The Importance of Failure by Tyler A. Watts

[Stephane Budge]

There is much discussion these days about bailouts. Are they needed?
Are they just? I say no on both counts. Yet many economists,
politicians, and businessmen tell us that bailouts are needed to
prevent catastrophic economic collapse. Without commenting on the
justice of bailouts, they warn that we are facing massive economic
pain if we stand aside and let markets run their course. Bailouts can
staunch this pain, they claim, and restore order and calm to the
economy.

I don't buy the probailout folks' predictions of impending economic
chaos. But what if they're right? What if the short-run pain in store
is just too terrible to endure if we don't start bailing out key
industries? After all, we're talking massive unemployment, a new wave
of foreclosures, a shrinking economy — in a word, recession. If the
dire forecasts of the bailouters are correct, we'd be stupid not to do
it; we'd be like a beaver caught in a trap: slowly dying, yet too
timid to chew off his own foot to escape.

Capitalism depends on three highly complementary, yet distinct,
institutions: prices, property, and "profit and loss." Classical-
liberal economists have demonstrated the essential role of these
pillars of prosperity for centuries. These fundamental institutions of
the market economy are like legs of a stool. If we gradually weaken
one leg, we will eventually bring the stool toppling down — economic
collapse.

In this light, the implications of bailout are clear. Bailouts are
designed to insulate people from the effects of bad decisions. When
market prices change dramatically, exposing yesterday's poor
investment choices, bailouts come "to the rescue," promising those
left holding the bag that they won't have to endure the full cost of
their errors.

But we should realize, as the fine print always says, that prices are
subject to change. Change is a defining feature of markets.
Entrepreneurs make money by casting about for "wrong" prices and
making bets on what direction particular prices will move in the
future. Successful entrepreneurs, who correctly anticipate price
changes, are rewarded with profits. Erroneous entrepreneurs, who do a
poor job of estimating price movements, are penalized with losses.
This is the essence of the market process.

Bailouts, then, attempt to erase the effects of losses, or economic
failure. But such efforts inevitably undermine the loss aspect of
"profit and loss." Profit and loss go together — like up and down,
left and right, good and bad. If we try to do away with losses, we'll
wind up diluting the meaning of profits. After all, why strive for
profits if Uncle Sam will cover your losses with a bailout? Why bust
your butt to compete and succeed if you can just clamor for a handout
instead? Bailouts destroy the profit motive — and all the benefits of
a competitive economy.

There's a great irony in bailouts, too. The only reason we can afford
to even talk about bailouts is because of the accumulated wealth
brought about by centuries of capitalism.


Long ago, bailouts were unheard of; failure meant starvation, perhaps
death. Consider the caveman: Ug's tribal chief couldn't afford to say,
"It OK Ug no kill deer this week. It not Ug's fault. Tribe will bail
out Ug."
If he wants his tribe to stick around, the chief must say, "Ug no kill
deer: Ug family starve."

But modern man lives in a world of comparative abundance. If Doug is
laid off because of recession, he'll have to find a new job and maybe
tighten his belt. But Doug doesn't face starvation in our economy, and
there are ample opportunities for him to adjust to economic changes.
Yes, Doug will suffer somewhat during the transition, but the short-
term pain of economic failure will guide him toward more productive,
successful choices.

Failure is no fun, but it does teach essential lessons. We shouldn't
miss out on those lessons simply because we think we can afford to
bail people out. Instead of trying to abolish failure via bailouts, we
should let markets work, let failure run its course, and be so much
the wiser for it.