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Ten Elements of Clear Thinking About Economic Progress and the Role of Government


Title: Ten Elements of Clear Thinking About Economic Progress and the Role of Government Subject: Economics Author: Tawni Hunt Ferrarini, James D. Gwartney and Amy Willis – PowerPoint PPT presentation

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Title: Ten Elements of Clear Thinking About Economic Progress and the Role of Government

Ten Elements of Clear Thinking About Economic
Progress and the Role of Government
Common Sense Economics James Gwartney, Richard L.
Stroup, and Dwight R. Lee CommonSenseEconomics.com
Some Questions to Consider
  • How does a democratic government really work?
  • Is it a corrective device? Does it sometimes
    thwart economic progress?
  • Will a policy supported by a voting majority be
  • What are the unintended consequences of
    well-intended governmental policies and programs?
  • What is needed to reduce waste and direct
    governments toward productive activities?

What Role for Government?
  • A wise and frugal government, which shall
    restrain men from injuring one another, which
    shall leave them otherwise free to regulate their
    own pursuits of industry and improvements, and
    shall not take from the mouth of labor the bread
    it has earned. This is the sum of good
  • -Thomas Jefferson

Clear Thinking Proposition 1
  • Government promotes economic progress by
  • protecting the private rights of individuals and
  • supplying goods that cannot be provided through

Governments Protective Function
  • Governments protective function includes the
    maintenance of a framework for security and
  • Protect people and their property against
    aggressors through force if necessary.
  • Enforce contracts.
  • Help avoid restrictions, regulations and
    discriminatory taxes.

"If men were angels, no government would be
  • James Madison
  • Federalist Paper No. 51
  • 1788

Life, Liberty and the Pursuit of Happiness
  • Government promotes economic progress by
    protecting individuals rights to life, liberty,
    and the pursuit of happiness. It can use force
    to protect against loss of life, threat to
    liberty, and damage of property.
  • Individuals will use resources efficiently,
    invest and innovate if their rights to benefit
    from doing so are protected. Economic progress

Governments Productive Function
  • Governments productive function includes the
    provision of public goods goods that cannot be
    provided easily in private markets.
  • Public goods
  • Are available to others once provided to an
  • Are difficult to provide only to paying
  • National defense
  • Flood control
  • projects

The Case for Public Goods
  • The legitimate object of government is to do for
    a community of people whatever they need to have
    done, but cannot do, at all, or cannot, so well
    do, in their separate and individual capacities.
  • Abraham Lincoln

Clear Thinking Proposition 2
  • Government is not a corrective device. It can
    and does fail!!!!

A Democratic Government
  • A method of social organization where individuals
    make and carry out choices collectively.

In a Democratic Government
  • Decisions are made at the margin. Voters, elected
    officials and lobbyists support those proposals
    from which they expect to derive net benefits.
  • Too often the secondary effects of political
    actions are ignored and/or pushed into the future
    when the elected officials are out of office.
  • So there is no assurance that governmental
    actions will be productive.

CSE Table 3. Benefits and Costs of a Hypothetical
Government Project
 Building a Road or Civic Center  Building a Road or Civic Center Tax Payment Tax Payment
Voter Benefits Received Plan A Equal Tax Plan B Taxed Proportionate to Benefits
Adams 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Brown 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Green 15.00 (30 of 50) 12.00 18.00 (30 of 50)
Jones 3.00 (6 of 50) 12.00 3.60 (6 of 50)
Smith 2.00 (4 of 50) 12.00 2.40 (4 of 50)
TOTAL 50.00 in total benefits 60.00 60.00
A Democratic GovernmentSome Important Points
  • Policies proposed by the government may or may
    not be productive.
  • Policies favored by the voting majority do not
    necessarily promote economic progress.
  • The benefits and costs faced by voters belonging
    to different interest groups are often

Unlike Democratic Governments, When Markets Are
  • Producers can not force consumers to buy their
  • They have incentives to undertake only productive

Lets Compare Democratic Governments and Markets
  1. The government can use coercion to tax and
    subsidize. Markets can not.
  2. Markets can charge high prices but can not force
    people to pay. Governments can and do.
  3. Unconstrained political democracy is a system of
    majority rule, while market allocation is based
    on proportional representation. In markets,
    consumers buying one commodity will not interfere
    with the ability of others to buy a different

What Is Needed to Encourage Democratic
Governments To Be Productive?
  • To reduce the likelihood that people can
    participate in government projects without
    paying, it is important to link benefits
    proportionately to costs.
  • A democratic majority vote does not guarantee the
    passage of productive proposals.
  • Supermajority support (75 of the voters) will
    increase the likelihood of passing productive

Clear Thinking Proposition 3
  • The costs of government are not only taxes.

Which of the following is true of taxes?
  1. Taxes increase the volume of mutually
    advantageous exchanges.
  2. Tax increases are the primary cause of inflation.
  3. Business taxes generate government revenue
    without imposing a burden on consumers and
  4. Taxes drive a wedge between what buyers pay and
    what sellers receive.

3 Types of Costs Incurred
  • The loss of private sector output that could
    otherwise be produced
  • The cost of resources expended in tax collection
    and enforcement of government mandates
  • The cost of price distortions caused by taxes and

Costs of Collection Enforcement
  • Preparation, monitoring and enforcement of
    tax law and regulatory legislation require time,
    talent and money.
  • These resources could be used elsewhere.
  • People will use resources to avoid taxes.
  • Government expenditures plus compliance costs and
    mandated private spending represent more than 1/2
    of GDP.

Lets Review How To Measure Governments Share of
Total Output
  • Government expenditures share of total U.S.
    spending on goods and services produced
    represents approximately 35 of total GDP.
  • When the costs of regulations are added, this
    share rises to over 50 of GDP.
  • Government is big in the U.S.!

Government Can Distort Prices
  • Taxes alter consumption and production
  • Consider supply and demand. Taxes increase what
    consumers pay and reduce what sellers receive.
    They reduce the volume of exchanges and squeeze
    out some of the gains from trade.
  • Some exchanges will not occur because the tax
    wedge makes them disadvantageous.
  • Deadweight loss of taxation adds 9-16 above the
    costs of compliance and regulation.

Taxes in a Nutshell
  • Taxes distort prices.
  • Taxes transfer income from individuals to the
  • Businesses do not pay taxes. Instead, they
    collect taxes from customers, employees and
  • Politicians want to conceal the tax costs of
    their programs and make you think businesses
    are paying!

Do you agree or disagree? Explain.
  • Taxing is much like plucking a goose. It is the
    art of getting the greatest number of feathers
    with the least amount of hissing.
  • Senator Bob DoleWall Street Journal
  • December 16, 1983

Clear Thinking Proposition 4
  • Unless restrained by constitutional rules,
    special-interest groups will use the democratic
    process to fleece taxpayers and consumers.

A Democratic Government
  • Can contribute to economic progress when it fills
    its protective and productive roles.
  • However, more than a majority rule and popular
    vote is needed to assure that it restricts itself
    to those roles.
  • Why? Incentives matter! Consider the following
    three examples.

1. Democratic Government Incentives
  • Government regulators and legislators may be
    heavily influenced by lobbyists and the
    possibility of securing highly paid jobs after
    leaving government, and so they may focus on the
    interests of the regulated party rather than

The Power of Special Interests
  • Special interest groups will help politicians get
    elected through donations and getting workers to
  • While the majority of unorganized voters is
    harmed, there is little incentive to act in
  • In varying degrees, all politicians cater to
    special interests.

2. Democratic Government Incentives
  • If a small but organized group cares a great
    deal about a certain government policy, while the
    majority is unorganized and apathetic, then the
    special interest often prevail.

Consider This Sweet Example
  • In 2000, the sugar lobby contributed 13 million
    to politicians.
  • The government restricts sugar imports into the
    U.S. through quotas.
  • The average U.S. consumer pays 20 per year in
    higher sugar prices while sugar growers gain
    about 1.9 billion.

3. Democratic Government Incentives
  • Log-rolling implicit vote trading among
  • They vote for programs that benefit the districts
    of other legislators in exchange for votes for
    their pet projects.
  • Federally funded dams, highways, housing
    projects, Veterans Administration hospitals, and
    job-training centers are often reflective of

Question Restrictions that limit sugar
imports, subsidies for the construction of sports
stadiums, and federal spending on programs like
the construction of an indoor rain forest in Iowa
all provide examples of government programs that,
  1. Are based on careful analysis of benefits
    relative to costs.
  2. Are designed to redistribute income from the rich
    to the poor.
  3. Reflect the political attractiveness of
    special-interest issues.
  4. Promote the general welfare.

Clear Thinking Proposition 5
  • Unless restrained by constitutional rules,
    legislators will run budget deficits and spend

The Attractiveness of Deficit Spending to
  • Budget Deficit Government spending that exceeds
    revenues. Deficits are financed by borrowing.
  • Spending is attractive to legislators because it
    allows them to take credit for programs that
    benefit voters.
  • Taxes are unattractive because they impose
    visible costs on voters.
  • Thus, legislators tend to spend more than they
    are willing to tax.

The National Debt
  • The cumulative effect of all past budget deficits
    and surpluses of the federal government.
  • Check out the U.S. Debt.
  • The U.S. Treasury borrows funds by selling
    securities like U.S. Treasury Bills, Notes, and
  • Borrowing makes the current cost of running the
    government less visible.

Deficit Spending and National Debt
  • Borrowing pushes the visible cost of running the
    government and policies into the future.
  • Bottom line. Immediate benefits with deferred
    costs are politically attractive!
  • Deficit spending and public debt appear to
    transfer costs into the future when current
    politicians are no longer office.

Constitutional Changes That May Restrain
  • Require the federal government to balance its
    budget like most states.
  • Require a 2/3 or ¾ majority vote in both branches
    of Congress to fund deficit spending or increase
    its borrowing power.
  • Require that Congress only spends an amount equal
    to last years tax revenue.

Clear Thinking Proposition 6
  • Government slows economic progress when it
    becomes heavily involved in trying to help some
    people at the expense of others.

Production or Plunder?
  • A neutral government can help make the economic
    production pie bigger when it protects property
    rights and provides public goods!
  • It shrinks the economic pie when it plunders
    the income of one group to satisfy the interests
    of another.

Counterproductive, favor-seeking activities are
a natural outgrowth of unrestrained democracy.
CSE, p97
Clear Thinking Proposition 7
  • The costs of government income transfers are far
    greater than the net gain to intended

Income Transfers
  • It is difficult to improve peoples well-being
    through income transfers when benefits are not
    attached to costs.
  • The unintended consequences of secondary effects
    can get in the way.

The Unintended Consequences of Income Transfers
  • Reduce incentives of both taxpayer and transfer
    recipient to earn income
  • Free income reduces work effort and innovation
    among transfer beneficiaries.
  • Increased tax burdens stifle incentives to
    produce and earn more among persons earning
    income and paying taxes.
  • Competition for transfers erodes most of the
    long-term gain of the targeted beneficiaries.
  • When qualification requirements must be met,
    resources and potential production are wasted as
    individuals seek to qualify for the transfers.

Income Transfers (cont.)
  • Protection from adversity arising from imprudent
    decisions makes people more likely to increase
    the likelihood of that adversity.
  • Consequences of adversity become less severe.
  • Potential recipients have less incentive to avoid
  • If you subsidize something, you get more of it.
  • Transfers directed toward the poor
    unintentionally encourage high-risk lifestyles.
  • Charitable efforts are crowded out.

The War on Poverty IllustratesThese Points
Clear Thinking Proposition 8
  • Central planning replaces markets with politics,
    which wastes resources and retards economic

The Man of System
  • The man of system is apt to be very wise to his
    own conceit. He 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.
  • -Adam Smith

The Fatal Conceit of Central Planning
  • Central planning merely substitutes politics for
    market outcomes.
  • Subsidies and investment funds disbursed by
    planners are influenced by political
  • Old firms tend to be favored over new,
    growth-oriented firms.
  • Pork barrel projects are still pursued.

The Fatal Conceit of Central Planning
  • The incentive of government-operated firms to
    keep costs low, be innovative, and supply goods
    efficiently is weak.
  • Boosting efficiency or lowering costs generate
    little political gain.
  • Per-unit costs rise as increased inefficiencies
    get built into the political allocation.

The Fatal Conceit of Central Planning
  • Investors risking their own money will make
    better investment choices than central planners
    spending the money of taxpayers.
  • Private investors bear the consequences of poor
    decisions directly but central planners do not.
  • Private investors have a strong incentive to
    increase productivity and keep costs low. In
    contrast, political rather economic
    considerations are more important for central

The Fatal Conceit of Central Planning
  • There is no way that central planners can acquire
    enough information to create, maintain, and
    constantly update a plan that makes sense.
  • Market prices generally channel information
    quickly and accurately to both producers and
    consumers. On the other hand a political
    process, particularly one with checks and
    balances like those found in the U.S., will
    respond slowly and often in a contradictory

Clear Thinking Proposition 9
  • Competition is just as important in government as
    in markets.

Government Competition
  • Leaders of public sector firms have little
    incentive to cut costs or boost performance when
    there is little competition.
  • Inefficient programs are permitted to linger.
  • Failure to achieve goals is often rewarded by
    increased funding. Consider increased funding in
    police departments with higher crime rates.
  • In the market economy, profits and losses
    register performance. Inefficient producers are
    weeded out and efficient ones are rewarded.
    There is no parallel in the centralized

Government Competition
  • 3. Increased competition among decentralized
    government units or between the government and
    private sector creates incentives for government
    officials to work productively, seek efficiency,
    cut costs and innovate.
  • 4. Citizens with differing preferences and views
    about government activities can vote with their
    feet in a decentralized system a centralized
    system does not permit this.

Clear Thinking Proposition 10
  • Constitutional rules that bring the political
    process and sound economics into harmony will
    promote economic progress.

Constitutional Checks
  • The scope of government must be limited.
  • An unrestrained government results in the
    fleecing of citizens.
  • Constitutional checks
  • 10th Amendment
  • 5th Amendment

A Positive Program for Prosperity
  • List the seven constitutional constraints
    presented by the authors.
  • Explain the purpose of each constraint.
  • Indicate why you think it will be either
    effective or ineffective.

A Positive Program for Prosperity 7
Constitutional Suggestions
  1. No government shall use its regulatory powers to
    take private property, either partially or in its
    entirety, for public use without paying the owner
    the full market value of the property taken.

A Positive Program for Prosperity 7
Constitutional Suggestions
  • 2. The right of individuals to compete in a
    business or profession and/or buy and sell
    legally tradable goods and services at mutually
    acceptable terms shall not be infringed by
    Congress or any of the States.i

A Positive Program for Prosperity 7
Constitutional Suggestions
  • 3. Congress shall not levy taxes or impose quotas
    on either imports or exports.
  • 4. A three-fourths approval of both Houses of
    Congress shall be required for all expenditure
    programs of the federal government. At least
    two-thirds approval of the legislative branches
    of state government shall be required for the
    approval of expenditures by state governments.

A Positive Program for Prosperity 7
Constitutional Suggestions
  • 5. A three-fourths approval of both Houses of
    Congress shall be required before the federal
    government is permitted to borrow any funds to
    finance a deficit in its annual budget.

A Positive Program for Prosperity 7
Constitutional Suggestions
  • 6. A three-fourths approval of both Houses of
    Congress shall be required for the federal
    government to mandate any expenditures by either
    state governments or private business firms.

A Positive Program for Prosperity 7
Constitutional Suggestions
  • 7. The function of the Federal Reserve System
    (Fed) is to maintain the value of the currency
    and establish a stable price level. If the price
    level either increases or decreases by more than
    4 percent annually during two consecutive years,
    all Governors of the Federal Reserve System shall
    be required to submit their resignations.
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