Slam the brakes on bailouts

Following the bailout of several banks, the government is now considering measures to ‘save’ the British car industry.
Such a bailout would be wrong in itself but would also set a very dangerous precedent. The political pressure to support other struggling industrial sectors will be immense. And given the impossibility of bailing them all out, how should the government decide which firms should survive and which should fail?

Politicians are notoriously bad at picking winners and there is a high risk that rent-seeking behaviour will play a bigger part in the decision-making process than economic considerations. But, even if that were not the case, government simply does not have the ability to decide which businesses have been unlucky but are sound long-term prospects and are therefore deserving of support.

Worse still, the increased government borrowing and higher taxes needed to finance further bailouts will remove capital from healthy businesses and some of those will fail as a result. Overall, a greater share of economic resources will be allocated to ‘lame ducks’ rather than vibrant, high-growth sectors.

Corporate failure is an essential part of the creative renewal that drives market economies forward. Moreover, firms that behaved recklessly must face the full consequences of their actions if moral hazard is to be avoided.

State rescues hamper this self-correcting adjustment process. They risk prolonging the downturn and creating perverse incentives that will make future crises more likely. Of course this all goes back to Bastiat’s distinction between the “seen” and the “unseen” – there is a action to save the noisy businesses who campaign for support but less obvious are the thousands of businesses that struggle as a result.

16 December 2008, IEA Blog

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