Friday, 1 February 2008

Why do governments back losers? Two parts of an answer.

Tim Harford has a piece up at in which he tries to unravel why governments so unerringly back losers. Harford points out that "[i]f you want to dismay an economist, just mention the phrase "national champion."" On hearing such a phrase economists automatically think of "wheezing corporate behemoths protected from domestic competition, propped up with generous government subsidies and shielded behind trade barriers." Not a pretty picture, it has loser written all over it. So, asks Harford, if governments want to back winners, Why are they so good at backing losers?. He answers,
Partly, it's because picking the winners is inherently a difficult job. Left alone, the market does a great job of rewarding the very best and cutting the rest down to size. Any corporation that gets big and stays big in a competitive environment is likely to be very good at what it does. A corporation that stays big only because of government backing probably won't be.
He then goes on to explain that government favouritism may have a somewhat more sinister logic behind it,
Namely, firms in emerging, competitive industries have virtually no incentive to lobby for government hand-outs, while firms in aging, shrinking industries have the most to gain.
The reason for this is simple he says,
Firms in an open, competitive, growing young industry have little to gain from government support. More government funding for, say, biotechnology, is going to mean more biotechnology companies, more competition and (perhaps) more innovation. That might be good for America, but probably not much good for any single biotech company. Sure, they'll all enjoy the government help, but each must weigh that assistance against the swarm of new competitors attracted by the handouts. No one firm would choose to hire top lobbyists and send them to D.C. to bring back the pork.

By contrast, firms in aging, shrinking, capital-intensive industries have everything to gain from government support. Because the industry is shrinking and it's expensive to enter--think steel mills--the government subsidies and tax breaks are probably not going to attract new competitors. If there are no new competitors, the old guard gets to pocket all the money.
D R Myddelton looked at a related question in his recent book They Meant Well: Government Project Disasters. In this work, published by the Institute of Economic Affairs in London, Myddelton asks How is it that so many major, government-sponsored projects can lose so much money? He points out that the the answer to this question does not lie with malign intentions on behalf of their promoters in government. On the contrary the supporters within government of such projects only have the best of motives, so why do these projects go so wrong?

Myddelton considers six projects covering a period of 80 years to find answers. He looks at The R. 101 airship, the groundnut scheme, nuclear power, Concorde, the channel tunnel and the infamous Millennium Dome. A recurring rationale for these grandiose projects has been to boost "national prestige", but this concept has little real value.

Myddelton's explanation for the continual failure of such projects is that failure results from mismanagement, lack of clear lines of responsibility and lack of accountability. The point is made that
[n]one of the six projects was well managed and many of the failures were down to politicians: installing inadequate or over-complex organisations, appointing incompetent managers, or insisting on excessive secrecy.
These problems have their roots in the wider economic problems of undertaking quasi-commercial ventures in the public, rather than in the private, sector. This results, argues Myddelton, in well-meaning politicians and government officials wasting huge sums of taxpayers' money.

The arguments of both Harford and Myddelton should make us apprehensive when governments start talking of "national champions" and starting want to back these notions with our money. Odds are things will end badly.

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