Not to Mention Private Investors’ Greater Relevant Experience

by Don Boudreaux on December 20, 2013

in Economics, Other People's Money, Subsidies

Ms. Lindsey Murphy [an economics major at an unnamed college who objects to my argument in this post on the Ex-Im Bank]

Dear Ms. Murphy:

Thanks for your e-mail.

You remember accurately from your economics classes that markets are imperfect.  You’re mistaken, however, to allege that I “illegitimately assume a perfect market” when I argue that projects that require government funding (because they can’t attract private funding) are unlikely to be economically worthwhile.  I assume not that markets are perfect but, rather, that markets work better than governments at allocating capital to genuinely profitable uses.

Try the following game with your friends.  It’ll cost you some money, but the learning experience will be worthwhile.  Here’s the game:

Put three identical paper cups upside down on a countertop.  As a friend (call her Jane) looks on, she sees you place a $10 bill beneath one of the cups.  For a full ten minutes you will scramble the positions of the three cups while Jane observes.  If at the end of the ten minutes Jane incorrectly identifies the cup containing the money, she must pay you $1.  But if she correctly identifies the $10 cup, she gets to keep the $10.  Repeat this game fifteen times.

Then play the same game fifteen times with another friend (call him Tom).  The only difference is that if Tom incorrectly identifies the $10 cup, he owes you nothing, but even when he correctly identifies the $10 cup, he gets none of the money.  He gets from you only a handshake and a hearty “Attaboy!”

Who do you think will, at the end of these 30 plays of this game, have the better record at identifying the cups containing the $10 bills?  Tom or Jane?  I’m confident that it will be Jane.  I’m sure that it will be Jane not because I assume that her powers of observation are “perfect,” or even that her powers of observation are superior to those of Tom.  Instead, I’m confident that Jane will have the better record at identifying profitable opportunities (the $10 cups) because she has much stronger incentives than does Tom to do so.

The take-home, of course, is not that private investors are “perfect,” but, rather, that they have stronger incentives than do politicians and government bureaucrats to correctly identify profit opportunities.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

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