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Government shouldn’t pick winners either

by Matt Mitchell on February 22, 2013

in Government-Granted Privilege

Last week, Steven Mufson of the Washington Post reported:

The Energy Department gave $150 million in economic Recovery Act funds to a battery company, LG Chem Michigan, which has yet to manufacture cells used in any vehicles sold to the public and whose workers passed time watching movies, playing board, card and video games, or volunteering for animal shelters and community groups.

This week, Mufson’s colleague Thomas Heath reports about another firm that has received gov’t aide:

District-based daily-deal company LivingSocial has received a much-needed $110 million cash infusion from its investors, according to a memo the company sent to employees Wednesday.

“This investment is a tremendous vote of confidence in our business from the people who know us best, our current board members and investors,” LivingSocial chief executive Tim O’Shaughnessy said in the memo, which was obtained by The Washington Post.

Mr. O’Shaughnessy is putting a nice gloss on it. A LivingSocial “senior company insider” tells PrivCo:

We scrambled for cash quickly….we did receive one other funding offer, but the current investors’ terms were the least bad of two terrible proposals….which we had no choice but to take it or file for Chapter 11.

According to PrivCo, the company ended the year with just $76 million in cash and assets while it faces some $338 million in liabilities.

Readers will no doubt remember that just eight months ago, the D.C. Council unanimously voted to give LivingSocial a $32,500,000 get-out-of-tax-free card.

These stories (and the many, many more that could be told) suggest that President Obama’s former economic adviser  Larry Summers, was right to warn that government is a crappy venture capitalist. Milton and Rose Friedman’s simple explanation of the four ways money can be spent offers a nice explanation:

how to spend money

A private venture capitalist spends her own money to buy equity in a firm. And if that firm does well, she does well. Since she is spending her own money on herself, she has an incentive to both economize and seek the highest value.

But when government policymakers play venture capitalist, they are spending other peoples’ money on other people. They therefore have little incentive to either economize or seek high value. It is no wonder that they often make the wrong bets.

But the scandal has much more to do with a bad bet. Even if the bet pays off—which it sometimes does—there are problems associated with taxpayer support of private industry. There are more details in my paper, but just to name a few, government-supported industries will tend to:

  • Be cartelized, which means consumers are stuck with higher prices;
  • Use less-efficient productive techniques;
  • Offer lower-quality goods;
  • Waste resources in an effort to expand or maintain their government-granted privileges;
  • Innovate along the wrong margins by coming up with new ways to obtain favors rather than new ways to please customers.

Together, these costs can undermine long term growth and even short-term macroeconomic stability. And since the winners tend to be the wealthy and well-connected and the losers tend to be the relatively poor and unknown, privileges such as these undermine people’s faith in both government and markets.

We should be upset when governments sink money into firms that then go bankrupt. But it is no less scandalous when government sinks funds into firms that survive.

Governments should stay out of the business of picking winners or losers.

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