It is well established that political favoritism for certain kinds of goods results in — surprise — production and consumption of those goods beyond what the market would bear, meaning that there will be trouble once the subsidies or mandates end. The problem is not so much an excess inventory of consumer goods (GM will sell those Volts . . . someday) but the distortion of capital investment necessary to create those goods. Once you have put your money, real estate, training, etc., into setting up an assembly line for producing Volts, it takes time and money to convert it into an assembly line that produces something else, for instance a car that people might wish to purchase at a profit-producing price. The distortions ripple throughout the economy: It is not only the subsidized firm that misallocates its resources, but its suppliers, bankers, business partners, warehousing companies, transportation firms, etc. At the highest level, you end up with misallocation of public resources, too. For example, an oil-industry executive once told me in no uncertain terms that his ethanol business would not exist without the federal mandate supporting it, and the presence of those ethanol plants no doubt influences decisions about government spending on things like roads and water utilities, and in the long term even schools.
But subsidies do not last forever, so these “investments,” if we may call them that, are destined to be bad ones.
That is one of the biggest problems with one-shot stimulus bills of the sort we’ve seen over the past five years or so: They create a short burst of demand, encouraging the misallocation of resources to produce goods to satisfy buyers who turn out not to be there. A recent example from Michigan is that of the firms that produce batteries for electric cars having to furlough workers and curtail operations because the demand for the Volt and other electric cars is not as high as expected, even with government buying up inventory and subsidizing the industry. From the Holland Sentinel:
Two plants in Holland that produce lithium ion cells — LG Chem and Johnson Controls — received roughly $150 million each from a federal stimulus bill. The cells have other applications, but are best known for their use in some electric and hybrid vehicles.
LG Chem since April has been running “rolling furloughs” for its 200 employees, based on a lack of a demand for the lithium-ion cells that it is tooled to produce . . . .
Kelsey Knight, spokeswoman for the Mitt Romney presidential campaign in Michigan, wrote in a Friday statement that “a factory that produces nothing and furloughs workers is a symbol of where America is going under (Obama’s) failed policies.”
Two key phrases there: “lack of demand” and “tooled to produce.” Switching from one production set-up to a different production set-up is not free, especially for manufacturing businesses. This is why it seems to me that attempted stimulus programs in the end impose costs far in excess of the government spending itself. Stimulus spending, as practiced by the Obama administration, amounts to paying firms to make bad investments.
(The Austrian theory of the business cycle holds that similar distortions happen on an economy-wide basis as a result of monetary expansion, a form of scattershot stimulus producing the recession-recovery roller coaster with which we are all familiar. The theory is controversial — Milton Friedman rejected it, as do most mainstream economists — but the role of monetary policy in booms and busts is worth thinking about.)
Keep this in mind: The misallocation of capital here includes human capital: Workers’ most important asset is their skills and training, and when they receive training to produce unwanted goods, when their skills and experience are related to unprofitable enterprises, they are being done an important disservice to the extent that those skills are not transferable to economically viable activities.