NCPA - National Center for Policy Analysis

AN ECONOMY OF LIARS

April 20, 2010

Free markets depend on truth telling.  Prices must reflect the valuations of consumers; interest rates must be reliable guides to entrepreneurs allocating capital across time; and a firm's accounts must reflect the true value of the business.  Rather than truth telling, we are becoming an economy of liars.  The cause is straightforward: crony capitalism, says Gerald P. O'Driscoll Jr., a senior fellow at the Cato Institute. 

Nobel laureate Friedrich Hayek described the price system as an information-transmission mechanism: 

  • The interplay of producers and consumers establishes prices that reflect relative valuations of goods and services.
  • Subsidies distort prices and lead to misallocation of resources (judged by the preferences of consumers and the opportunity costs of producers).
  • Prices no longer convey true values but distorted ones.  

Hayek's mentor, Ludwig von Mises, predicted in the 1930s that communism would eventually fail because it did not rely on prices to allocate resources.  He predicted that the wrong goods would be produced: too many of some, too few of others.  He was proven correct, says O'Driscoll. 

In the United States today, we are moving away from reliance on honest pricing: 

  • The federal government controls 90 percent of housing finance.
  • Policies to encourage home ownership remain on the books, and more have been added.
  • Fed policies of low interest rates result in capital being misallocated across time.
  • Low interest rates particularly impact housing because a home is a pre-eminent long-lived asset whose value is enhanced by low interest rates. 

Distorted prices and interest rates no longer serve as accurate indicators of the relative importance of goods.  Crony capitalism ensures the special access of protected firms and industries to capital.  Businesses that stumble in the process of doing what is politically favored are bailed out.  That leads to moral hazard and more bailouts in the future.  And those losing money may be enabled to hide it by accounting chicanery, says O'Driscoll. 

If we want to restore our economic freedom and recover the wonderfully productive free market, we must restore truth-telling on markets.  That means the end to price-distorting subsidies, which include artificially low interest rates.  No one admits to preferring crony capitalism, but an expansive regulatory state undergirds it in practice, says O'Driscoll. 

Source: Gerald P. O'Driscoll Jr., "An Economy of Liars," Wall Street Journal, April 20, 2010.

 

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