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How Much Should Government Be Cut?

Even 200 years ago, free-market advocate Adam Smith believed government had a role to play in the economy.
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Politicians of both parties are arguing for less government. But how much should government be cut? Is no government a reasonable objective for business owners?

Even Adam Smith, a patron saint of conservative economics, urged a limited government role, one which would concentrate its efforts on insuring that competitive forces were free to work. To maintain Adam Smith-style competition today we need a strong set of rules. And since competition often makes life difficult for businesspeople as well as making the system as a whole function efficiently, we may need more regulation than some businesspeople would like.

When Adam Smith published Wealth of Nations in 1776, he was himself arguing against excessive government, especially excessive government regulation of business. In Smith's day, the government granted certain corporations monopolies over trade with regions such as India, Africa, or North America. Smith felt the government should leave the economy largely alone, and rely primarily on the "invisible hand" of competition to regulate production and trade.

Smith's "invisible hand," however, depended on free entry into all markets -- which Smith believed would lead to rivalry among many small firms in the sale of any given product. And it depended on a government able to provide three essentials: justice, national defense, and public works and institutions.

Much of Smith's opposition to the monopoly corporations of his day was based on his recognition of the wastefulness of big corporate bureaucracies. He didn't even feel that big business experience was useful in running a government, for example. "Monopolistic businessmen are held to make the worst governors," he noted.

On the other hand, key to Smith's concept of justice was the idea that government should establish rules for the economic game. Before markets can be developed, property rights must be widely recognized. Then contracts must be made enforceable. When government makes reneging on contracts easier (as the United States has recently with changes in its bankruptcy laws) the costs of doing business go up for everyone.

Smith supported public works and institutions for "facilitating the commerce of the society." He suggested that transportation and communication systems be financed by revenue bonds and tolls. He also advocated measures to protect and support those involved in trade with what we now call the Third World.

A few of the public institutions Smith supported had no obvious economic function. He was concerned with supporting the "dignity of the sovereign" and advocated "more splendor" at the highest levels of government. (He probably would not have complained about Nancy Reagan's new china in the White House.)

But the primary thrust of Smith's arguments was that competition was crucial for the efficient operation of the economic system. Government programs and regulations that diminished competition were to be deplored and government programs and regulations that aided competition were to be supported.

I believe Smith would have supported an effective antitrust policy. Mergers can significantly reduce the number of competitors or, by creating giant conglomerate-backed competitors, can change the nature of their markets and increase the cost of entry, thus reducing the effectiveness of the invisible hand.

I also believe he would have supported a Small Business Administration that increased the opportunity for new business to get started. Both controls on mergers and promotion of small business can make the invisible hand more effective.

At the very least, we need government to guarantee property rights and to enforce contracts. But beyond that, Smith's writings and the financial panics of the 1800s and of 1929 -- produced by unregulated speculation in land, stocks, and other commodities -- suggest that laissez-faire does not work ideally. The game of business needs rules. The problem is not government per se, but that excessive size (in government, private corporations, or unions) tends to stifle free entry into markets, to interfere with the entrepreneurial-innovative process, and to limit competition, and thus to disrupt the workings of the invisible hand.

True conservatives today, if they were followers of Adam Smith, would not cut back all government, only those aspects that limit how well competition works. The true conservative would demand that existing regulatory bodies be made more efficient in preserving competition. The true conservative might even ask for more government if government actions could improve the operation of the invisible hand by unleashing Americans' pent-up entrepreneurial abilities.

Is the Reagan Administration's approach to economic policy truly conservative? As I see it, Reagan policy -- which officially seeks to aid all business -- is likely to favor larger firms. The benefits of new depreciation policies, for instance, will go primarily to the capital-intensive firm, which is normally the larger firm. A better policy to strengthen the invisible hand would be to aim benefits at new, smaller competitors and let the benefits be "trickled up" to bigger firms.

Last updated: Feb 1, 1982




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