Coercion Is Bad Economics

Free markets generate value, deliver diversity, and spur better ways of doing things

A common feature of Obama administration economic policies is the use of government coercion. The Obamacare health law mandated that individuals buy insurance. The administration's tax increases grabbed more earnings from millions of people. And federal agencies are imposing an increasing pile of labor, environmental, and financial regulations on businesses.

Pro-market policy experts point out the negative effects of each intervention, but the administration keeps dreaming up with new ways to take our money, restrict what we do, and manipulate the economy. 

Liberals or progressives seem to have no inkling of why free economies work better than economies based on central authority. They favor using centralized force apparently because they think that it creates practical benefits.

But coercion is not a practical way to help the economy—regulations and taxes rarely make us better off. Some people may gain, but the vast majority of people lose. Coercion tends to destroy value, not create it.

There are at least four fundamental reasons why.

First, because the government uses coercion, its actions are based on guesswork. Regulations are top-down commands, not efforts at finding common agreement. Spending relies on compulsory taxation, not voluntary customer revenue. So government actions generate no feedback regarding whether or not they generate any net value.

Compare that to markets. We know markets generate value because they are based on voluntary and mutually beneficial exchanges. Decisionmaking in markets is a reality-based system guided by individual preferences.

Consider the purchase of aircraft. In the private sector, an airline chooses the number to buy based on the demand for air travel, which is aggregated through the price system from choices made in the marketplace. By contrast, when the Pentagon buys aircraft, it has no price system or measured demand to guide it, so its decisions are made flying blind.

Second, government actions often destroy value because they create winners and losers. Regulations squelch personal choices and impose one-size-fits-all rules. The amount of federal spending on each program is chosen for the whole nation, and thus differs from the amount that would be favored by each individual. 

In markets, people choose the amount of each item they purchase, and they can pursue a vast array of different interests, lifestyles, and careers. "The great advantage of the market," Milton Friedman said, "is that it permits wide diversity," while "the characteristic feature of action through political channels is that it tends to require or enforce substantial conformity."

Liberals like using the word "diversity," but it is free markets that actually deliver it. With their support of big government, liberals seem to believe that people can be made better off by quashing their individual choices. But with America's increasingly pluralistic society, it makes more sense to allow for diverse market solutions, rather than top-down rules from Washington.

Third, government activities fail to create value because the funding comes from a compulsory source: taxes. Unlike in markets, bad government decisions are not punished and failed policies are not weeded out because the funding is not contingent on performance. Low-value programs can live on forever, and they block the reallocation of resources to better uses.

In markets, the quest for profits spurs businesses to search for better ways of doing things. Businesses aim to maximize value for themselves, and they end up boosting the broader economy, which is the "invisible hand" of Adam Smith. In government, there is no invisible hand, no guide to steer policymakers in a constructive direction.

Fourth, government programs often fail to generate value because the taxes to support them create "deadweight losses" or economic damage. Taxes are compulsory, and so they induce people to avoid them by changing their working, investing, and consumption activities. That reduces overall output and incomes.

Let's say that the government imposes a tax on wine. That would transfer money from wine drinkers to the recipients of government programs. But an additional cost—the deadweight loss—would be created as people cut back their wine consumption. People would enjoy less wine and suffer a reduction in welfare or happiness.

The wine tax has blocked mutually beneficial exchanges from taking place, and thus has damaged the economy. The size of the damage depends on the type of tax, but for the income tax, empirical studies show that the deadweight loss of raising taxes by a dollar is roughly 50 cents.

Suppose that a philanthropist spends $10 million on a charitable program that generates $12 million in benefits. That private program would be a success. But a similar program run by the government would be a failure because the tax funding would create deadweight losses. The government program would cost $10 million directly, plus another $5 million in deadweight losses, for a total cost that is higher than the benefits.

In sum, coercion imposes deadweight losses and creates winners and losers, which is the polar opposite of the win-win exchanges in markets. Politicians may hope that their interventions create more winners than losers, but that is wishful thinking because their decisions are based on no more than guesswork.

Liberals might assume that the government has an advantage in tackling society's problems because it is such a powerful institution. But because it uses coercion to raise funds and impose its will, the government tends to make bad decisions, entrench them, and drag the whole economy down.