John Locke Update / Research Brief

Economic Growth & Economic Development: Free Exchange vs Interventionism

posted on in Economic Growth & Development, Spending & Taxes
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Over the years I’ve written several articles about the differences between economic growth and economic development. I have pointed out that, in terms of practical policy, emphasis on one or the other leads to different conclusions.

Those who are interested in economic growth generally focus on expanding GDP, national or state, and will tend to advocate for policies like across-the-board tax cuts for individuals and businesses, the elimination of the double taxation of saving and investment, and a reduction or amelioration of the regulatory burden on all businesses, small and large. In contrast, those who focus on economic development argue for subsidies and targeted tax and regulatory relief for particular business or industries and particular groups of people or regions.

The contrast couldn’t be starker. In fact, those who advocate for economic growth often find themselves trying to eliminate or block the very policies that are supported (or proposed) by those who are the strongest advocates for economic development.

I believe that the basic difference between the two approaches is not only about economics but is also philosophical and speaks to how policy makers in each camp view market activity and its relationship to government. Undergirding the view of those that focus on economy-wide economic growth is the strong belief that wealth is created through processes of unfettered exchange between producers and consumers. That is, any economy will perform as strongly as it can if, first, entrepreneurs are left free, that is, unencumbered by taxation and regulation, to survey present and future markets, resource costs and availability, and anticipated consumer demands.

Second, and just as importantly, that they are free to act on those assessments by purchasing and assembling resources (labor included) in an attempt to earn a profit. And, finally, if those profits are indeed realized, they need to be left free to utilize them as they wish. If an entrepreneur or company faces losses, it likewise needs to be responsible for and suffer the consequences of those losses. In other words, the entrepreneurs who earned them should not be shielded from losses by government intervention. This ensures that the inefficient use of resources will be abandoned, allowing those resources to flow into more valuable endeavors.

The approach to policy, then, is to ferret out tax and regulatory impediments to this entrepreneurial process and eliminate, or at least ameliorate, them. There is also an understanding that if resources are to be allocated as efficiently as possible, the rules governing the process, i.e., tax and regulatory policy, must be applied even-handedly, rather than in a targeted way. As F.A. Hayek noted, if a market order is to operate in a way that benefits the most people, the “rules of the game” must be “universal.” That is, they should be applied to everyone without special favors or carve-outs.

Ultimately, those who advocate policies based on a concern for economic development see the process described above much differently than the advocates for economic growth. There is, to varying degrees, a belief that entrepreneurs, left to their own devices, will fail to allocate resources efficiently. Essentially, the belief is that Adam Smith was wrong; that people pursuing their own interests through a process of purely voluntary exchange will not promote the interest of society as a whole. And ultimately, the state or local government needs to nudge market activity in one direction or another, that direction ultimately being chosen by government officials, in order to improve on the outcomes that would otherwise occur.

Given this perspective, it is easy to see why, not only is it desirable but necessary to institute economic development programs that promote selected industries—film, solar and wind power, agriculture, tourism, etc.—with subsidies and favors that take a variety of forms. These could include special breaks on property, payroll, and corporate taxes, regulations, and land use rules.  While very often we cynically use terms like “corporate welfare” and “cronyism” for these kinds of policies, it is quite likely the case that those who consistently advocate for them sincerely believe that resource allocation, left to the free decisions of consumers and entrepreneurs, will not yield the best possible economic outcomes, that, at least at the margin, government does indeed know best.

This suggests that the debate between these two approaches needs to take place on a very fundamental level. It is really part of the debate that has been going on since the publication of Adam Smith’s Wealth of Nations in 1776. Which has the best chance of bettering the lives of citizens, markets based on free and open exchange or markets directed, in part or whole, by government manipulations? That is by an invisible or a visible hand.

For those of us who believe in the economic growth model, this means that we have to seriously study and understand the arguments for a free economy and be able to communicate those arguments to a skeptical public. The case for free and open markets is not easy to make. Very often the arguments are not obvious or intuitive.  They necessitate having to have a meaningful understanding of economic analysis and the ability to reference historical facts. The interventionists who advocate for economic development policies have the advantage of being able to affect outcomes directly. They incentivize a company to do X–hire a certain amount of people, locate in a particular area, etc.– and indeed the company does X. We have no such advantage. We have to be able to explain that because of those incentives, A, B, and C—other possible outcomes—do not occur and as a result society as a whole is made worse off.

These are sophisticated arguments and, if they are not understood and effectively conveyed, the battle for economic growth over economic development will be lost.

Roy Cordato is Senior Economist and Resident Scholar at the John Locke Foundation. From January 2001 to March 2017, he held the position of Vice President for Research at the Locke Foundation. He is also an adjunct faculty member in… ...

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