a similar situation with all sorts of private activity, such as pursuing friendships, supporting charities, and promoting social projects. In such voluntary activities, people engage with others in mutually beneficial ways. Individuals, of course, make mistakes and sometimes pursue harmful activities, but in those situations the damage will be limited because others are not compelled to go along.

A great advantage of markets is that individuals can choose their own levels of each good and service to consume. Markets allow for diversity. Indeed, economist Thomas Sowell noted that "the diversity of tastes satisfied by a market may be its greatest economic achievement."17

By contrast, the government tends to impose one-size-fits-all solutions on society. That creates winners and losers because the chosen level of a government activity will differ from many people's individual preferences. This loss caused by forced uniformity has been called a "political externality" of government interventions.18

In his 1962 book, Capitalism and Freedom, economist Milton Friedman said, "the great advantage of the market … is that it permits wide diversity," while "the characteristic feature of action through political channels is that it tends to require or enforce substantial conformity."19 The suppression of individual choices in favor of top-down decisions destroys value, and it is a key reason why we should keep the scope of government activities limited.

One of the side effects of forced uniformity is the generation of social conflict. In 1850, economist Frédéric Bastiat argued against France's subsidies for religion, education, and arts because of the discord they were creating. He said, "All these vital forces of society should develop harmoniously under the influence of liberty and that none of them should become, as we see has happened today, a source of trouble, abuses, tyranny, and disorder."20

Milton Friedman similarly argued that "the widespread use of the market reduces the strain on the social fabric by rendering conformity unnecessary with respect to any activities it encompasses," whereas government intervention "tends to strain the social cohesion essential for a stable society."21 As America becomes increasingly pluralistic, it makes even more sense to expand market and voluntary institutions and eliminate one-size-fits-all government policies.

All that said, federal activities can generate net value in some situations. The government can provide "public goods," which are items we all benefit from, but that are underprovided by markets.22 National defense is a good example. And the government can generate value by fixing "externalities," such as pollution.23 When it addresses these and other market failures, federal policies can be win-win propositions that improve economic efficiency and increase welfare.24 The challenge is to keep the government narrowly focused on these roles, and to tackle them effectively with a minimum of failure.

Taxes Create Deadweight Losses

When evaluating spending programs, policymakers should take into account the full costs of funding them. The direct cost of any program is the tax revenues the government will extract from the private sector. But another cost is created by the extraction process itself. Since taxes are compulsory, they induce people to try and avoid them by changing their working, investing, and consumption activities. Such responses harm the economy, a harm called a "deadweight loss."

Suppose the government imposes a tax on wine. Wine drinkers would be harmed because part of their money would be confiscated. But an additional cost, the deadweight loss, would be created as people cut back their wine consumption.25 Because of the tax, people would enjoy less wine and lose some amount of welfare or happiness.

While the revenue generated by the wine tax would represent a loss for the private sector and a gain for the government, the deadweight loss is a loss to society as a whole. The tax would block mutually beneficial exchanges from taking place. Every federal tax causes this sort of damage by reducing market exchanges. Income taxes, for example, reduce the working and investing efforts of millions of families and businesses.

How large are the deadweight losses of federal taxes? They vary depending on the tax rate, the type of tax, and other factors. But for the federal income tax, studies have found that, on average, the deadweight loss of raising taxes by a dollar is roughly 50 cents.26 Based on his pioneering work, Harvard University's Martin Feldstein thinks that the loss may be higher, perhaps exceeding "one dollar per dollar of revenue raised, making the cost of incremental governmental spending more than two dollars for each dollar of government spending."27 Other estimates are, however, lower than Feldstein's.

Suppose that Congress is considering spending $10 billion on an energy subsidy program. Putting aside whether the program is ethical or constitutional, does the program make any economic sense? The program's benefits would have to be higher than the total cost of about $15 billion, which includes the $10 billion direct cost to taxpayers plus another $5 billion in deadweight losses.

Currently, federal lawmakers do not consider deadweight losses when they make spending decisions, but they should. The scorekeeper of Congress, the Congressional Budget Office (CBO), generally does not include deadweight losses in its analyses. Federal agencies generally do not consider deadweight losses either, even though the Office of Management and Budget has recommended that they be included in program evaluations.28

The absence of deadweight loss information biases policymakers in favor of approving programs. Consider the debate over the Affordable Care Act (ACA) in 2010. Health scholar Chris Conover estimated that ACA-imposed taxes would create up to about $500 billion of deadweight losses during the law's first decade, which was in addition to the bill's official cost of about $1 trillion.29 If such an estimate had been provided to Congress by the CBO in 2010, it might have changed the debate over the legislation.

To see why deadweight losses can result in government failure, let's compare a private charitable project to a government program. Suppose that a philanthropist creates a $10 million project to help disadvantaged individuals, and the program generates $12 million in benefits. It would be a success. Now suppose a similar program is run by the government. It would be a failure because it would use tax funding and thus generate deadweight losses. The government program would cost $10 million directly plus another $5 million or so in deadweight losses, for a total cost that was higher than the benefits. Since government projects are funded by compulsory taxes, they are more costly than private projects. Coercion is not free.

Unintended Consequences

Markets allow millions of individuals and businesses to coordinate their activities. Prices are the key to markets, and they perform two functions. First, prices aggregate and communicate constantly changing information about resources, tastes, and technology. Second, prices create incentives for people to produce and consume efficiently. If a resource is expected to be in short supply, for example, the price rises and people start reducing their use of it while shifting to other products.

Vast adjustments are made continuously in markets, steering the economy toward higher levels of output and income. Investors and entrepreneurs direct their resources to the most promising industries. Workers figure out where to best use their skills and add value. Businesses strive to keep production flowing and customers happy. There are lots of mistakes, but prices are continually adjusting to keep everything on track and moving forward.

When the federal government intervenes in markets with subsidies and regulations, it throws a wrench into the price mechanism. Agriculture price supports, for example, are intended to help farmers, but they prompt farmers to overproduce subsidized crops and underproduce other crops. Minimum wage laws are intended to help workers, but they raise the cost of hiring low-skill workers and so businesses hire fewer of them.

As with taxes, subsidies and regulations cause people to change their productive efforts, and that imposes deadweight losses. Consider a welfare program. The higher taxes needed to fund the program will induce taxpayers to work less, and the spending itself will induce welfare recipients to work less. The late Sen. Daniel Patrick Moynihan of New York said, "It cannot too often be stated that the issue of welfare is not what it costs those who provide it, but what it costs those who receive it."30 Actually, it is both.

Consider an unsubsidized market for corn where people buy ears for 50 cents each. Since markets are voluntary, we know that customers value those ears at 50 cents or more, and we know that the cost of growing the ears is 50 cents or less.

Now suppose the government subsidizes farmers 10 cents per ear. Farmers would grow more corn and reduce their investments in other activities. The additional ears would likely cost more to produce than 50 cents, but they would be valued by consumers at less than 50 cents. The subsidy has thus destroyed value by generating production that costs more than it is worth. The amount of value destroyed is the deadweight loss.

Hundreds of federal subsidy programs and regulations create such damage. Federal policymakers intend to help people, but their interventions induce people to change their behavior and undermine the economy. Sometimes those negative effects ripple across the economy with numerous unintended consequences.31 In his book, Economics in One Lesson, Henry Hazlitt said that economics "is the science of tracing the effects of some proposed or existing policy not only on some special interest in the short run, but on the general interest in the long run."32

Consider farm subsidies again. The direct effect of farm subsidies is to increase the output of subsidized crops. A secondary effect is to push up the demand for cropland, which causes less fertile lands to be brought into production. Those lands may require more intensive fertilizer and irrigation use, which in turn may generate environmental problems. Another secondary effect may be that as the price of farmland is pushed up, it becomes harder for young farmers to break into the business.

Here is a sampling of the unintended harmful effects of current federal subsidies and regulations:

  • The minimum wage reduces employment of low-skill workers.
  • Unemployment insurance reduces labor supply.
  • Subsidized flood insurance induces people to live in riskier flood-prone areas.
  • Irrigation subsidies cause overconsumption of water and exacerbate droughts.
  • Subsidized loans for housing and college induce people to borrow too much.
  • Traditional welfare encourages people to work less and form single-parent families.
  • Ethanol subsidies reduce the cropland available for food and increase food prices.
  • Trade restrictions designed to aid some industries harm others.
  • Business subsidies undermine incentives for companies to innovate.
  • Endangered species laws prompt landowners to rid their land of endangered species.
  • Foreign aid empowers foreign dictators and stalls reforms.
  • Food aid reduces the incentives for poor countries to feed themselves.
  • Disability benefits encourage people who could work to drop out of the labor force.
  • Social Security and Medicare discourage saving for retirement.
  • Health mandates raise insurance costs and induce firms to drop coverage.
  • Drug prohibition spawns organized crime and violence.
  • Public housing creates negative social effects.
  • Programs for the needy reduce private charity.
  • Fuel efficiency standards result in more people buying smaller cars and more road deaths.
  • Workers' compensation induces workers to be less careful on the job.

Federal programs generate an endless amount of such negative effects. Consider Medicare. Under Parts A and B, the government pays doctors and hospitals a set fee for each service provided. That encourages them to deliver unnecessary services because they make more money the more services they bill. As an example, investigations have found that doctors are ordering many unneeded drug tests for seniors.33 Another problem is that doctors and hospitals are paid by the government regardless of the quality of service, so they have less incentive to reduce errors. Indeed, the system can pay more when there are errors if the errors lead to complications that require more services to be billed.

Medicare's fee-for-service system is essentially a price-control system for thousands of services purchased from more than 400,000 doctors and about 7,000 hospitals and clinics.34 When the government sets prices too low, it creates shortages, which is the case with primary care doctors. When prices are set too high, doctors and hospitals have incentives to provide too much, which is the case for advanced imaging services.35 The vastness of the system combined with its top-down nature have also made fraud rampant.36

In sum, federal subsidies and regulations induce individuals and businesses to change their behaviors. Those changes undermine overall prosperity because resources are diverted from their best uses. It is true, however, that just because a federal policy creates collateral damage does not automatically mean that the overall policy is a failure. Some federal interventions do generate higher benefits than costs. The important thing is that policymakers look beyond the intended effects of their programs, and consider how people and businesses may respond in negative ways over the longer term.

What Is Seen and Not Seen

In defense of federal policymakers, they have a difficult task. There are no clear cut metrics they can use to judge the success or failure of programs. The benefits are usually visible, but the costs are often unseen. In the marketplace, when consumers dislike products, sales and profits fall, which signals companies to change course. There is no such built-in feedback for government programs.

Policymakers feel pressure to "do something" to solve society's problems. It seems reasonable to them that spending and regulations should be able to fix things. The benefits of government action are often immediate, while the costs are more distant and hard to understand. To make matters worse, politicians are usually not experts in the areas that they legislate in, so it is hard for them to understand the negative effects of their policies.

In "What Is Seen and What Is Not Seen," Frédéric Bastiat described how policymakers focused on benefits and ignored costs. He said that a common argument against cutting the military was the harm from the loss of military jobs, but what was ignored was the jobs that would be created as taxpayers kept more of their money and used it for other purposes.37 As another example, he described how iron manufacturers lobbied the "great law factory in Paris" to save mining jobs by imposing iron trade barriers. What was unseen were all the jobs that import barriers would destroy for metalworkers, blacksmiths, and cartwrights, who relied on imported iron.38

Government intervention is not just an invisible job killer, it is an invisible knowledge killer. Markets generate information about consumer needs, costs, and technologies, but intervention undermines those processes. When regulations block entrepreneurs from entering markets, we never learn what innovations they might have created. When taxes prevent companies from buying new machines, innovation is slowed because new machines often incorporate new designs. When farmers receive subsidies, we lose improvements they might have discovered if they had faced the full rigor of the market. Hayek noted, "Freedom is important in order that all the different individuals can make full use of the particular circumstances of which only they know. We therefore never know what beneficial actions we prevent if we restrict their freedom to serve their fellows in whatever manner they wish."39

What is often "not seen" by the government is how the market can solve problems by itself. A government analysis of an automobile fuel efficiency mandate in 2010 illustrated this blindness.40 The government estimated that the consumer savings on gasoline from the mandate would be far higher than the added costs of the more expensive cars that met the standard. The government assumed that this estimate justified its mandate. But if the estimate were correct, we would not need the mandate because consumers would buy more fuel-efficient cars by themselves to save money. The government simply assumed that markets would not work, which has been called a "planner's paradox."41 To the government, top-down mandates on paper look neat and tidy compared to the decentralized operations of markets.

When government intervenes, it preempts the development of market solutions, which is called "crowding out." The federal government began providing flood insurance in 1968 because it thought that private companies would not provide it.42 Over the years, the federal program has built up a large debt and created distortions. Meanwhile, insurance companies have made advances, including improved computer modeling, such that private flood insurance would probably work today. But the existence of the subsidized federal program has blocked it from developing.

What is not seen by policymakers are all the state, local, business, and charitable efforts that would exist today if the federal government had not grown so huge. The classic example is welfare. Milton Friedman said, "One of the major costs of the extension of government welfare activities has been the corresponding decline in private charitable activities."43 This point can be summarized simply as "state help kills self help."44

In sum, policymakers usually do not grasp the full effects of their programs. They seem to view the economy as a simple machine that can be easily manipulated. Adam Smith had a name for such policymakers:

The man of system … seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it.45

More than two centuries after Smith, governments are still full of "men of system." They assume that regulations and subsidies can be used to organize society in a pattern of their choosing, like on a chessboard. Program after program coming out of Washington reflects overconfidence in the ability of the government to solve problems. One of actor Clint Eastwood's most famous lines is, "A man's got to know his limitations." The government does as well.

Beyond Central Control

If legislators were more diligent and more humble, couldn't they carefully design regulations and subsidies to improve on markets? After all, there are areas—such as fixing externalities—where government can, in theory, generate net value.

The reality is that improving on markets is difficult to achieve. In The Road to Serfdom, Hayek argued that government planning could not successfully coordinate an advanced economy. He said, "it is the very complexity of the division of labor under modern conditions which makes competition the only method by which such co-ordination can be adequately brought about."46 Government cannot achieve the "differentiation, complexity, and flexibility" of markets.47

Unlike governments, markets are able to tap into vast information that is distributed across society. It is "knowledge of the particular circumstances of time and place," Hayek observed, which "never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess."48 This sort of knowledge is tacit and subjective, so it "cannot be conveyed to any central authority in statistical form."49

An article by health scholar and practicing surgeon Jeff Singer on electronic health records (EHRs) illustrates Hayek's point. The federal government mandated EHRs without adequately studying them in the real world. Singer has found that the one-size-fits-all mandate harms his practice: "This rigidity inhibits my ability to tailor my questions and treatment to my patient's actual medical needs. It promotes tunnel vision in which physicians become so focused on complying with the EHR work sheet that they surrender a degree of critical thinking and medical investigation."50

Rather than being a chessboard—as Smith's man of system assumed—the market economy is like a natural ecosystem that has subtle and hidden relationships that keep things in balance. Hayek coined the phrase "spontaneous order" to describe ecosystems in human society. A spontaneous order is a set of complex, evolutionary patterns or rules that come from bottom-up relationships. Other than the market economy, language is a good example of a spontaneous order. The idea that dispersed actions of individuals could create overall order was developed by Adam Smith and other thinkers of the Scottish Enlightenment.51

One of the features of both spontaneous orders in society and natural ecosystems is that they are not easy to successfully manipulate from the top down. Australian officials brought cane toads to their continent in the 1930s to control agricultural pests. As it turned out, the toads were not effective at controlling pests. But worse, the toads multiplied beyond control, and have become major pests themselves damaging the nation's biodiversity.

A Washington Post story described similar episodes. One regards parrotfish in the Pacific Ocean: "A decades-long conservation program there has led to a boom in parrotfish numbers, so much so that they are now harming local populations of corals and other species."52 The Post story goes on, "This is not an isolated case: Ecologists are facing similar dilemmas with elephants in a South Africa reserve that are killing trees in the savanna and with protected sea turtles in the Bahamas that are harming meadows of invaluable sea grass. These instances show how even the best-thought-out conservation efforts can have unintended effects on the environment…"53 That sounds a lot like government intervention in the economy.

Economist Dan Klein compared the spontaneous order of the market to the coordination that occurs on a skating rink.54 A skater looks out for her own interests, and she meshes in with other skaters and tries to avoid collisions. She makes ongoing adjustments and traces a unique path, yet an overall order of skaters is achieved. The rink manager sets a few rules, but the coordination is almost all bottom up. Mistakes are made, and people fall down. But others respond, some by skating around the fallen skaters and some by helping the skaters get up.

Suppose that the manager wanted to centrally plan the skating. He could shout orders to individual skaters, telling them each movement to make and what speed to go. But it would not work; it is too complex and fast changing. Only individuals know their own skills, know when they are getting tired, and know when they are losing balance.

In his central planning efforts, the rink manager might try to slow people down and impose tight regimentation, but that would ruin the fun. Skaters "would not find the joy and dignity that come from making one's own course."55 Perhaps the rink manager could control a small number of skaters, but as the numbers increased, his task would become impossible. The lesson, says Klein, is that the more complex an economy or society, the stronger is the case against government intervention.[56

In the modern economy, markets guide billions of decisions based on fast-changing information across the globe. Prices, profits, and other market signals inform people about the adjustments they should make. Entrepreneurs try new strategies in millions of trial-and-error processes. Individuals and businesses often fail, but they have strong incentives to get back on track. Markets are a process of ongoing change and discovery.

By contrast, government does not have enough knowledge to make good decisions, and it lacks the flexibility to change direction when it makes mistakes. If government enacted an alternative energy program to combat high oil prices, but then oil prices plunged, the program might become worthless, but it would probably live on for years. Bastiat said that a "public service" provided by government often becomes a "public nuisance" because it gets entrenched even as conditions change.57

Conditions are always changing, and always catching governments by surprise. Consider how inaccurate macroeconomic projections are. Economist Edward Lazear calculated that over a 15-year period, CBO projections of real growth in the U.S. economy for the following year were 1.7 percentage points off, on average.58 That is a giant error given that the average growth rate during the period was 2.1 percent. If the government cannot predict the future, it cannot successfully manipulate the future, especially because it is such an inflexible institution.

Consider the lead up to the last economic recession. The housing bubble peaked in 2006 and then began deflating. Government experts did not recognize that falling housing prices were beginning to cause a broad-based economic implosion. Even with its sophisticated computer models, CBO completely missed it. In January 2008, CBO projected that growth would strengthen from 2.0 percent in 2008, to 2.3 percent in 2009, to 3.4 percent in 2010.59 Actually, the economy fell through the floor in 2009, shrinking 2.8 percent.

In his book examining federal government performance, Yale's Peter Schuck concluded that the government's "endemic failure is rooted in an inescapable, structural condition: officials' meager tools and limited understanding of the opaque, complex social world that they aim to manipulate."60 Schuck is right. But then what should governments do?

Adam Smith advised governments to adopt the "simple system of natural liberty."61 By removing government interventions,

the sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society.62

Government policymakers have just as many "delusions" today as in Smith's time. And given the complexity of the modern economy, their wisdom to be able to superintend people and industry is even less sufficient. So we should cut the government's size and scope and discharge it from the duty of trying to manage and manipulate the economy.


1 See Clyde Wayne Crews Jr., "Ten Thousand Commandments 2014," Competitive Enterprise Institute, 2014, pp. 2, 63. These are final rules published in the Federal Register and the total page count of the Code of Federal Regulations.

2 For the number of subsidy and benefit programs, see www.cfda.gov.

3 Most public finance textbooks provide background on cost-benefit analysis. For example, see David N. Hyman, Public Finance: A Contemporary Application of Theory to Policy (Mason, Ohio: Thomson South-Western, 2005), chap. 6.

4 President Reagan issued Exec. Order No. 12291 in 1981 mandating the use of cost-benefit analysis for significant regulatory actions, which are those that have an impact of more than $100 million a year. This order was superseded by President Clinton's Exec. Order No. 12866 in 1993. "Independent" federal agencies are exempt from the requirements, including most of the agencies that impose financial regulations.

5 Susan E. Dudley, "OMB's Reported Benefits of Regulation: Too Good to Be True?" Regulation 36, no. 2 (Summer 2013): 26–30.

6 Jerry Ellig, Mercatus Center, "Improving Regulatory Impact Analysis through Process Reform," testimony before the Joint Economic Committee, June 26, 2013.

7 The Office of Management and Budget's "Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs" (Circular A-94, October 29, 1992), establishes guidelines for cost-benefit analyses within agencies.

8 Chris Edwards, "Cutting the Army Corps of Engineers," DownsizingGovernment.org, Cato Institute, March 2012. And see Marc Reisner, Cadillac Desert: The American West and Its Disappearing Water (New York: Penguin, 1993).

9 Michael Grunwald, "Reining in the Corps of Engineers," Time, September 20, 2007.

10 Government Accountability Office, "Corps of Engineers: Observations on Planning and Project Management Processes for the Civil Works Program," GAO-06-529T, March 15, 2006, p. 5.

11 For suggestions on improving regulatory cost-benefit analyses, see Susan E. Dudley, Mercatus Center, testimony before the Joint Economic Committee, June 26, 2013.

12 In cost-benefit analyses, costs and benefits imposed on different people are tallied in dollars, and if the latter are larger than the former the project is deemed beneficial. The procedure assumes that it is appropriate for the government to impose losses on some people as long as others gain more. But, of course, that does not take into account more fundamental values such as individual rights.

13 Brian Headd, Alfred Nucci, and Richard Boden, "What Matters More: Business Exit Rates or Business Survival Rates?" U.S. Census Bureau, Business Dynamics Statistics Brief 4, 2010.

14 Adam Smith, The Wealth of Nations (Chicago: University of Chicago Press, 1976), vol. 1, bk 4, chap. 2.

15 Friedrich A. Hayek, "The Market Order or Catallaxy," in Law, Legislation and Liberty, Volume 2 (Chicago: University of Chicago Press, 1976), p. 109.

16 Ibid., p. 110.

17 Sowell goes on to say that diversity "is also its greatest political vulnerability" because many people and political leaders have a desire to impose their values on others. Thomas Sowell, Knowledge and Decisions (New York: Basic Books, 1980), p. 42.

18 James Buchanan, "Politics, Policy, and the Pigovian Margins," in The Collected Works of James M. Buchanan, Volume 1: The Logical Foundations of Constitutional Liberty, ed. Leland B. Yeager (Indianapolis: Liberty Fund, 1999), p. 66. See also James M. Buchanan and Gordon Tullock, The Calculus of Consent, The Selected Works of Gordon Tullock, Volume 2 (Indianapolis: Liberty Fund, 2004). Political externalities (or "external costs") would be eliminated in a political system based on unanimous agreement. But a requirement for unanimity would impose high decisionmaking costs. The Calculus of Consent examines the tradeoffs an individual might consider between the external costs and decisionmaking costs of government.

19 Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), p. 15.

20 Frédéric Bastiat, "What Is Seen and What Is Not Seen," in Selected Essays on Political Economy (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995), p. 13.

21 Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), pp. 23, 24.

22 Public goods are usually defined as those that are "nonrivalrous" and "nonexcludable." Nonrivalrous means that one person's use of the good is not reduced as others use more of it. Nonexcludable means that once a good is provided, it is difficult to exclude anyone from consuming it. National defense is a classic public good. See Tyler Cowen, "Public Goods," The Concise Encyclopedia of Economics, www.econlib.org/library/Enc/PublicGoods.html.

23 Externalities occur when production or consumption activities of one person have an effect on another person outside of the price system. There is a large literature examining whether market failures have occurred in particular situations and whether the government should try to fix them given the government's own tendency to fail. Economist Ronald Coase famously described how private parties could agree to efficient solutions with respect to externalities without government intervention if transaction costs are low.

24 The main idea of efficiency used by economists is "Pareto efficiency." An efficient outcome is one where nobody can be made better off without somebody being made worse off. Put another way, resources are allocated to their most productive uses. Perfectly functioning competitive markets achieve Pareto efficiency.

25 Deadweight loss is also called "excess burden." For an excellent review of the development of the theory, see James R. Hines, "Three Sides of Harberger Triangles," National Bureau of Economic Research Working Paper no. 6852, December 1998.

26 Chris Conover surveyed the literature and reported an average of 44 cents for the marginal cost of all federal taxes, and 50 cents for federal income taxes. Christopher J. Conover, "Congress Should Account for the Excess Burden of Taxation" Cato Institute Policy Analysis no. 669, October 13, 2010. See also Edgar K. Browning, Stealing from Each Other: How the Welfare State Robs Americans of Money and Spirit (Westport, CT: Praeger Publishers, 2008), pp. 156, 166, 178. The Congressional Budget Office has stated, "Typical estimates of the economic cost of a dollar of tax revenue range from 20 cents to 60 cents over and above the revenue raised." See Congressional Budget Office, "Budget Options," February 2001, p. 381.

27 Martin Feldstein, "How Big Should Government Be?" National Tax Journal, vol. 50, no. 2 (June 1997): 197–213.

28 The White House issued guidelines for cost-benefit analyses in 1992 that recommended that agencies multiply project costs by 1.25 to take into account the deadweight losses from taxation. But these procedures are not a hard mandate and, I am told, are not widely used. The guidelines are Office of Management and Budget, Circular No. A-94 Revised (October 29, 1992).

29 Christopher J. Conover, "Congress Should Account for the Excess Burden of Taxation," Cato Institute Policy Analysis no. 669, October 13, 2010.

30 Quoted in Nicholas Eberstadt, "American Exceptionalism and the Entitlement State," National Affairs 22 (Winter 2015).

31 The secondary effects rippling outwards from subsidies and regulations may or may not cause further deadweight losses beyond the immediate market. It depends on whether other markets have distortionary aspects that prevent them from adjusting. See James R. Hines, "Three Sides of Harberger Triangles," National Bureau of Economic Research Working Paper no. 6852, December 1998.

32 Henry Hazlitt, Economics in One Lesson (Norwalk, CT: Arlington House Inc., 1979), p. 191. Originally published 1946.

33 Christopher Weaver and Anna Wilde Mathews, "Doctors Cash In on Drug Tests for Seniors, and Medicare Pays the Bill," Wall Street Journal, November 10, 2014.

34 Number of doctors and hospitals from Fred Schulte, Joe Eaton, and David Donald, "Code Creep Costs Medicare $11 Billion," Washington Post, September 16, 2012.

35 Government Accountability Office, "Higher Use of Advanced Imaging Services by Providers Who Self-Refer Costing Medicare Millions," GAO-12-966, September 2012.

36 Chris Edwards and Michael Cannon, "Medicare Reforms," DownsizingGovernment.org, Cato Institute, September 2010.

37 Frédéric Bastiat, "What Is Seen and What Is Not Seen," in Selected Essays on Political Economy (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995), p. 5.

38 Ibid., p. 26.

39 F. A. Hayek in the introduction to Frédéric Bastiat, "What Is Seen and What Is Not Seen," in Selected Essays on Political Economy (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995.

40 Susan E. Dudley, "OMB's Reported Benefits of Regulation: Too Good to Be True?" Regulation 36, no. 2 (Summer 2013): 26–30.

41 Brian Mannix, "The Planner's Paradox," Regulation 26, no. 2 (Summer 2003).

42 Chris Edwards, "The Federal Emergency Management Agency: Floods, Failures, and Federalism," DownsizingGovernment.org, Cato Institute, December 2014.

43 Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), p. 191.

44 Albert Venn Dicey quoted by Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), p. 201.

45 Adam Smith, The Theory of Moral Sentiments (London: A. Millar, 1759), chap. 6, sec. 2, para. 42. Available at www.econlib.org/library/Smith/smMS.html.

46 F. A. Hayek, The Road to Serfdom (London: Ark Paperbacks, 1986), p. 36.

47 Ibid., p. 37.

48 F. A. Hayek, "The Use of Knowledge in Society," American Economic Review 35, no. 4 (September 1945), p. 519.

49 Ibid., p. 524.

50 Jeffrey A. Singer, "ObamaCare's Electronic-Records Debacle," Wall Street Journal, February 17, 2015.

51 Ronald Hamowy, The Scottish Enlightenment and the Theory of Spontaneous Order (Carbondale, Ill: Southern Illinois University Press, 1987). Bernard Mandeville, writing in the early eighteenth century, is also credited with developing these ideas.

52 Gayathri Vaidyanathan, "Sometimes, Protecting One Species Harms Another," Washington Post, February 2, 2015.

53 Ibid.

54 Daniel B. Klein, Knowledge and Coordination: A Liberal Interpretation (Oxford, UK: Oxford University Press, 2012), chap. 1. I have expanded on Klein's story.

55 Ibid.

56 Hayek made a similar point: "The more complicated the whole, the more dependent we become on that division of knowledge between individuals whose separate efforts are co-ordinated by the impersonal mechanism for transmitting the relevant information known by us as the price system." F. A. Hayek, The Road to Serfdom (London: Ark Paperbacks, 1986), p. 36.

57 Frédéric Bastiat, "What Is Seen and What Is Not Seen," in Selected Essays on Political Economy (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995), p. 19.

58 Edward Lazear, "Government Forecasters Might as Well Use a Ouija Board," Wall Street Journal, October 16, 2014.

59 Congressional Budget Office, "The Budget and Economic Outlook: Fiscal Years 2008 to 2018," January 23, 2008. See also Chris Edwards, "CBO Forecast Accuracy," Cato at Liberty (blog), Cato Institute, February 6, 2012.

60 Peter H. Schuck, Why Government Fails So Often: And How It Can Do Better (Princeton, NJ: Princeton University Press, 2014), p. 412.

61 Adam Smith, The Wealth of Nations (Chicago: University of Chicago Press, 1976), p. 208.

62 Ibid., p. 208.

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