Further thoughts on incentives

In reflecting on Boyes' observation earlier this week on the impact on investment from government intervention I have to think my response failed to consider several institutional components of our system that make it a real challenge to determine the impact on investment.

I believe that Boyes was thinking about wealth enhancing investment in his original posting and embedded in his thinking I can see an assumption about the level of investment generated in a free market compared to the level of investment generated by a command economy.

In thinking about this comparison it is clear that, depending upon the institutional matrix of the command system the comparative investment level will be indeterminant.

I have specific examples in mind.

First, the sugar industry in the US is an excellent example of overinvestment due to government subsidy and support. Government intervention in the agricultural market has most asssuredly lead to overinvestment in land and capital devoted to agriculture, certainly more than one would expect the free market to generate.

Three of the four articles in the June 2011 Journal of Economic Literature are useful in thinking about the point the Boyes raises. Chad Syverson's piece - What Determines Productivity? is exellent reading and a great review of the challenge in determining and measuring productivity and the complexity of the relationships between the institutional framework of a society and productivity.

That said, he points out that the state can take actions to enhance productivity (clear defintion and enforcement of property rights, enforcement of contracts, independent, transparent and consistent judiciary) as well as reduce productivity.

In looking at the later, Syverson describes US government policy in the sugar industry. His discussion of the Bridgeman, Qi, Schmitz (2009) study is worth reading as it traces the impact of the 1934 Sugar Act. He writes: "This transfer scheme led ot the standard quantity distortions (more sugar beet production - more land and capital invested in sugar beet production than would be expected in the absence of government intervention) but it also distorted the incentives for efficient production." (354)

A second component of government intervention leading to excessive investment is the consistent action of the government to prevent failure of individual firms in a number of industries ranging from manufacturing to finance. This "safety net" acts to increase the level of investment found in these industries.

A common form of government intervention to "protect" US industry and thus lead to excessive investment include subsidy, other tax benefits and direct trade protection. The sugar industry in the US has enjoyed all three of these benefits and, given the world price of sugar and the relative comparative disadvantage of US sugar producers it is hard to argue that investment in this market would most certainly decline (to zero?) in the absence of the government.


Doug Barlow writes:

"The sugar program directly empowers producers to plunder consumers. Import quotas limit sugar supplies, sharply hiking prices and pushing food-makers to use high-fructose corn syrup. Explained Michael K. Wohlgenant of North Carolina State University: “Since the mid-1970s, as a result of the sugar program, the price of sugar in the United States has been almost twice as high as the price of sugar on the world market in most years. The resulting estimated costs to U.S. consumers have averaged $2.4 billion per year, and with producers benefiting by about $1.4 billion per year.”


http://blogs.forbes.com/dougbandow/2011/07/18/its-time-to-kick-farmers-off-the-federal-dole/2/

In thinking about the impact that the government has on the incentives to invest it might be useful to think about comparative advantage. The following hypothesis might be worthy of testing: If the market being intervened by the US government is one characterized by a dynamic comparative disadvantage, government action might well lead to excessive investment. The reverse might well hold in the case of a market in which the US has a comparative advantage.

Regardless of the nature of the market, distortions to investment, malinvestment (as opposed to no invesment) and time distortions to investment are inevitable consequences of government intervention.