Here is another example of how incentives play a huge role in economic outcomes. Macroeconomists and econometricians have no way to deal with these important determinants of human behavior. Their mathematical modeling leaves no room for individual incentives.
Free markets depend upon the trust between participants backed up by the Rule of Law. Markets cease to function efficiently when participants suspect either. When concern becomes too great, market participants withdraw from markets.
The economic problem developed because of bad economic policies. Recovery has not occurred because of the continuation of bad policies. The effects of corruption and the lack of law enforcement, not usually considered economic variables, are important determinants in our current condition. James Howard Kunstler explains this condition:
In short, world banking is now hopelessly pranged, and I am not at all sure the project of civilization (modern edition) can continue by other means. The impairments of capital formation are now so profound that no one and nothing can be trusted. Not only are all bets off, but nobody will want to make any new bets – and by that I mean venture to invest accumulated wealth (capital) in some useful project designed to sustain human well-being. What remains is just the desperate hoarding of whatever remains in assets uncontaminated by the pledges of others to pony up.
Some of the issues creating unprecedented uncertainty are the following:
- Accounting balance sheets are no longer true measures of asset values. Governments encourage the overvaluation of assets. No one, including management, truly knows how insolvent financial institutions are. Financial institutions no longer trust each other.
- Contracts provide less protection than they are used to and are supposed to. Government mandates override and nullify them when it is in their interest.
- The value of money is suspect as its purchasing power is in decline. Continuous currency debauchery is practiced by central banks who run printing presses in an attempt to avoid sovereign bankruptcies.
- Sovereign bankruptcy is a risk in many developed countries. If a government defaults on its debts and social obligations, what does that mean for property rights, civil unrest, etc.?
This business environment is fraught with unusual, mostly politically imposed risks. It is one thing to assume business risks in a game that is played with known and stable rules. It is quite another in a world where accounting statements are deliberately misstated with government approval, the Rule of Law is suspended when convenient, the future value of the currency is unknowable and the world teeters on financial collapse. These risks are un-quantifiable, beyond the realm of normal business and not worth facing.
No one knows where capital is safe, so it is increasingly hoarded. Capital always “goes Galt” before industry captains do so. When capital goes on strike, so do jobs and economies. Distrust and unfathomable political risks are not conducive to, or consistent with, free markets.
Mr. Kunstler points out:
Reality dislikes fraud and accounting tricks. Reality is serious about settling scores. Reality eventually intervenes and puts an end to monkey business. What will it be this time?
In addition to whatever macroeconomic problems face nations, these microeconomic disincentives are at least as important. Without the commitment of capital, recovery is impossible, regardless of what government does in terms of spending or monetary stimulus. That should be obvious based on the incredibly unproductive stimulus of the last four years.
The ideologues in Washington seem to hate capitalism. Obviously they do not understand the role of capital. Without capital (and money is not capital) there can be no recovery. The war on private property, wealth and capital has driven much of the capital to Galt’s Gulch where it patiently rests, waiting for more amenable conditions to be deployed.
Nothing government can do can force it to be employed if it is not in the best interests of the owners. Attempts to do so or delays in a return to sanity will cause it to flee to areas where it will be treated fairly, i.e., outside of US borders.
The concept is so simple that even Socialists and macroeconomists should be able to understand it. Sadly, that does not appear to be the case. As a result, millions of people suffer so that an ideology can be extended. Eventually the suffering will explode into an economic collapse of historic proportions.