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Wake Up to the Law of the Ratchet

by Steve H. Hanke and Robert Higgs

This article appeared in Financial Times on November 26, 2001

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As the USconfronts a new crisis, the opportunists are once again play- ing the system and exploiting it for their own ends.

Much of the growth of government in the US and elsewhere occurs as a direct or indirect result of national emergencies such as wars and economic depressions.

Laws are enacted, bureaux are created and budgets are enlarged. In many cases these changes turn out to be permanent. The result is that crises act as a ratchet, shifting the trend line of government's size and scope up to a higher level.

It comes as no surprise that governments spend more money and regulate more actively during crises - wars and economic bail-outs are expensive and complicated. But a more active government also attracts opportunists, who perceive that a national emergency can serve as a useful pretext for achieving their own objectives.

The US and other countries seem no more aware of this today than they were in the past. And yet history has provided many examples to illustrate how damaging it is.

Take the Great Depression. At that time, the organised farm lobbies, having sought subsidies for decades, took advantage of the crisis to pass a sweeping rescue package, the Agricultural Adjustment Act, whose title declared it to be "an act to relieve the existing national economic emergency".

Almost 70 years later, the farmers are still sucking money from the rest of society and agricultural policy has been enlarged to satisfy a variety of other interest groups, including conservationists, nutritionists and friends of the third world.

Then, during the second world war, when government accounted for nearly half the US's gross domestic product, virtually every interest group tried to tap into the vastly enlarged government budget. Even bureaux seemingly remote from the war effort, such as the Department of the Interior, claimed to be performing "essential war work" and to be entitled to bigger budgets and more personnel.

Smaller crises have sent the opportunists into feeding frenzies, too. The ever-opportunistic International Monetary Fund is a classic case. Established as part of the 1944 Bretton Woods agreement, the IMF was primarily responsible for extending short-term, subsidised credits to countries experiencing balance-of-payments problems under the postwar pegged-exchangerate system. In 1971, however, Richard Nixon, then US president, closed the gold window, signalling the collapse of the Bretton Woods agreement and, presumably, the demise of the IMF's original purpose. But since then the IMF has used every so-called crisis to expand its scope and scale.

The oil crises of the 1970s allowed the institution to reinvent itself. Those shocks required more IMF lending to facilitate, yes, balance-of- payments adjustments. And more lending there was: from 1970 to 1975, IMF lending more than doubled in real terms; from 1975 to 1982, it increased by 58 per cent in real terms.

With the election of Ronald Reagan as US president in 1980, it seemed the IMF's crisis-driven opportunism might be reined in. Yet with the onset of the Mexican debt crisis, more IMF lending was "required" to prevent debt crises and bank failures. That rationale was used by none other than President Ronald Reagan, who personally lobbied 400 out of 435 congressmen to obtain approval for a US quota increase for the IMF. IMF lending ratcheted up again, increasing 27 per cent in real terms during Mr Reagan's first term in office.

Not surprisingly, the events of September 11 did not catch the IMF flat-footed. On September 18, Paul O'Neill, the US Treasury secretary, had breakfast with Horst Kohler, the IMF's managing director, to discuss the financial needs of coalition partners. Also on their agenda was the IMF's denial of funds to countries that failed to toe Washington's line.

Within the US government, the latest emergency has given cover to a multitude of parochial opportunists, whose proposals range from bailing out the airlines to nationalising vaccine production. The resulting "stimulus package" amounts to about Dollars 100bn (Pounds 70bn).

The ratchet continues to operate on ideology, too. A recent poll conducted by The Washington Post indicates that 53 per cent of Americans think the government "is run for the benefit of all the people", up from 35 per cent last year. Only 37 per cent agreed that "the government is pretty much run by a few big interests looking out for themselves", the lowest percentage since 1966, when 33 per cent embraced that view.

It may be too much to expect a speedy end to the law of the ratchet but it is time to acknowledge what is going on. That, at least, may make it easier to reverse the trend during times of stability.