Investment Contrarians

Why Government Bailouts Actually Lower GDP Growth Potential

By for Investment Contrarians |









One of the most interesting ideas I’ve heard to restore investor confidence is to remove the incentive for firms to become too big to fail. Instead of forcing companies to be broken up, Taleb suggests that any firm deemed “too big to fail” should pay its staff no more than a corresponding civil servant. (Source: “From Fat Tails to Fat Tony,” The Economist via The World in 2013, last accessed January 15, 2013.)

According to Taleb, since the government is effectively backing the company, the firm is essentially an extension of the government and should not pay employees any higher wages than other government workers.

Another good idea from Taleb that would help restore investor confidence and long-term GDP growth is that any person who becomes a politician should never earn more than a set amount from the private sector, meaning no massive payday.

As it stands right now, politicians have the huge incentive to create favorable conditions for a company that they might join upon leaving politics. This can lead to a massive misallocation of capital that favors companies that will grant guaranteed bonuses and jobs to politicians; not what’s best for the economy.

Any time an economic decision is not optimal for the economy, potential GDP growth levels will decline and investor confidence will weaken.

One idea that Taleb suggests, which I have supported for some time, is that the “value-at-risk” calculation should be banned. The problem with trying to calculate risks in such a manner is that they underestimate the possibility of massive moves.

By creating a lower-than-expected probability of an extreme event, the risk manager assumes false confidence. This leads to higher levels of risk-taking, making the entire system more fragile.

The core to all these ideas is not changing how humans act, since that’s not possible, but working with our human traits. This is something that I’ve suggested for a long time: creating an incentive and disincentive structure for all major human activities.

For an economy to generate strong, long-term GDP growth, we need to incentivize people in the proper areas. This will create a high level of investor confidence in the knowledge that the funds allocated to various businesses are being used in the best possible way.

Investor confidence has waned over the last few years due to the inexcusable level of uncertainty throughout the economy. Business owners are constantly unsure of how politicians will act. Plus, there’s the structural fragility of some parts of the economy due to government intervention and bailouts.

Sustainable GDP growth has to be built on a solid foundation. This means that businesses that are truly innovative will have capital flowing into them that’s not based on bureaucratic intervention.

Risks to the entire economy need to be systematically reduced by creating natural disincentives to government bailouts. We can’t have it both ways; the company managers can’t take risks if they are not willing to bear the losses.

This type of structural reform, I’m afraid, is not likely to occur anytime soon. With so much of the infrastructure embedded, this naturally will lower GDP growth potential for the economy.

For now, all we can hope for is a lower level of government intrusion to help restore investor confidence and to at least try to improve GDP growth levels to a sustained level.

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  • FreedomFromTyrants

    "For now, all we can hope for is a lower level of government intrusion to help restore investor confidence and to at least try to improve GDP growth levels to a sustained level." We can also hope that 1000 lbs of gold will appear on each of our doorsteps tomorrow. About the same likeliness to happen.

    Once you establish the premise that a company is 'too big to fail' and it should be government backed, you have removed free market capitalism from the market place and inserted a strange form of nationalism. The implied backing needs to be removed and then the failures need to be allowed to fail. It's the same principal with our welfare state for individuals. STOP taking away the disincentive to fail and stop taking away the rewards to legitimately succeed, whether it be corporations or individuals. This handout society we've become is doomed to failure.

    I think the idea to limit what individuals make at corporations is a terrible idea. It flies in the face of your suggestion of lower level of government intrusion. It is based on the premise that government should be the master control of the economy. Terrible, terrible premise. The government should be there to protect against fraud/theft in the free market, not to prevent pain from natural cycles in an economy. They cannot prevent pain and have repeatedly proven that they only create unnatural bubbles that make things worse.