The Tyranny of Controls – Why Government Intervention Fails
The second major argument in Free to Choose is the direct corollary to the first: if voluntary exchange through the free market is the key to prosperity and freedom, then government-imposed controls on economic activity are the primary source of economic inefficiency and a grave threat to liberty. These controls, whether they take the form of tariffs on international trade, price and wage controls, or detailed industrial regulations, are inherently tyrannical. While often enacted with noble intentions—to protect consumers, to save jobs, or to promote fairness—they invariably produce outcomes that are the opposite of what their proponents intended. They disrupt the vital communication network of the price system, misallocate resources, stifle innovation, and empower special interests at the expense of the general public, ultimately leading to a less prosperous and less free society.
To understand this argument, let us start with a principle of common sense that Adam Smith articulated in The Wealth of Nations: “What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” This simple idea, the wisdom of buying in the cheapest market and selling in the dearest, is the foundation of economic well-being. Yet, this is precisely the logic that government controls are designed to subvert. The clearest and most historically significant example of this is in the realm of international trade.
The Fallacies of Protectionism
For centuries, a persistent set of fallacies has fueled the demand for tariffs, quotas, and other barriers to international trade. These measures are often given the appealing label of “protection,” but the question we must ask is: who is being protected, and from what?
A fundamental error is the belief that a nation’s economic health is measured by its “favorable balance of trade”—that is, exporting more than it imports. This is a profound misunderstanding of the purpose of economic activity. The goal is not to send as many goods abroad as possible; the goal is to acquire goods and services for our consumption and use. Imports are the gains from trade; exports are the price we pay to get those imports. A truly “favorable” situation is one in which we can acquire the most imports for the least amount of exports. To think otherwise is like a householder believing he is better off if he pays more for his groceries.
The most powerful and emotionally appealing argument for protectionism is the need to protect domestic jobs from “unfair” competition from low-wage countries. It seems self-evident that if we allow goods to be imported from a country where workers earn a fraction of what American workers earn, our high-paid workers will be thrown out of their jobs and our standard of living will collapse. This argument is a compelling piece of “interested sophistry,” but it is based on a complete misunderstanding of how trade works.
Let us dissect this argument. First, it ignores the crucial role of productivity. American workers command high wages not because of union strength or government benevolence, but because they are, on average, highly productive. They are equipped with vast amounts of capital, advanced technology, and sophisticated skills. Their high wages are a reflection of the high value of what they produce. The relevant comparison is not wages per hour, but labor cost per unit of output. A high-wage American worker who produces a widget in ten minutes may have a lower labor cost per widget than a low-wage foreign worker who takes an hour to produce the same item.
But what if a foreign country, even with lower productivity, has lower labor costs per unit for everything? This seems to be the protectionist’s ultimate nightmare. Let’s imagine an extreme scenario where, at the current exchange rate, Japan can produce every single product—from cars and computers to wheat and corn—more cheaply than the United States. If trade were free, we would rush to buy everything from Japan, and it would seem we could sell them nothing.
But how would we pay for these Japanese goods? We would offer them U.S. dollars. The Japanese exporters, having sold us cars and televisions, would be holding vast sums of dollars. What would they do with them? They cannot use dollars to pay their workers or buy groceries in Tokyo; they need yen. They would try to sell their dollars in the foreign exchange market to buy yen. But who would want to buy the dollars? By our assumption, no one in Japan wants to buy American goods, so they have no need for dollars. If the Japanese exporters are willing to simply accumulate useless stacks of green paper, that would be a fantastic deal for America—we would be getting real goods in exchange for printing-press money.
Of course, this would not happen. The Japanese exporters want to get something real for their efforts. Faced with a glut of dollars that nobody wants at the current exchange rate, they would have to offer them at a lower price. The value of the dollar in terms of yen would have to fall. Instead of 250 yen to the dollar, it might become 200, or 150. As the dollar becomes cheaper, two things happen simultaneously: Japanese goods, priced in yen, become more expensive for Americans to buy in dollars; and American goods, priced in dollars, become cheaper for the Japanese to buy in yen. The exchange rate would adjust until a balance is reached, where the value of goods we want to import from Japan is roughly equal to the value of goods they want to export from the United States. The foreign exchange market is the automatic balancing mechanism that ensures trade can occur between countries with very different wage and productivity levels.
This brings us to the principle of comparative advantage, a cornerstone of economic science. Even if one country is more efficient at producing everything than another, it is still mutually beneficial for them to trade. A simple analogy illustrates this: imagine a brilliant surgeon who is also the fastest typist in town. Should she fire her secretary and do her own typing? Of course not. Even though she is better at both surgery and typing, her advantage in surgery is far greater. It pays for her to specialize in surgery—her area of comparative advantage—and leave the typing to her secretary, even if the secretary is a slower typist. Both are made better off by this division of labor. Similarly, a nation benefits by specializing in producing and exporting those goods where its productivity advantage is greatest, and importing those goods where its advantage is smallest or where it has a disadvantage. The “protecting jobs” argument for tariffs fails because it ignores this fundamental source of the gains from trade.
A tariff on, say, imported steel may indeed “save” the jobs of some American steelworkers. But these visible gains are dwarfed by the unseen losses. The tariff raises the price of steel. This means that every American consumer pays more for cars, appliances, and any other product made with steel. Furthermore, the tariff harms American export industries. Since foreign countries sell less steel to us, they earn fewer dollars. With fewer dollars, they are forced to buy fewer American goods—be it agricultural products from Iowa, airplanes from Seattle, or computers from California. The tariff does not create jobs; it merely shuffles them from more efficient, competitive export industries to a less efficient, protected domestic industry. The nation as a whole is poorer, because labor and capital are being used in a less productive way.
The Case of Japan and India: A Controlled Experiment
The destructive nature of economic controls is not limited to international trade. It is most starkly illustrated by a historical comparison that serves as a near-perfect controlled experiment: the economic development of Japan after the Meiji Restoration in 1867 versus that of India after its independence in 1947.
The initial conditions of the two countries were remarkably similar. Both were ancient civilizations with deeply ingrained, rigid social structures—a feudal system in Japan, a caste system in India. Both underwent a profound political transformation, with a new group of dedicated, nationalistic leaders coming to power, determined to modernize their nations and escape stagnation.
If anything, the initial advantages lay overwhelmingly with India. In 1867, Japan was emerging from centuries of near-total isolation, technologically far behind the West, with almost no modern infrastructure or civil service. India, in 1947, inherited from the British a vast and efficient railway system, a trained civil service, modern factories, and a leadership class educated in the West’s finest universities. India’s natural resources were vastly superior to Japan’s mountainous islands. Finally, post-independence India received enormous amounts of foreign aid from the West; post-restoration Japan received none.
Despite these initial differences, the outcomes were staggeringly different. Japan experienced an economic miracle. It dismantled its feudal structure, unleashed the energy of its people, and transformed itself into a major industrial power, with rapidly rising living standards for the ordinary citizen. India, by contrast, saw economic stagnation. Despite its leaders’ stated goals of helping the poor, the gap between rich and poor widened, economic output per person barely grew, and hundreds of millions remained trapped in desperate poverty.
What accounts for this dramatic divergence? The answer is not rooted in some inherent cultural difference between the Japanese and Indian peoples. Observers in the 19th century described the Japanese as indolent and content with little. Conversely, Indian immigrants in countries around the world have consistently proven to be highly successful and enterprising entrepreneurs. The difference lies in the fundamentally different paths the two governments chose.
The Meiji leaders of Japan, influenced by the dominant intellectual climate of the 19th century, adopted the British model of free enterprise and free trade. The government played a role in establishing pilot plants and sending students abroad, but it did not attempt to centrally plan the economy. It allowed the market to work. For its first thirty years, an international treaty even prohibited Japan from imposing tariffs higher than 5 percent—a restriction that proved to be an unintended blessing.
The leaders of newly independent India, by contrast, were steeped in the intellectual climate of the mid-20th century: the Fabian socialism of Great Britain. They viewed capitalism as a tool of imperialist exploitation and believed that economic progress required centralized planning. They instituted a series of five-year plans modeled on the Soviet system. The government controlled imports and exports, reserved key industries for itself, and required a government permit for almost any significant private investment. The ideal was self-sufficiency.
The results speak for themselves. In Japan, reliance on the market forced industries to be efficient and responsive to consumer demand. It released an astonishing torrent of ingenuity and hard work. In India, reliance on controls frustrated initiative and channeled it into non-productive activities like navigating the bureaucracy to obtain a permit or seeking special privileges. It protected inefficient, established businesses from competition and substituted the whim of a bureaucrat for the test of the market. The tragedy of India is that a nation brimming with talented and capable people has been impoverished by a system that smothers their potential. This historical comparison is a powerful indictment of the tyranny of controls and a testament to the power of the market.
The Political Dynamic of Controls
If government controls are so counterproductive, why are they so pervasive? The answer lies in a fundamental defect of the political process, an “invisible hand” in politics that works in the opposite direction of Adam Smith’s. In the economic market, people pursuing their own interest are led to promote the general interest. In the political market, people pursuing the general interest are led to promote special interests.
This happens because of the asymmetry between concentrated benefits and diffuse costs. Consider again a tariff on steel. The benefits from the tariff are large and are concentrated on a small, easily identifiable group: the owners, executives, and workers of steel companies. For them, the tariff is a matter of immense importance, affecting their profits and their jobs. They have a powerful incentive to organize, hire lobbyists, make political contributions, and campaign vigorously for protection.
The costs of the tariff, on the other hand, are spread thinly over the entire population of over 200 million consumers. The cost to each individual, in the form of slightly higher prices for a multitude of goods, is small and almost invisible. Most people are not even aware they are paying it. The cost to any single person is not worth the time and expense of organizing a political counter-movement. The individual consumer who tries to fight the steel tariff is on a fool’s errand. As a result, the well-organized, intensely interested minority almost always prevails over the disorganized, diffuse majority.
This political mechanism is the engine that drives the proliferation of government controls, subsidies, and regulations. Each group sees a benefit in getting the government to grant it a special privilege, and it is not in the interest of anyone else to mount a concerted opposition. The end result is a maze of restrictions that harms almost everyone, as the losses we suffer from the thousands of measures that benefit other special interests far outweigh the gains we get from the one or two measures that benefit our own.
From Economic Control to Political Control
The tyranny of controls extends beyond the economic sphere. The concentration of economic power in the hands of government inevitably threatens political and personal freedom. When economic survival depends on a government license, a subsidy, or a favorable regulatory ruling, individuals and businesses are no longer free to speak their minds.
A business executive who is dependent on the government for contracts or for protection from foreign competition will be reluctant to publicly criticize the policies of the officials who hold his fate in their hands. This creates a “chilling effect” on free speech. The oil industry executives, publicly excoriated by a powerful senator for their “obscene profits,” stand silent, knowing that defiance could bring retaliatory tax audits, antitrust lawsuits, or crippling new regulations.
This danger is not confined to businessmen. Academics who depend on government grants, journalists who rely on government sources, and artists who receive government subsidies all feel the subtle pressure to conform. Freedom is indivisible. A government that is powerful enough to control the nation’s economic life is powerful enough to control its political life as well. The great virtue of a free market is that it separates economic power from political power. It allows for a multitude of independent centers of power, each of which can serve as a check on the others. By enabling people to cooperate peacefully without coercion, it minimizes the area over which political power is exercised. The combination of economic and political power in the same hands, which is the essence of a controlled economy, is a sure recipe for tyranny. The failure of government controls is not merely a matter of economic inefficiency; it is a matter of the slow and steady erosion of the foundations of a free society.