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October 3, 2011

The Function of Loss in Capitalism

In the most recent Federal Reserve decision, the Fed stated that the economy continued suffer from “low rates of resource utilization.” I wondered why resource utilization was low. I did some research online and found that some economists believe that resource utilization steadily declines as an economy matures. I have a different feeling.

I believe the reason why resource utilization is so low is because the government is supporting assets that produce low or no returns. It’s a simple proposition. The government propped up a majority of the big banks, some insurance companies, and two of the three major automotive manufacturers. Why adopt best practices when your business is given the cushion of not failing? We’ve seen companies like AIG, Fannie Mae, and Freddie Mac become government owned with no profits and hundreds of billions in government infusion.

None of these government run organizations have produced job growth or profits. This is where the government needs to realize that loss is an essential function to capitalism. When an organization is using capital that is not gaining a return or creating a loss, it must be reallocated by the market towards creating a return.

A good example of capital being reallocated is when the horse and buggy industry gave way to the automobile industry. This process has also been referred to as creative destruction. This process is not limited to the scope of an economy. When a company downsizes to avoid circumstances that would jeopardize everyone’s employment, that would be an example of creative destruction occurring within a company.

We may never know where the capital from these bailed out organizations would have gone had they been allowed to fail or downsize. Entire industries may have formed and grown from the opportunity to acquire capital cheaply. With the growth of these organizations comes the creation of jobs. Unfortunately, when the government bails out these bulky, inefficient organizations, it thinks it is doing the economy a favor.

Would that have been the case if they had bailed out the horse and buggy industry or typewriter companies?

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