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October 23, 2008

Central Planning at Home
and Abroad


David R. Henderson

"The man of system … seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chessboard…"
- Adam Smith, The Theory of Moral Sentiments

One reason it has taken me so long to write my October column is that I have been busy writing (here and here) and arguing on radio (here and here) against the Bush-Paulson-Bernanke $700 billion bailout of various Wall Street companies' bad investments. My main moral argument against the bailout is that the government is forcibly taking our resources and giving them to the government's favorites. On a Denver radio station, I suggested that Hank Paulson's motives should not be assumed to be pure, given the huge amount of personal wealth he had at stake. The interviewer asked me incredulously, "Are you suggesting something sinister?" "Actually, yes," I said.

My main pragmatic argument against the bailout is that the government, by choosing where $700 billion goes, is essentially engaging in central planning. Government officials think they can do a better job than decentralized free markets can do at allocating resources.

Then I realized that there's a close connection between the U.S. government's domestic policy and its foreign policy. In both cases, the government is forcibly taking our resources and, to the extent it finances its activities with deficits, our children's resources, and using them to pursue its own ends. In the cases of Afghanistan and Iraq, the U.S. government brought down foreign governments that it disliked and replaced them with leaders that it likes. In the case of the bailout, the government is putting resources into places where we consumers and investors, with our "dollar votes," have decided we don't want to put them.

In short, the Bush administration has completed the philosophical journey it began with its invasions of Afghanistan and Iraq. Bush believed that he could get rid of governments in Afghanistan and Iraq and come up with a better government. He was like Adam Smith's "man of system" referenced in the above quote. Bush thought he could plan what Smith called "the great chessboard of human society" in Afghanistan and Iraq. But what he didn't take account of is, in Smith's words, that "every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it." Bush, along with his various appointees, thought he could be a central planner of other societies. Well, as Dr. Phil would ask, "How's that working for you, Mr. Bush?"

Although Bush's major step toward centralized economic planning of the U.S. economy appears – and, in fact, is – large, philosophically it is the logical next step. Someone who believes that he can look "the man in the eye" and "be able to get a sense of his soul" – as George Bush said after meeting Vladimir Putin the first time – is not someone who has a lot of humility about his own abilities. It's not surprising, therefore, that George Bush, with incredibly little knowledge of the Middle East and, apparently, no awareness of the animus between the Sunnis and the Shias, could be confident that he could bring a stable democratic government to Iraq.

Similarly, if he has that degree of confidence without ever having traveled to Afghanistan or Iraq before making war on them, it's not surprising that Bush would have the same confidence in Henry Paulson's being able to plan Wall Street and Main Street from the Treasury Building. After all, Paulson used to work on Wall Street, and Bush has actually been in New York a few times. So how difficult could it be, really, to plan an economy?

The late Ludwig von Mises and the late Friedrich Hayek told us how difficult it would be: try impossible. In 1974, Hayek shared the Nobel prize in economics. Part of what earned it for him was his insight on this issue. Although it was von Mises who, in 1922, had the original insight about information, Hayek elaborated and added to the argument. In a series of essays in the 1930s and 1940s, Hayek drove the final intellectual nail into the coffin of socialism. He pointed out that even if central planners had pure motives – so that we wouldn't have to worry about their incentives – they simply could not have the information they would need to plan an economy well. In any complex economy, there are hundreds of thousands of items, and central planners, having thrown out the free market, cannot know relative supplies and demands for these products. This, wrote Hayek, is precisely what the market tells us. The free market, he argued, works so well because the information that really matters in any economy exists in a decentralized form in the minds of the millions of participants in the market. In his famous 1945 article, "The Use of Knowledge in Society," which I have my students work through in every course I teach, Hayek writes:

"[P]ractically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation."

The term that modern economists in Hayek's tradition use for this "unique information" is "local knowledge."

Hayek goes on to argue that this local knowledge can't possibly be aggregated in the minds of a few central planners, no matter how brilliant. And if the government does not leave people free to act on their own local knowledge, most of it won't be acted on.

The analogy between centrally planning an economy and centrally deciding to intervene in another country's affairs is not perfect. Analogies seldom are. The main difference is that a government that forswears central planning and leaves individuals free to make their own decisions within a system of property rights will typically end up being the government of a prosperous country. A government that forswears planning other countries' affairs, by contrast, will not, by doing so, cause people in that other country to make good choices about their own governments. But the point of the analogy is that a government that refuses to interfere with choices about another country's government will avoid making a bad choice, whereas a government that tries to meddle will almost inevitably make a bad choice.

Unfortunately, both of the major candidates running for president are what Adam Smith would call "men of system." McCain and Obama have shown that they believe they can plan affairs in Afghanistan (both), Pakistan (both), and Iraq (McCain). Both, but especially Obama, think they can move us Americans around on the domestic chessboard also. Both are wrong. Each of us has his or her own "principle of motion." Unfortunately, whoever gets elected, we will pay for what Hayek would have called their "fatal conceit."

Copyright © 2008 by David R. Henderson. Requests for permission to reprint should be directed to the author or Antiwar.com.

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David R. Henderson is a research fellow with the Hoover Institution and an associate professor of economics in the Graduate School of Business and Public Policy at the Naval Postgraduate School. He is author of The Joy of Freedom: An Economist’s Odyssey and co-author, with Charles L. Hooper, of Making Great Decisions in Business and Life (Chicago Park Press.) His latest book is The Concise Encyclopedia of Economics (Liberty Fund, 2008.)

He has appeared on The O’Reilly Factor, the Jim Lehrer Newshour, CNN, and C-SPAN. He has had over 100 articles published in Fortune, the Wall Street Journal, Red Herring, Barron’s, National Review, Reason, the Los Angeles Times, USA Today, and the Christian Science Monitor. He has also testified before the House Ways and Means Committee, the Senate Armed Services Committee, and the Senate Committee on Labor and Human Resources. Visit his Web site.

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