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From Chapter 14: The Undermining of Capital Accumulation and Real Wages by Government Intervention (pp. 636-639)

This excerpt is taken from George Reisman, Capitalism: A Treatise on Economics. Ottawa, Illinois: Jameson Books, 1996. Copyright © 1996 by George Reisman. All rights reserved. May not be reproduced in any form without written permission of the author. The following limited exception is granted: Namely, provided they are reproduced in full and include this copyright notice and are made for noncommercial use, i.e., for use other than for sale, including use as part of any publication that is sold, copies of this excerpt may be downloaded into personal computers and distributed electronically or on paper printouts from a personal computer; reproduction on the internet is permitted provided the copy of the excerpt is accompanied by the following link to the Jefferson School's home page (which may, and hopefully will, be displayed elsewhere and more prominently): The Jefferson School of Philosophy, Economics, and Psychology.

It is essential to realize the extent to which government intervention undermines capital accumulation, and with it the demand for labor and the productivity of labor, and thus real wages and the general standard of living.

The progressive personal income and inheritance taxes, and the corporate income and capital gains taxes, are paid mainly with funds that would otherwise have been saved and productively expended. Thus, their effect is to reduce the demand for capital goods and the demand for labor by business enterprises, and thus to reduce the economic degree of capitalism and the degree of capital intensiveness in the economic system. Consumption expenditure of the government and of those to whom it gives money replaces expenditure for capital goods and labor by business enterprises, and thus consumption expenditure of the employees of business enterprises. In accordance with this change in demand, the existing ability of the economic system to produce is diverted from the production of capital goods to the production of consumers' goods, and from the production of consumers' goods that the employees of business would have bought to the production of the consumers' goods that the government and its employees and dependents buy. Such taxes threaten not only the economic system's ability to progress, but even its ability to produce sufficient capital goods to replace those that are used up in production--i.e., to remain stationary.

These taxes also greatly undermine the incentives to introduce improvements in efficiency in the economic system, as do government subsidies, antitrust laws, prounion legislation, environmental legislation, and government regulation in general. In all these ways, government intervention operates to reduce output per unit of capital goods and thus to retard capital formation by this means too. The taxes reduce the rewards of economic success and thus discourage the efforts necessary to achieve it. At the same time, subsidies perpetuate inefficient methods of production by sustaining their practitioners. Thus, the taxes and the subsidies hold down the productivity of capital goods.

Furthermore, in depriving innovative small firms of the profits that would make possible their expansion, or more rapid expansion, most of these taxes also substantially reduce the force of competition in the economic system. They create a protective shelter around established firms that have already accumulated substantial capital and are now made more or less immune from the threat of new competition, since the potential competitors are prevented from accumulating capital, or from doing so as rapidly as they might have.⁸⁶ Essentially the same analysis applies to government regulation insofar as it is more difficult for small firms to comply with it, as when the regulations give an advantage to firms able to afford the employment of staffs of lawyers and accountants.

The antitrust laws stand in the way of business mergers that would achieve important economies and thereby render production more efficient. For example, the larger firm that results from a merger can often provide a sufficient volume of production to justify the purchase of machinery that the smaller firms which preceded it could not, or makes it possible to eliminate wasteful duplication in the use of existing equipment. In such ways, mergers make possible a more efficient use of capital. Preventing them prevents such more-efficient use of capital. In so doing, it retards capital formation.

Similarly, prounion legislation, in making it possible for the unions to prevent or delay the introduction of labor-saving machinery and more-efficient work practices, holds down the total output that otherwise could be produced in the economic system by the same quantity of labor working with the existing quantity of capital goods. In so doing, it holds down the size of the output that is available to meet whatever relative demand may exist for capital goods. So-called environmental legislation likewise provides numerous examples of reducing output per unit of capital goods, such as depriving the capital and labor employed in the energy industry of its most productive uses by closing off vast territories to the very possibility of exploration and development, and imposing all manner of regulations on business in general that require the employment of additional capital and labor to accomplish a given result. All such regulations needlessly reduce output per unit both of labor and of existing capital goods, while correspondingly increasing costs per unit.⁸⁷ Indeed, in some cases business firms must invest once in order to produce their products, and the equivalent of a second time in order to be in compliance with the government regulations inspired by the pathological fears of the environmentalists.

Every government regulation, of whatever description, that needlessly raises costs, correspondingly reduces the output of the economic system and thus the efficiency with which existing capital goods are employed. This conclusion follows from the proposition established back in Chapter 6 that reductions in unit cost underlie increases in output in the economic system, by virtue of releasing labor and capital to produce more either of the good whose unit cost is reduced or of other goods.⁸⁸ The corollary of this proposition is that increases in unit cost operate to reduce output in the economic system. Both propositions also follow from the fact that with any given magnitude of aggregate productive expenditure [i.e., expenditure for capital goods and labor by business firms], average unit cost in the economic system as a whole varies in inverse proportion to output.

Indeed, given any definite magnitude of aggregate productive expenditure, the only way that average unit cost in the economic system can increase is by virtue of aggregate production correspondingly decreasing, for average unit cost in the economic system as a whole is aggregate productive expenditure divided by aggregate output. By the laws of mathematics, with a numerator that is fixed, the only way that a fractional expression can increase is by virtue of a corresponding decrease in the denominator, which in this case is aggregate output. Thus, any government regulation that raises average unit costs in the economic system is accompanied by a corresponding reduction in aggregate output.

The consequence of any lesser overall ability to produce is, of course, a reduced ability to produce capital goods, as well as consumers' goods. More precisely, the effect of all such regulations is to reduce the ratio of output to the capital goods consumed in producing that output, and therefore to make the maintenance proportion unnecessarily high. When placed together with the taxes described a few paragraphs back, the combined effect is a lower relative production of capital goods and a higher maintenance proportion, with a corresponding two-sided reduction in the portion of output available for new capital formation. Indeed, that portion can be eliminated altogether, and stagnation or outright capital decumulation made to take the place of capital accumulation.

Government budget deficits and social security, like the taxes I have described, also operate to reduce saving and productive expenditure. To the extent the deficits are financed by borrowing from the public (as opposed to the printing of money), they represent a diversion of savings from use as capital to the financing of the government's consumption. To the extent they are financed by the creation of money, they operate to create both additional nominal profits, on which businesses must pay taxes, and to raise the replacement cost of capital assets. Thus, they operate to make it more difficult or even impossible to replace capital assets. And in still other ways, inflation-financed deficits undermine capital formation.⁸⁹ Social security leads people to reduce their provision for the future, in the belief that their needs will be provided for by the government. Meanwhile the government consumes their social security contributions. Thus, in this way too, capital accumulation is undermined.⁹⁰

In the face of such an assault on the foundations of capital formation, it should hardly be surprising that the present-day United States has fallen from its previous position of unchallenged economic eminence. The United States is a country whose economic foundations have been sapped by wave after wave of socialistically motivated assaults on capital formation. In this century, there has been the Progressive Era and the Square Deal, then the New Deal, the Fair Deal, and the Great Society, all bent on fundamentally altering the nature of the American economic system and, unfortunately, succeeding in doing so. Until these policies, and the envy- and resentment-filled mentality on which they are based, are reversed, the United States will continue on its path of decline.

What is required to restore economic progress and rising real wages in the United States is nothing less than radical reductions in government spending, taxation, and government regulation of business. Specifically, what is necessary is to begin phasing out the progressive personal income and inheritance taxes, the corporate income tax, the capital gains tax, the social security system, and the whole of the welfare state, which makes the revenues raised by these destructive taxes appear necessary, and, at the same time, to move toward a gold standard and the end of the arbitrary creation of money. Such a program, coupled with an equally massive reduction in government regulation, would enormously increase not just the incentive and means to save, which would be important enough, but all of the incentives to produce and compete. People would work harder and produce more in the knowledge that more of what they earned was theirs to keep. More new companies would be started and be able to grow rapidly and challenge the established firms, if they could plow back most of their profits. All firms would improve in efficiency if they were free of restrictive regulations. The rate of innovation and technological progress would increase. Thus, along with a sharp rise in the relative production of capital goods, the productivity of capital goods would greatly increase and the maintenance proportion correspondingly decrease. This combination of a higher relative production of capital goods and reduced maintenance proportion would assure a sharply higher rate of capital accumulation. It would thus restore a rising productivity of labor and rising real wages. (And, of course, real wages would increase on the strength of a rise in the demand for labor made possible by the reduction in government spending, taxes, and deficits.) This is clearly the path to the long-term economic recovery of the United States (or any other country). The effect would be to lift the United States out of the stagnation of the last generation and restore it to rapid economic progress--to rapidly rising real wage rates and a rapidly rising general standard of living.

Regrettably, so powerful is the grip of ignorance and envy, that no amount of economic decline by itself seems likely to awaken the present generation of Americans to the fact that they, their twentieth-century political heroes, and their present chosen leaders might in any way be responsible for the decline through the economic policies they support and sustain, and that what is required is the radical reversal of those policies. Following the completion of my economic analysis, the final chapter of this book will attempt to develop a concrete, long-range political-economic program and strategy for achieving the necessary changes.

Happily, a leading implication of the analysis of capital accumulation I have presented here is that it is never too late for such a program. For what I have shown is that while no amount of existing capital goods and prosperity, however great, is a guarantee of the maintenance of those capital goods and prosperity, so too it is possible even for the very poorest of countries to rise, or for a country to resume its rise no matter how great its fall from former prosperity. All that is necessary is that it become more efficient in the use of whatever capital goods it continues to possess, and devote a proportion of them and of its labor to the production of further capital goods that is greater than the maintenance proportion. It is highly unlikely that the economic decline the United States may experience in the coming decades will place it below the level of Japan in 1950. But even if that were the case, it would still be possible for the United States rapidly to reverse the damage and, before too long, to exceed its former peak and go on advancing from there. To do so, it would simply have to turn once again to the philosophy of economic freedom on which it was built. That would ensure both the necessary efficiency in the use of whatever capital goods existed and a sufficient concentration on the production of further capital goods.

 
Notes

86. Cf. Ludwig von Mises, Bureaucracy (1944; reprint ed., New Rochelle, N. Y.: Arlington House, 1969), pp. 13­14.

87. See above, pp. 98­99. The hampering of the energy industry is an example of the wider phenomenon of the environmental movement's systematic thwarting of efforts to overcome the operation of the law of diminishing returns in agriculture and mining. On this point, see above, pp. 316­317.

88. See above, pp. 178­179.

89. On the subject of the undermining of capital formation by inflation, see below, pp. 930­937.

90. Concerning social security, see above, pp. 22­23.