Economics-The Missing Lesson?

Last week one of my finance classes was assigned a case on a startup that received the majority of its funding through a government grant. The grant this company received was part of a program designed to fund high-risk technologies that were predicted to have spillover benefits or “positive externalities that accrued to others besides the direct recipients of the funding.” As part of the case discussion, the class considered whether this government program was an appropriate state action, and the negative ramifications of partnering with the government.

Some suggested that the mission of the program was a good one, but that this particular investment in developing a software platform for massively-parallel computing was a poor choice. Others questioned the ambiguous guidelines for receiving a grant under this program (“technology commercialization [but not] product development”). The CEO, a guest in the class, spoke to the critical nature of the grant in the life of his company, and attempted to reinforce the idea that the government’s investment would have greater returns to society than merely his company’s profits. He argued that this technology would not have been made viable without this investment and spoke of how difficult the decision to eventually wean the company from this government funding was.
As the discussion drew to a close, it dawned on me that not a single person questioned what the cost of this company’s government grant really was-what the grant money would have bought had it not been used by the government in this manner. Allow me to make a grossly simplifying assumption that this $2 million would not have been removed from taxpayers’ pockets if it weren’t needed for this program. This assumption may make it easier to see my point.

So imagine the $2 million is still in America’s pockets. Let me describe one possible scenario for this money. One man may use his share to put a down payment on a new car. The purchase of the car put some of that money into the car salesman’s pocket, some into the car dealer’s, some into the manufacturer’s. The manufacturer may then spend the money to help develop a new safety feature that saves the life of a 4-year old child. The salesman uses his commission on the sale to purchase a new suit. The suit vendor now has some of the money, as does the suit manufacturer, who may be enticed to expanding his factory and hiring into labor. Mr. Jones moves from a lower-paying job to the suit factory job and uses his salary to buy a new computer. The computer company… well you get the idea.

If you find this story believable, when the government arbitrarily gave this money to this small company in the case, America, as an economic community, may have lost the following: a car, a new safety feature, a 4-year old child’s life, a suit, a better job for Mr. Jones, and a computer (and many other things as the wealth circulated through the economy). But it is difficult to see this from our case, because we never knew we could have had any of these things. We can’t see what wasn’t allowed to come into existence. Now this may seem obvious, yet we discount this fundamental idea of economics on a regular basis. For example, I heard a politician on the radio saying how much better off the city would be when the Big Dig is completed. He failed to mention and we, the listeners, failed to remember all the things that do not and will not come into existence because of the $6 billion (so far) that was not allowed to flow through an undistorted economy. I once heard a classmate say that the G.I. Bill, which sent a generation of American’s to college, was the best investment the government ever made. But how can we know. Government spending is, by definition, arbitrary whenever the person whose wealth is expended does not willingly provide it.

The lesson may be as simple as this: every purchase made by the government means one or more purchases by the private economy will never happen; every government job means a private sector job will not be created; and every government grant to a startup means the private-sector will fund one less startup. So the next time someone speaks of a particular government expenditure as a “good investment”, please remember to ask them to prove it.