February 27, 2010

Bail or Fail, What are the risks? What are the Incentives?

In recent times, we have heard about the “big three” and the controversial discussion regarding the question of whether or not tax dollars should be used to bailout failing businesses. Those in favor of bailouts justify their stance by explaining that such a move would alleviate economic trouble and perhaps hold us back “from the brink” of economic disaster. In contrast to such sentiment often found in discussions within the media, one can see a much different perspective if he only steps back from the situation and makes an effort to see what is really going on. As a topic that most of us have heard about, I would like to discuss the role of failure and the significance of bailouts within our economy.

When an entrepreneur starts a business, he takes a risk-a calculated risk. He takes a risk with the belief that, provided he is correct in his decision-making, he will make a profit on his idea. He knows, however, that if his idea fails and he does not make a profit, he will suffer the costs of a failing business. I'm sure we have heard that (approximately) 50% of businesses fail within the first five years of operation. At the same time we know that 80% of the U.S. Economy is run by small businesses. Why then do prospective business owners decide to start their own businesses? Is it not (at least in part) because they know that they have an idea that is as good, if not better, than a similar product on the market? It is in this way that a person chooses to go into business- because he has determined that it is worth the risk for him to try to enter the market for a certain good or service. How then can a person say that a bailout is necessary for a company that the markets have all ready determined as being inefficient. Does not such a bailout prop up the business and save it from failure? If this is the case, then why would people want to go into business? What is their incentive to bring a better product to market if they will have to compete with an artificially propped- up business- which they know would be traditionally inefficient in the market? As Tyler Watts states in his article, “The Importance of Failure,” “...why strive for profits if Uncle Sam will cover your losses with a bailout? Why bust your butt to compete and succeed if you can just clamor for a handout instead?” In a sense, Watts says, “bailouts destroy the profit motive — and all the benefits of a competitive economy.” If one has the ability to make a profit, he should be allowed to suffer losses.

Clearly, bailouts are requested by those businesses who see that their previous poor decisions are now leading them to an unsustainable (losing profits) path. Do these businesses deserve to be rescued from their business troubles? Most people would answer “no” to these questions. Of course, when a business is viewed as being “too big too fail,” thereby implying that the absence of a bailout would surely mean economic disaster for the public as a whole, people begin to look at the situation quite differently. Does this argument justify such a move? Taking on the traditional Austrian perspective, one would answer, "no” and respond by saying, “just allow the insolvent entities to fail and let the chips fall where they may and let the short-term pain of failure guide a business owner towards more productive, successful choices.” While this is a somewhat simplistic discussion of failure, it is important to note that, in the end, failure within markets allows “capital to move from weak hands to strong hands” (Blumen), thus permitting us to be better off because of it.


Blumen, Robert. "Bail or Fail." 7 Oct 2009. Web. 22 Feb 2010. http://blog.mises.org/archives/010791.asp

Watts, Tyler. "The Importance of Failure." Mises Daily 10 Feb 2009. Web. 26 Feb 2010. http://mises.org/daily/3321

1 comment:

stephan said...

I also saw the Newsweek article dealing with paying kids to study. At the time, I thought it was an interesting idea because I generally don't have a problem with incentive based programs. However, this suggestion requires the government to play a very paternalistic role in our children's lives. It seems to me that that Mises' oft cited example of the government's price control to attempt to increase satisfaction for milk drinkers is applicable. Having a monetary incentive to do well is not the problem; in fact, that is what drives most of us in our professional lives. Very few people work solely for the satisfaction of putting in a hard day's work, we do it to earn a living. But when government begins paying our children for their educational efforts, they begin to set what amounts to another minimum wage. There becomes a higher level of sustenance for those teenagers as well as their families, as they now have more disposable income as a whole. However, these students are not actually producing a tangible good or service at this point. This therefore leaves the government no way to recuperate this money. This, while obviously well intentioned, becomes a drain on our system. At least social security requires it's beneficiaries to pay into it.
This can create a serious problem when people are being paid for things that don't generate income. There will undoubtedly come a point in time where the kids are forced to enter the workforce. Regardless of what skills these people are bringing to the workforce, they will not accept less than what they were being paid for their schooling. If they are having trouble finding employment of significantly higher wages, the easy option is to go back to school. So does then government continue paying at the next level of schooling? And the next? At what level can the government stop paying a student? And how does an employer compete other than offering a higher wage? Not everyone may be producing enough labor to warrant that higher wage but because the government pays a certain amount, one cannot pay any less than that for even the most menial of tasks, whether it be shoveling snow or mowing lawns. Then, younger students may have an incentive to do well in school, but none to do more outside of school. This seems to me as something that would undermine the entrepreneurial spirit of our capitalist society.