The Flawed Logic of Bailouts

December 5, 2008

by Gene Callahan

I am periodically re-astonished at the brilliance of Frédéric Bastiat. His satire “The Candlemaker’s Petition” is perhaps the most brilliant send-up of protectionism ever penned. And, listening to the news on the radio today, I again was made aware of how important but, apparently, difficult to grasp, is Bastiat’s point about “what is seen and what is unseen.”

What brought that point of Bastiat’s to my mind is the recent media focus on the proposed bailout of the US automakers. It is certainly the case that, if the government provides the US automakers with oodles of greenbacks they would not otherwise have had, then the automakers are more likely to make it through this recession. That, in Bastiat’s formulation, is “what is seen.” However, “what is not seen” is all of the other businesses that will fail as a result of that bailout.

To understand that point, we must recognize that what matters is not the quantity of pieces of paper with politicians’ pictures on them that the auto companies possess, but the quantity of resources that those pieces of paper will allow them to acquire. The government, if it gives the automakers boatloads of those pieces of paper, has not created so much as a single new side-view mirror or brake pedal. To make those items will take real resources, such as workers, glass, rubber, and so on. If the government chooses to re-direct such factors of production to automakers, it is inevitable that some other, potential users of those resources will not be able to acquire them. Thus, there are marginal businesses that would have made it through these hard times in the absence of a “Big Three” bailout that will, instead, fail due to such a bailout. Some construction company, outbid for steel by the newly empowered auto firms, will not be able to acquire the steel it needs to complete its projects, and thus will go under. Some window manufacturer, now outbid for glass by Ford or GM, will as a result shut its doors. Some sneaker producer, unable to compete with the politically favored Chrysler Corporation for rubber, will go out of business. In Bastiat’s lingo, “what is seen” is the auto workers who will not be laid off if this bailout goes through. “What is not seen” is the consequential failure of other businesses that lack the lobbying power of the auto industry.

It is remarkable that I have not encountered a single story or commentary about the proposed bailout that mentions the inevitable demise of businesses not favored with government largesse. Bailouts, tax breaks, price restrictions, and so forth, never create new, real resources, but only re-distribute existing resources from some economic actors to others.

10 Responses to “The Flawed Logic of Bailouts”

  1. Roger Koppl Says:

    Gene,

    Why not write an op ed and try to place it? You’ve already got a great closing line:

    “Bailouts, tax breaks, price restrictions, and so forth, never create new, real resources, but only re-distribute existing resources from some economic actors to others.”

  2. Mario Rizzo Says:

    What about the (Keynesian) argument that if we are not at full employment there are unused resources with no opportunity costs?

  3. Jay Chambers Says:

    Mario – there are indeed unused resources. But they sure as hell aren’t going to be used optimally by government. Only by economic agents in the private sector who can discover their true opportunity costs.

  4. John W. Says:

    (Excuse the presence of a newbie wading in on this)

    A very interesting point. And certainly this *would* be one of those unseen effects. However, it is also very hypothetical and that in its loosest sense. Where are these manufacturers and why are they failing? I would like to see a followup with some actual evidence of this (either rising costs for those construction firms due to scarcer materiel, or outright failure due to a lack of materiel). That would certainly prove interesting.

  5. Rick Says:

    John W.,

    I’m rather new here too, not an economist so I’m not speaking for these guys. However, I don’t see this as a hypothetical. The results surround us constantly. Here is one example.

    In 2002, I was involved in a construction project where we were trying to decide between roofing materials. The choices in this area were between two types; high end architectural shingles or metal roofing. A new tariff on imported steel had been instituted under the Bush Administration shortly after he came into office because of a promise he made to protect steel unions in the U.S. from “cheap” imports. The “seen” result was indeed the saving of union jobs for steel workers, however temporary.

    The “unseen” was that steel prices spiked for all businesses who purchased steel throughout the U.S. including the auto industry and yes, metal roofing. We went with the architectural shingles on my project because the metal would have pushed us over budget. So the tariff had negative effects on at least three industries who dealt with metal roofing; the manufacturers, local retailers (this one actually went out of business a little later) and construction companies.

    Finally, all this extra cost was pasted on to the consumer. Bush later rescinded the tariffs after realizing the costs to the larger economy. Not scientific but I think it might answer your question. Yes?

  6. Rick Says:

    Sorry, the the word is “past” in the last paragraph.


  7. Mario, I’ve given some thought to the point you bring up here, and I can’t dismiss Keynes argument as crazy or as never having force. Nevertheless, in terms of the auto bailout, my intuition is that the “transfer of resources” effect swamps any “bringing idle resources into the process of production” effect.

    John W., the basic theory of “why are they failing” is that, by directing resources to firms that would have failed without an intervention, the government has made those resources more difficult for other, non-favored firms to acquire. (There is only so much steel on the market at one time — if A is aided to acquire it more easily, someone else will suffer under an increased difficulty in acquiring it.) As far as your call for empirical study of this process, that’s an excellent idea — just not one I possibly can devote any time to at present!

    And, Roger, thanks for your suggestion, and the compliment it implicitly contains — but my last sentence in response to John W. holds here as well!

  8. Bob Murphy Says:

    Mario, I touched on the issue of idle resources (though it was only tangential to my main point) in this article, where I wrote:

    “The Keynesians are right that in a condition of “full employment,” their proposals won’t cause more physical TVs and pickup trucks to roll off the assembly lines. But even in a state of widespread unemployment, the Keynesian solutions don’t help. To repeat, this is because we can’t simply increase activity in all sectors by, say, 1% to raise output back up to pre-recession levels. Generally speaking, this is physically impossible. No matter how much money consumers or the government throw at it, Ford can produce 1,000 more Rangers only if it can purchase 4,000 more of the appropriate tires. And the tire producer in turn can only meet Ford’s request if it can buy the appropriate amount of extra rubber. And the rubber producer can only do this if…and so on.

    When the recession is the result of a central-bank-induced artificial boom (such as the recent housing boom), the downturn is a period of readjustment, when misallocated resources are channeled back into more appropriate lines, consistent with consumer preferences and technological realities. When the government steps in and tries to prevent this readjustment, it simply maintains an unsustainable deployment of scarce resources. Bottlenecks occur in the millions of different “pipelines” tracing the flow of natural resources through millions of different workers’ hands and onto the store shelves.”


  9. Bob, the point you make above ignores Keynes rather than handles his argument. What Keynes is saying is precisely that those 4000 tires are available, lying idle in a warehouse. And in another is a bunch of steel. And in a bar are a bunch of laid off workers. And all we need to do to build cars is solve the liquidity crisis and they can all be put to use. So simply to claim they aren’t available is a very good answer.

  10. Bob Murphy Says:

    Gene,

    Well, I admit it didn’t come through very well in the excerpt I gave, but actually I am addressing the idle resources point; it has to do with the “1%” statement.

    What I explained earlier in the piece was the during the recession, it’s not the case that all activities shrank by the same amount (e.g. 1%), and so all we need to do is have everyone boost output by the same amount.

    No, what happens during the recession is that some sectors shrink a lot, while others shrink a little, and some might even expand. So fine, let’s stipulate there are 4000 tires, a bunch of steel, and a bunch of laid off workers in a bar. That alone isn’t enough to crank out 1000 new trucks. You also need resources XYZ…and they are not all idle to the same degree.

    In general, you can’t expand production with Keynesian pump priming in a way that only draws down the idle resources. For sure, you’re not going to be able to just suck away the unemployed workers–as if all of the unemployed possess the same ratios of needed skills to expand output effectively, *without* diverting real resources from operations that were still functioning during the recession.

    So I admit my quotation looked like I was ignoring the problem, but I wasn’t.🙂


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