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The Henry Hazlitt Series: Credit Diverts Production

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The Hazlitt Series

This latest stewardship post is a continuation of our monthly exploration and modern application of the economic writer  Henry Hazlitt, and his seminal work, Economics in One Lesson. This work draws heavily upon the insights of the great French economist Frederic Bastiat.  His key insight was to look at that which is not seen.  So, for example, do not simply look at the benefits of a trade restriction of say wool, but also look at the costs to the rest of the economy.  Hazlitt updates this insight with a more modern take to look not just at the short-run effects on a small group, but also the long-term effects for the whole economy.  Hazlitt then applies this lesson to a variety of topics.  Each installment will pay homage to this superbly clear economic thinker and writer by applying each of his applications to our world today.

Credit Diverts Production

This month’s installment of the Hazlitt series considers the phenomenon of government provided credit.  The argument goes that credit encourages production and overcomes an inadequate economic environment.  All this government provided credit serves to help the economic environment.

All of this is a fallacy.  As Hazlitt reminds us, all credit is debt.  You only need to think of the money your credit card company extends to you.  It is a loan you must repay.  This is equally true of a home mortgage.  It is a credit extended to you, that is a form of debt that you must repay. 

In terms of business credit, there are two forms.  One is credit to buy or upgrade supplies, and machinery.  The other form of credit is used to buy a business or start one from scratch.

If we are talking about a private lender, then we recognize that they are risking their own funds.  This braces them to carefully evaluate the risks of the loan and to better evaluate to whom they lend funds.  This is clearly not the case with the government, if for no other reason than that they are not lending their own money.  Also, if the government were as careful as private lenders, then they would not need to act; yet it is the claim of “market failure” that is the chief justification of this type of government program.

In reality, the government lends money to people who cannot get credit.  Government officials admit that this will result in higher loan losses but claim that this is offset by the added production that is brought into existence.  That government granted or guaranteed loans produce higher losses is clear.  Over 16% of government made or guaranteed loans default.  In contrast, commercial bank business loans only have a delinquency rate that hovers around 1%.

Always Look at the Unseen

As is the case with most economic fallacies, people only look at that which is seen.  Yet, we must always look to what is unseen.  In this case the focus is on those who get loans and ignores those who are deprived of loans as a result.  First, it is crucial to understand that real wealth is being loaned.  That is, production that is not consumed (savings).  We will look at the fallacies surrounding the creation of money (inflation) in a later post in this series.  This being the case, wealth that is loaned to one cannot be loaned to another.

Second, either a business (or farm) loan is obtained on one’s own merits or the government guarantees the loan using lower standards than a private lender.  These lower standards lead to losses as we have seen.  This means that scarce resources will be wasted due to the inefficient diversion of these resources to less creditworthy borrowers.  So, borrower B gets the loan instead of potential borrower A.  This is because A may get squeezed by higher interest rates or prices rising due to the government subsidizing the borrowing of B.  This has the effect of reducing overall wealth by placing real capital (farms, businesses, etc.) in the hands of less efficient producers.

That this is clearly the case is demonstrated by the “logic” of these government programs.  The rationale is that the government assumes risks that are too great for private industry.  In plain English, the government takes risks with someone else’s money that they would not take with their own.  Besides the higher loan loss rate, and squandering of scarce resources, there are some other deleterious consequences.  First, these programs lead to favoritism, both among some industries (think “green” energy) as well as within an industrial sector (think padding House districts with a startup, complete with a ribbon cutting ceremony).  These politically motivated loans typically come a cropper, as we can see from stadium subsidies, as well as industrial policy grants, and loans.  This touches on the fact that subsidies act in the same perverse manner as outright grants and loans.

Second, this leads to an outright drive to totally socialize the economy because the question will arise, “if the government is taking the risk, why shouldn’t government get the profits”.  I think the picture of the Korean peninsula below shows the defect of this line of thinking:


All of this leads to a waste of capital, and therefore reduced production of goods and services.  That is, we are poorer than we would otherwise be, if the government just stayed out of the interactions of the marketplace.  Since real capital is limited (again, we will discuss inflation in a later post), what is given to the lower credit risk B cannot be given to the better credit risk A.  Less efficient producers will be granted control of scarce capital because the “analysis” only sees the recipient of the loan, not the one who was denied the loan.

But What of Fairness and Equity?

Many will object that the government must redress centuries of discrimination perpetrated against marginalized communities.  The descendants of slaves come immediately to mind.  Well, look at the New Deal.  The argument was made that this program would help those most disadvantaged.  Yet, the reality is that the New Deal was largely responsible for the segregation of the US housing market in the 20th. century, as this report details.  Why should anyone think that biases and prejudice will suddenly just go away.  Remember government is the institution in institutional racism

What is denied marginalized communities and people of color specifically is free entry into the marketplace.  This takes the form of laws of licensure, poorly run government run schools, the drug war, and a host of disincentives to work inherent in the welfare state.  The best way to bring equity to these groups is to allow the marketplace to work, allow them the same rights of opportunity as anyone else by removing government from the equation as much as we can.  To equate the free market with something akin to slavery (which progressives are wont to do) is to completely misread the history of how capitalism was largely responsible for ending actual slavery in the west.

The answers to these questions may not be intuitive or obvious to many, much like the economic fallacy of only looking at what is seen, but clear and effective answers do present themselves when we look at the unseen and use the logic God gave us to build a better world.  Next month we will look at one of the oldest economic fallacies around, the hatred of machines.

Praise Be to God

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