Quotation of the Day…

by Don Boudreaux on October 28, 2020

in Complexity & Emergence, Creative destruction, Financial Markets, Hubris and humility

… is from pages 73-74 of the 2016 Third Edition of James D. Gwartney’s, Richard L. Stroup’s, Dwight R. Lee’s, Tawni H. Ferrarini’s, and Joseph P. Calhoun’s excellent Common Sense Economics:

In a world of uncertainty, mistaken investments are a necessary price that must be paid for with fruitful innovations in new technologies and products. Such counterproductive projects, however, must be recognized and brought to a halt. In a market economy, the capital market performs this function. If a firm continues to experience losses, eventually investors will terminate the project and stop wasting their money.

Given the pace of change and the diversity of entrepreneurial talent, the knowledge required for sound decision-making about the allocation of capital is far beyond the scope of any single leader, industrial planning committee, or government agency. Without a private capital market, there is no mechanism that can be counted on to consistently channel investment funds into wealth-creating projects.

DBx: Indeed so.

Today’s proponents of industrial-policy schemes will protest that they have no wish to get rid of capital markets. This protest is both true and reassuring. But these proponents do have a wish to prevent capital markets from working in those parts of the economy embraced by industrial policy. That is, proponents  of industrial policy want to get rid of capital markets in certain parts of the economy.

Decisions on how capital will be allocated in those parts of the economy embraced by industrial policy will be made, not by market forces – including capital-market forces – but, instead, by administrative fiat. And so the discovery and disciplining functions of capital markets – properly celebrated in the quotation above as being so vital to a healthy economy – are eliminated by industrial policy in whatever areas this policy is imposed. Indeed, that’s the very point of industrial policy: to substitute the fancies and knowledge of government planners for the demands of consumers and the knowledge generated by competitive markets. And the knowledge generated by competitive markets is inconceivably greater and more reliable than is the puny, microscopic, inevitably politically and ideologically distorted knowledge of government officials and the intellectuals who advise them.

This truth cannot be too often repeated: Proponents of industrial policy propose to substitute the ignorance of government officials for the intelligence of competitive markets.

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