How Governments Create Poverty

“It is intuitive to assume that, when people struggle, government “help” is the answer. The opposite is true. American groups who are helped the most, do the worst.”
-John Stossel, Fox Business News and johnstossel.com.

Government can create poverty. We’re so accustomed to hearing that the oppression of the rich against the middle class and the poor is the cause of most poverty that we intuitively don’t consider how government creates poverty. How do governments do this? Essentially two ways: over-extraction of wealth and market distortion that causes bubbles.

Wealth Extraction

In their insightful book, Why Nations Fail, Daron Acemoglu and James Robinson spent the first part of their book detailing how governments that are purposefully extractive of a community’s wealth create significant – and in some cases, generational – poverty. The extractive process is full of human rights violations, human degredation, and the implementation of laws that can never be fulfilled by the masses and a level of selfishness on the part of the rulers that is truly remarkable. I quote at length:

“…poor countries are poor because those who have power make choices that create poverty. They get it wrong not by mistake or ignorance but on purpose. To understand this, you have to go beyond economics and expert advice on the best thing to do and, instead, study how decisions actually get made, who gets to make them, and why those people decide to do what they do. This is the study of politics and political processes…Countries differ in their economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people…Inclusive economic institutions , such as those in South Korea or in the United States, are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish. To be inclusive, economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it also must permit the entry of new businesses and allow people to choose their careers…skills. Inclusive economic institutions require secure property rights and economic opportunities not just for the elite but for a broad cross-section of society. Secure property rights, the law, public services, and the freedom to contract and exchange all rely on the state, the institution with the coercive capacity to impose order, prevent theft and fraud, and enforce contracts between private parties. To function well, society also needs other public services: roads and a transport network so that goods can be transported; a public infrastructure so that economic activity can flourish; and some type of basic regulation to prevent fraud and malfeasance. Though many of these public services can be provided by markets and private citizens, the degree of coordination necessary to do so on a large scale often eludes all but a central authority. The state is thus inexorably intertwined with economic institutions, as the enforcer of law and order, private property, and contracts, and often as a key provider of public services. Inclusive economic institutions need and use the state…The economic institutions of North Korea or of colonial Latin America— the mita, encomienda, or repartimiento described earlier— do not have these properties. Private property is nonexistent in North Korea. In colonial Latin America there was private property for Spaniards, but the property of the indigenous peoples was highly insecure. In neither type of society was the vast mass of people able to make the economic decisions they wanted to; they were subject to mass coercion. In neither type of society was the power of the state used to provide key public services that promoted prosperity. In North Korea, the state built an education system to inculcate propaganda, but was unable to prevent famine. In colonial Latin America, the state focused on coercing indigenous peoples. In neither type of society was there a level playing field or an unbiased legal system. In North Korea, the legal system is an arm of the ruling Communist Party, and in Latin America it was a tool of discrimination against the mass of people. We call such institutions, which have opposite properties to those we call inclusive, extractive economic institutions— extractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset.”

Acemoglu, Daron; Robinson, James (2012-03-20). Why Nations Fail: The Origins of Power, Prosperity, and Poverty (p. 76). Crown Publishing Group. Kindle Edition.

In the 1500’s, it was the Spanish royalty who were focused on amassing more wealth through the extraction of gold and precious stones from the New World. What the Spanish demonstrated – some 500 years ago – is that when power is too centralized in the hands of too few people and they are not forced to follow a law that is both above and outside of themselves, they will often extract both more power and wealth from those they are ruling.

Today, our Federal Government is in danger of crossing the line into being too extractive. In the name of “helping” those who “need a level playing field” because “the rich” have somehow oppressed the poor by unfairly using their position and power to enrich themselves at the expense of everyone else. This basic line of reasoning rings hollow when one considers the coziness, if not downright incestuous relationship between big business and the Federal Government. While excoriating Wall Street for their greed, President Obama made sure that the banks and investment firms were bailed out in 2008. His policies might have saved the auto industry, but it was at the expense of hundreds of smaller car dealers whose owners saw their wealth vanish with a stroke of a pen.

We have extracted over $17 trillion of wealth from future generations to pay for our parties today. Future generations will rise up and call us thieves. And they will be right to do so. We continue to extract the wealth of future generations at the rate of $4 billion every second. If this isn’t the height of selfishness and irresponsibility, then I don’t know what is:

Anytime big business and government collude “for the good” of the population – watch out. They are both acting in their own self-interest and rarely do the masses realize a positive return. Incidentally, this is one of the core reasons that government should not finance professional sports stadiums. Why should billionaire owners and millionaire players extract money from the masses so they have a fancy palace in which to play their games? I’ve never understood stadium financing from a philosophical perspective. Besides, if the stadium is such a good deal, why can they not find private monies to finance it? And if it isn’t such a good deal, then why should public monies be spent on it?

Bubble Creation

“Thousands of apartments, houses, and malls are empty in China as a result of the country’s real estate bubble. During last night’s segment on 60 Minutes, Leslie Stahl reported that more and more of China’s middle class is investing in real estate due to limited investment options. “They’re not allowed to invest abroad, banks offer paltry returns, and the stock market is a rollercoaster.” Since “property values have doubled and tripled and more,” some Chinese have purchased multiple apartments although they have no intention of actually inhabiting them. In order to build these vacant buildings, residences which housed peasant laborers had to be demolished. Now there are millions who have to relocate to other parts of the country due to not being able to afford the newly constructed apartments.”
-Leslie Stahl, 60 Minutes, China Real Estate Bubble

Bubbles are created when goods or services are traded at prices well above their intrinsic values or when the prices appear to be based on implausible or inconsistent views of the future. Bubbles are best seen in retrospect, but level-headed thinking can at least assess bubbles that exist in the present. When too much money chases too few goods, bubbles are created.

As the Stahl story describes, when investment money can’t flow to instruments that would normally receive them because of government restrictions, then the investment money will end up flowing to those instruments that are less deserving of the money and will result in inflated prices and values for those instruments. For example, when the Federal Reserve pumps 85 billion of cash into the economy every month and allows banks to borrow at 0% interest, we find that stocks become over-valued. Just the housing market was over-valued in 2007 because the Federal Government was in bed with the banks and together, they were offering mortgages to those who couldn’t afford a home and shouldn’t have been offered these mortgages, we now see a real estate bubble in China that is sure to wipe out the little wealth that many have in that country.

I agree that some regulation is needed in a free market. The best markets have a baseline of regulation coupled with the strict and unbiased enforcement of the law. But over-regulation, the use of the tax code to implement social outcomes, the obvious redistribution of wealth for the purpose of gaining and holding political power – all of this and more can create bubbles in parts of the market.

Economies do not grow because consuming increases. Economies grow because investment dollars are efficiently committed by those who know best how to invest those dollars. As investment dollars flow efficiently through our economy, healthy businesses grow and in turn create jobs and offer goods and services at prices that can be afforded by those within the target market of that business. When government encourages over-consumption of a good or service, they create a pricing bubble for that good or service. When investment dollars flow into a bubble market, it is nearly certain that those investment dollars will be lost at some point in the future when the bubble bursts.

A bubble bursts when the number of goods chased by those dollars increases, causing downward pressure on pricing. As prices deflate, investments committed at high prices create negative returns and this, in turn, means that the investment is lost. Poverty is created.

Summary

I think Niall Ferguson said it well when he wrote:

“Public debt – stated and implicit – has become a way for the older generation to live at the expense of the young and the unborn. Regulation has become dysfunctional to the point of increasing the fragility of the system. Lawyers, who can be revolutionaries in a dynamic society, become parasites in a stationary one. And civil society withers into a mere no man’s land between corporate interests and big government. Taken together, these are the things I refer to as the Great Degeneration.”

Ferguson, Niall (2013-06-13). The Great Degeneration: How Institutions Decay and Economies Die (pp. 150-151). Penguin Group US. Kindle Edition.

For the Christian Business Owner, our focus should be on ensuring we distribute wealth among our employees as much as is reasonably possible. We should be working to build profitable businesses that increase their scope and influence so that we retard the natural tendencies of government to be extractive and for our society to degenerate. As business owners, we are constantly fighting government action that creates bubbles and extracts wealth for itself. Instead, we create jobs and the wealth that governments extract. We offer services and build products that enable our communities to flourish. We do not hoard our wealth – we give it away when directed by God. Why? Because we know it is a renewable resource. Wealth can be lost. But it can also be re-created. We don’t quit. We might be forced to stop through the force of law. But we don’t quit. And we trust God to restrain the incremental growth of evil in our society that surely wants to destroy us, so we fight the spiritual battles. We work within the law. And we work hard to give the next generation a better life than we have had.

Bill English, M.A., M.Div.
Licensed Psychologist
CEO, Mindsharp
Associate, The Platinum Group

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