CREDIT DIVERTS PRODUCTION

CREDIT DIVERTS
PRODUCTION
GOVERNMENT "ENCOURAGEMENT" TO business is sometimes as
much to be feared as government hostility. This supposed
encouragement often takes the form of a direct grant of government
credit or a guarantee of private loans.
The question of government credit can often be complicated,
because it involves the possibility of inflation. We shall defer
analysis of the effects of inflation of various kinds until a later
chapter. Here, for the sake of simplicity, we shall assume that
the credit we are discussing is noninflationary. Inflation, as we
shall later see, while it complicates the analysis, does not at
bottom change the consequences of the policies discussed.
A frequent proposal of this sort in Congress is for more credit
to farmers. In the eyes of most congressmen the farmers simply
cannot get enough credit. The credit supplied by private mortgage
companies, insurance companies or country banks is never
"adequate." Congress is always finding new gaps that are not
filled by the existing lending institutions, no matter how many
of these it has itself already brought into existence. The farmers
may have enough long-term credit or enough short-term credit,
but, it turns out, they have not enough " intermediate" credit; or
the interest rate is too high; or the complaint is that private loans
are made only to rich and well-established farmers. So new
lending institutions and new types of farm loans are piled on
top of each other by the legislature.
The faith in all these policies, it will be found, springs from
two acts of shortsightedness. One is to look at the matter only
from the standpoint of the farmers that borrow. The other is to
think only of the first half of the transaction.
Now all loans, in the eyes of honest borrowers, must eventually
be repaid. All credit is debt. Proposals for an increased
volume of credit, therefore, are merely another name for proposals
for an increased burden of debt. They would seem
considerably less inviting if they were habitually referred to by
the second name instead of by the first.
We need not discuss here the normal loans that are made to
farmers through private sources. They consist of mortgages,
of installment credits for the purchase of automobiles, refrigerators,
TV sets, tractors and other farm machinery, and of
bank loans made to carry the farmer along until he is able to
harvest and market his crop and get paid for it. Here we need
concern ourselves only with loans to farmers either made directly
by some government bureau or guaranteed by it.
These loans are of two main types. One is a loan to enable the
farmer to hold his crop off the market. This is an especially
harmful type, but it will be more convenient to consider it later
when we come to the question of government commodity
controls. The other is a loan to provide capital—often to set the
farmer up in business by enabling him to buy the farm itself, or
a mule or tractor, or all three.
At first glance the case for this type of loan may seem a strong
one. Here is a poor family, it will be said, with no means of
livelihood. It is cruel and wasteful to put them on relief. Buy a
farm for them; set them up in business; make productive and
self-respecting citizens of them; let them add to the total national
product and pay the loan off out of what they produce.
Or here is a farmer struggling along with primitive methods of
production because he has not the capital to buy himself a
tractor. Lend him the money for one; let him increase his
productivity; he can repay the loan out of the proceeds of his
increased crops. In that way you not only enrich him and put
him on his feet; you enrich the whole community by that much
added output. And the loan, concludes the argument, costs the
government and the taxpayers less than nothing, because it is
"self-liquidating."
Now as a matter of fact that is what happens every day under
the institution of private credit. If a man wishes to buy a farm,
and has, let us say, only half or a third as much money as the
farm costs, a neighbor or a savings bank will lend him the rest in
the form of a mortgage on the farm. If he wishes to buy a
tractor, the tractor company itself, or a finance company, will
allow him to buy it for one-third of the purchase price with the
rest to be paid off in installments out of earnings that the tractor
itself will help to provide.
But there is a decisive difference between the loans supplied
by private lenders and the loans supplied by a government
agency. Each private lender risks his own funds. (A banker, it is
true, risks the funds of others that have been entrusted to him;
but if money is lost he must either make good out of his own
funds or be forced out of business.) When people risk their own
funds they are usually careful in their investigations to determine
the adequacy of the assets pledged and the business
acumen and honesty of the borrower.
If the government operated by the same strict standards,
there would be no good argument for its entering the field at all.
Why do precisely what private agencies already do? But the
government almost invariably operates by different standards.
The whole argument for its entering the lending business, in
fact, is that it will make loans to people who could not get them
from private lenders. This is only another way of saying that
the government lenders will take risks with other people's
money (the taxpayers') that private lenders will not take with
their own money. Sometimes, in fact, apologists will freely
acknowledge that the percentage of losses will be higher on
these government loans than on private loans. But they contend
that this will be more than offset by the added production
brought into existence by the borrowers who pay back, and
even by most of the borrowers who do not pay back.
This argument will seem plausible only as long as we concentrate
our attention on the particular borrowers whom the government
supplies with funds, and overlook the people whom its
plan deprives of funds. For what is really being lent is not
money, which is merely the medium of exchange, but capital.
(I have already put the reader on notice that we shall postpone
to a later point the complications introduced by an inflationary
expansion of credit.) What is really being lent, say, is the farm
or the tractor itself. Now the number of farms in existence is
limited, and so is the production of tractors (assuming, especially,
that an economic surplus of tractors is not produced
simply at the expense of other things). The farm or tractor that
is lent to A cannot be lent to B. The real question is, therefore,
whether A or B shall get the farm.
This brings us to the respective merits of A and B, and what
each contributes, or is capable of contributing, to production.
A, let us say, is the man who would get the farm if the
government did not intervene. The local banker or his neighbors
know him and know his record. They want to find employment
for their funds. They know that he is a good farmer
and an honest man who keeps his word. They consider him a
good risk. He has already, perhaps, through industry, frugality
and foresight, accumulated enough cash to pay a fourth of the
price of the farm. They lend him the other three-fourths; and
he gets the farm.
There is a strange idea abroad, held by all monetary cranks,
that credit is something a banker gives to a man. Credit, on the
contrary, is something a man already has. He has it, perhaps,
because he already has marketable assets of a greater cash value
than the loan for which he is asking. Or he has it because his
character and past record have earned it. He brings it into the
bank with him. That is why the banker makes him the loan.
The banker is not giving something for nothing. He feels
assured of repayment. He is merely exchanging a more liquid
form of asset or credit for a less liquid form. Sometimes he
makes a mistake, and then it is not only the banker who suffers,
but the whole community; for values which were supposed to
be produced by the lender are not produced and resources are
wasted.
Now it is to A, let us say, who has credit, that the banker
would make his loan. But the government goes into the lending
business in a charitable frame of mind because, as we say, it is
worried about B. B cannot get a mortgage or other loans from
private lenders because he does not have credit with them. He
has no savings; he has no impressive record as a good farmer; he
is perhaps at the moment on relief. Why not, say the advocates
of government credit, make him a useful and productive
member of society by lending him enough for a farm and a mule
or tractor and setting him up in business?
Perhaps in an individual case it may work out all right. But it
is obvious that in general the people selected by these government
standards will be poorer risks than the people selected by
private standards. More money will be lost by loans to them.
There will be a much higher percentage of failures among
them. They will be less efficient. More resources will be wasted
by them. Yet the recipients of government credit will get their
farms and tractors at the expense of those who otherwise would
have been the recipients of private credit. Because B has a farm,
A will be deprived of a farm. A may be squeezed out either
because interest rates have gone up as a result of the government
operations, or because farm prices have been forced up as
a result of them, or because there is no other farm to be had in
his neighborhood. In any case, the net result of government
credit has not been to increase the amount of wealth produced
by the community but to reduce it, because the available real
capital (consisting of actual farms, tractors, etc.) has been
placed in the hands of the less efficient borrowers rather than in
the hands of the more efficient and trustworthy.
The case becomes even clearer if we turn from farming to
other forms of business. The proposal is frequently made that
the government ought to assume the risks that are "too great for
private industry." This means that bureaucrats should be permitted
to take risks with the taxpayers' money that no one is
willing to take with his own.
Such a policy would lead to evils of many different kinds. It
would lead to favoritism: to the making of loans to friends, or in
return for bribes. It would inevitably lead to scandals. It would
lead to recriminations whenever the taxpayers' money was
thrown away on enterprises that failed. It would increase the
demand for socialism: for, it would properly be asked, if the
government is going to bear the risks, why should it not also get
the profits? What justification could there possibly be, in fact,
for asking the taxpayers to take the risks while permitting
private capitalists to keep the profits? (This is precisely, however,
as we shall later see, what we already do in the case of
"nonrecourse" government loans to farmers.)
But we shall pass over all these evils for the moment, and
concentrate on just one consequence of loans of this type. This
is that they will waste capital and reduce production. They will
throw the available capital into bad or at best dubious projects.
They will throw it into the hands of persons who are less
competent or less trustworthy than those who would otherwise
have got it. For the amount of real capital at any moment (as
distinguished from monetary tokens run off on a printing press)
is limited. What is put into the hands of B cannot be put into the
hands of A.
People want to invest their own capital. But they are cautious.
They want to get it back. Most lenders, therefore, investigate
any proposal carefully before they risk their own money
in it. They weigh the prospect of profits against the chances of
loss. They may sometimes make mistakes. But for several
reasons they are likely to make fewer mistakes than government
lenders. In the first place, the money is either their own or has
been voluntarily entrusted to them. In the case of governmentlending
the money is that of other people, and it has been taken
from them, regardless of their personal wish, in taxes. The
private money will be invested only where repayment with
interest or profit is definitely expected. This is a sign that the
persons to whom the money has been lent will be expected to
produce things for the market that people actually want. The
government money, on the other hand, is likely to be lent for
some vague general purpose like "creating employment"; and
the more inefficient the work—that is, the greater the volume of
employment it requires in relation to the value of the
product—the more highly thought of the investment is likely to
be.
The private lenders, moreover, are selected by a cruel market
test. If they make bad mistakes they lose their money and have
no more money to lend. It is only if they have been successful in
the past that they have more money to lend in the future. Thus
private lenders (except the relatively small proportion that have
got their funds through inheritance) are rigidly selected by a
process of survival of the fittest. The government lenders, on
the other hand, are either those who have passed civil service
examinations, and know how to answer hypothetical questions
hypothetically, or they are those who can give the most plausible
reasons for making loans and the most plausible explanations
of why it wasn't their fault that the loans failed. But the
net result remains: private loans will utilize existing resources
and capital far better than government loans. Government
loans will waste far more capital and resources than private
loans. Government loans, in short, as compared with private
loans, will reduce production, not increase it.
The proposal for government loans to private individuals or
projects, in brief, sees B and forgets A. It sees the people into
whose hands the capital is put; it forgets those who would
otherwise have had it. It sees the project to which capital is
granted; it forgets the projects from which capital is thereby
withheld. It sees the immediate benefit to one group; it overlooks
the losses to other groups, and the net loss to the community
as a whole.
The case against government-guaranteed loans and mortgages
to private businesses and persons is almost as strong as,
though less obvious than, the case against direct government
loans and mortgages. The advocates of government-guaranteed
mortgages also forget that what is being lent is ultimately real
capital, which is limited in supply, and that they are helping
identified B at the expense of some unidentified A. Government-
guaranteed home mortgages, especially when a
negligible down payment or no down payment whatever is
required, inevitably mean more bad loans than otherwise.
They force the general taxpayer to subsidize the bad risks and
to defray the losses. They encourage people to "buy" houses
that they cannot really afford. They tend eventually to bring
about an oversupply of houses as compared with other things.
They temporarily overstimulate building, raise the cost of
building for everybody (including the buyers of the homes with
the guaranteed mortgages), and may mislead the building industry
into an eventually costly overexpansion. In brief, in the
long run they do not increase overall national production but
encourage malinvestment.
We remarked at the beginning of this chapter that government
"aid" to business is sometimes as much to be feared as
government hostility. This applies as much to government
subsidies as to government loans. The government never lends
or gives anything to business that it does not take away from
business. One often hears New Dealers and other statists boast
about the way government "bailed business out" with the Reconstruction
Finance Corporation, the Home Owners Loan
Corporation and other government agencies in 1932 and later.
But the government can give no financial help to business that it
does not first or finally take from business. The government's
funds all come from taxes. Even the much vaunted "government
credit" rests on the assumption that its loans will ultimately
be repaid out of the proceeds of taxes. When the government
makes loans or subsidies to business, what it does is to
tax successful private business in order to support unsuccessful
private business. Under certain emergency circumstances
there may be a plausible argument for this, the merits of which
we need not examine here. But in the long run it does not sound
like a paying proposition from the standpoint of the country as a
whole. And experience has shown that it isn't.