Co-written by Yergin and Stanislaw and published in 1998, this excellent book deals with the never ending battle between government and the private sector as to who will occupy what it describes as the commanding heights of the economy.
In the U.S. and most of the rest of the world as well, the pendulum has been moving away from freedom and in the direction of more government. Accordingly, the private sector has been losing ground in this zero sum game.
Stated another way, a society can't have more government control and growing individual freedoms at the same time. To choose more of one means that there will be less of the other.
Two recent articles about the U.S. and Chinese governments' roles in their respective economies are instructive in determining where each country is today.
We'll begin with the U.S. situation.
Subsidizing Wall Street to Buy Chinese Solar Panels was written by T.J. Rodgers, founder and CEO of Cypress Semiconductor. Although short, it's a must read.
Rodgers offers two examples--housing and the solar industry-- of wrongheaded government actions which illustrate what he refers to as the Law of Unintended Consequences and the corollary Law of Misguided Subsidies.
While we all have a tendency to underestimate everyone's intelligence but our own, this is especially true of government officials who set out to make things better through government intervention or control. What generally happens next is as easy as counting 1-2-3.
(1) Although the promulgated government rules may be well intentioned, they frequently don't work as intended and are often counterproductive. It's government elitism and arrogance in action. (2) The people who are subjected to the government intervention comply with the rules but also figure out how best to take advantage of those rules. It's as simple as MOM besting OPM. (3) The general and unsuspecting public taxpayer fails to notice. Even though the individual taxpayer is not directly involved, taxpayers as a whole will pay the bill in the end.
Specifically, people whose activities are subjected to government rules will often find a way to operate within but work around those rules to their individual advantage.
Taken as a whole, the marketplace is represented by the knowledgeable and self interested actions of the entire population base. In total, free market participants possess abundantly more intelligence than a few, albeit perhaps well intentioned, rules making government bureaucrats.
It's a simple case of large numbers of free choosing people and self interested MOM over small numbers of bureaucrats and OPM. Yet narrow minded government elites never seem to get that simple message.
One such example of well intentioned government creating poor results is the recent housing bubble and the actions of the private sector:
" . . . in creating mortgage-backed securities, Wall Street did nothing other than facilitate home-financing access to the next tier of less-qualified home buyers, as demanded by every president since Bill Clinton. After that, the bankers did exactly what their shareholders wanted: bundle those risky loans into securities, sell them to lock in the profits, and dump the risk right back onto the federal government—where it belonged.
My purpose is not to debate the morality of mortgage-backed securities but to update the Law of Unintended Consequences with the corollary Law of Misguided Subsidies: Whenever Washington disrupts a market by dumping subsidies into it, Wall Street will find a way to pocket a majority of the money while the intended subsidy beneficiaries are harmed by the resulting market turmoil.
The recent crash in mortgage-backed securities was a near-repeat of the savings-and-loan crash of the 1980s, in which Washington insured the S&L industry but failed to set limits on high-risk loans. When the bubble burst, Washington paid Wall Street the insurance money while homeowners lost huge sums in real-estate hell. Wall Street understands how to manage risk; the federal government and consumers do not."
An even more timely example is the role of government with respect to the federal solar subsidy for consumers:
"Washington and consumers are both notoriously shortsighted investors. Washington thinks in two-year election cycles, and consumers will usually choose a financially unfavorable option if it offers no money down. Today's most successful pitch for home solar financing goes like this: "Why pay a lot of money when you can get your solar system installed free and immediately reduce your utility bill?" Most homeowners find that proposition compelling. They ignore the fine print: "You must give your tax credit and depreciation to us and sign a long-term contract to buy power from us at prices just below market."
Today, most new home solar systems are purchased by special Limited Liability Corporations (LLCs) that are specifically created by Wall Street firms to purchase home solar systems and to sell power to the homeowner on a cell-phone-like contract. The homeowner does not mind giving up the tax benefits as long as the "free" system reduces utility bills.
However, when the system is paid off and the monthly LLC profit jumps to 100% of the electricity bill, the LLC solar electricity price to the homeowner is maintained just below market—and the profit really begins to roll into the LLC. Since the risks to the LLC grow as the solar systems age, many banks offload their risk by selling the LLCs before their 20-year lifetime is up, locking in much of the long-term profit. There is now a growing market for what might be called "solar-backed securities." Wall Street understands the time-value of money; the federal government and consumers do not.
One of the largest solar-system installers in the U.S., SolarCity Corp., uses the LLC strategy and currently buys a majority of its solar panels from the low-cost Chinese supplier, Yingli. Thus when President Obama said that we must subsidize our solar industry to remain competitive with the Chinese, it would have been more accurate to say that we subsidize Wall Street to create employee-less corporations that buy and install Chinese solar panels in the U.S. Wall Street and consumers understand that free markets are borderless; Washington does not.
Just last week, the U.S. International Trade Commission found the Chinese solar industry guilty of "dumping" solar panels in the U.S. Tariffs are likely to be levied against Yingli and others. Here then, is a practical guide to the Obama administration's nonsensical solar policy: Washington gives tax breaks to Wall Street to fund LLCs that buy solar panels from the Chinese to "help" the American solar industry, while the ITC threatens to levy a tariff on those solar panels, which would raise the price of solar energy to U.S. homeowners. In short, Wall Street pockets the money and consumers get higher solar-energy prices.
We should stop reflexively indicting Wall Street "greed" and focus instead on Washington as the disruptive force in one market meltdown after another. Solyndra, the poster child of the Law of Misguided Subsidies, borders on irrelevancy compared to the full impact of bad economic policy."
So even if their actions are well intentioned, government policy makers do the wrong things. Bureaucrats simply can't outsmart focused and self interested private market participants. And when government officials try to do so, the taxpayers invariably lose, other than those few players who know how to work within the rules while taking advantage of previously unforeseen (by government officials) opportunities at the same time.
The conclusion is straightforward. Wherever possible, government should just stay out of the private sector's way.
Now let's turn to a Chinese example.
Unlike the U.S., the Chinese government's good intentions frequently aren't in evidence. That country's communist government controls all aspects of the game and picks the winners and losers.
Entrepreneur's Rival in China: The State tells the story of China's commanding heights:
"There are a variety of reasons the Chinese government is seeking an enlarged role in the economy — including fears that wealthy entrepreneurs could begin to challenge the Communist Party. There is also an ingrained belief among leaders that the state is better at driving growth and redistributing wealth. And so state companies have been given the green light to expand their interests and move into anything that promises high returns — whether real estate, finance, technology or other fields."
Thus, what's happening to one successful private Chinese company wouldn't take place in the U.S. America is far too transparent for such a flagrant violation of private property rights by government officials to occur.
Specifically, the private company Cathay Biotech and its entrepreneurial founder Liu Xiucai are being destroyed by the interventionist actions and choices of the Chinese government. Here's some brief background:
"The patents Cathay won prompted Dupont, a leading global producer of nylon, to become one of Cathay’s biggest customers. And the $120 million that Goldman Sachs and other backers have pumped into Cathay in recent years primed investors in China and abroad to eagerly await a public stock offering that had been planned for earlier this year.
They’re still waiting.
According to Cathay, a factory manager stole its secrets and started a rival company that has begun selling a suspiciously similar ingredient, undermining Cathay’s profits. Instead of planning to go public, Cathay is now struggling to stay in business.
In this counterfeit-friendly nation, employees run off with manufacturing designs almost daily. But according to Cathay, this was copying with a special twist: the new competitor, Hilead Biotech, is backed by the Chinese government.
Court documents show that Hilead was set up with the help of the state-run Chinese Academy of Sciences. And because the project fit national and local government policy goals, Hilead received a $300 million loan from the national government’s China Development Bank. The loan came after the company won the approval of the party secretary of Shandong Province, one of the country’s highest-ranking public officials."
So there we have it. Although both have commanding heights, the U.S. and Chinese situations are totally dissimilar.
While both countries' private sectors have balancing issues with the commanding heights and government control, U.S. private sector issues with government intervention pale compared to those of private sector Chinese participants.
Achieving a balance between a government's legitimate role and the proper functioning of the free market is a continuing battle. Who occupies the commanding heights at any single point in time is always subject to change and will never be permanently fixed.
That said, arrogant politicians and other elitist government officials threaten our very freedoms and American prosperity each time they substitute their judgments for those actions that would otherwise be taken by free market participants. Even if the bureaucrats' intentions are honorable and their motives are pure. And, of course, they often aren't.
Consider these simple facts. There are more than 300 million Americans, more than one billion Chinese and more than seven billion people in the world today. Left to our own choices, free people left to make our own choices will do a much better job of creating a better future than will the decisions of a few thousand politicians.
So why this isn't obvious to everybody, including politicians?
The straightforward conclusion? Free people making free choices in free markets should occupy the commanding heights with only a small, helpful and when needed assist from their governments.
That's nothing more than the law of common sense.
Thanks. Bob.
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