Let the Market Pick Winners and Losers

Government intervention in the marketplace interferes with healthy competition and hinders innovation. Corporate bailouts ultimately decrease wealth and economic activity.

(Co-authored by Charles Lammam)

The financial crisis and economic recession have renewed the debate about the government’s role in the private economy. In the U.S., debate brews over the nationalization of major financial institutions. Thankfully, Canadian banks are in much better shape and talk of nationalization is almost non-existent. However, governments in both countries are providing billions of dollars in bailouts to prevent major businesses in non-financial sectors of the economy from failing.

Despite the lofty rhetoric of governments and recipients, corporate bailouts actually decrease wealth and economic activity. Governments should not be in the business of deciding which firms fail and which ones succeed; that’s a job best left to market forces.

Business failure is a natural and healthy element of economic progress. Economist Joseph Schumpeter famously used the term “creative destruction” to explain that in order for economies to prosper, they must allow inefficient and obsolete firms to fail, and efficient and innovative enterprises to replace them.

Whether through new methods of production or new consumer goods and services, innovative firms replace (destroy) those that are no longer competitive. This increased innovation, productivity, and efficiency leads to higher rates of economic growth and ultimately, better living standards for Canadians.

Corporate bailouts, however, delay the day of reckoning for troubled companies and industries and slows down the process of the “creative destruction.” Past experience shows that bailed-out companies do not improve operations or become more competitive, but remain dependent on government assistance.

Consider the millions of taxpayer dollars Canadian governments made available to the auto industry before the financial crisis took hold. From October 2004 to September 2008, the federal and Ontario governments together made over $750 million available to the auto industry including $200 million for Ford, $200 million for GM and $125 million for Toyota. Despite these sums, the auto sector successfully lobbied for an additional $4 billion – billion, not million! – in aid in December 2008.

Unfortunately, the auto industry is not alone. Nor are government handouts to businesses restricted to tough economic times. All told, Canada’s federal, provincial, and local governments spent more than $180 billion on corporate welfare (business subsidies, bailouts, and emergency loans) from 1994 to 2006. During that period, the economy was humming along at an average annual growth rate of 3.4 per cent, after adjusting for inflation.

Another reason to be skeptical of corporate bailouts is the dubious claim made by government officials that “loans” are temporary and subsidized businesses repay their debts. Repayment records actually show quite the opposite: companies, even profitable ones, repay very little of what they get from government and often default on loans altogether.

Consider Pratt & Whitney Canada Corp., an aircraft engine manufacturer and Canada’s top corporate welfare recipient. The company had revenues exceeding $56 billion in 2005 yet received $1.25 billion in subsidies between 1982/83 and 2005/06. As of March 2006, the company repaid slightly more than $92 million – only 7.4 per cent of the money received. Similarly, Bombardier Canadair repaid just 26 per cent of what it got from taxpayers over the period.

There is also good reason to be skeptical of the apocalyptic claims that entire industries will disappear and that economic disaster looms when major companies are on shaky ground. While certain firms will undoubtedly go out of business – either because of their own decisions, changes in consumer preferences or the broader economy – bankruptcy laws often give companies a second chance to succeed by allowing them to restructure and continue operations more efficiently.

It is critical to understand why bailouts and other forms of corporate welfare persist. Self-interested politicians want to be seen as doing something to create jobs and “help” the economy. They will therefore enact policies that give certain businesses benefits at the cost of a wider group of taxpayers.

If Canadian governments truly want to help the economy, they should eliminate subsidies to some firms at the expense of others and instead improve the general investment climate. Resources currently used for corporate welfare should be used to reduce taxes on investment. Broad-based tax relief would improve the incentives for all businesses to invest in capital and enhance productivity.

Business failure is an unfortunate but critical aspect of a dynamic and growing economy. Slowing down the competitive process through bailouts and other forms of corporate welfare decreases the rate of innovation, productivity, and economic growth. Canadians would benefit tremendously if corporate welfare was eliminated and the job of picking winners and losers was left to market forces.