As humans, we want to satisfy our needs in the present rather than the future. This is a fundamental truth of human action. If we preferred to satisfy needs in the future over the present, we would never act. An individual’s time preference remains high until basic needs are met and savings can occur. This becomes incredibly important when understanding human behavior in economies.
This oversight or misunderstanding of human action is why the many government economic development agencies have made countless errors in their execution of centrally planned economic development. Tax incentives, abatements, and low interest rates break the laws of time preferences of human nature.
A relevant example is the billion-dollar Tesla tax-incentive package awarded by my home state of Nevada to build the Tesla Gigafactory. Tax incentives are awarded to Tesla for investing into equipment and manufacturing which creates new jobs and ultimately new electric automobiles. This sounds great in theory but in practice it has many unseen and unintended consequences.
We as humans must satisfy our basic needs first and until we can satisfy those basic needs we have no room to think towards the future. Therefore, savings and investment can not occur until basic needs are met. The best way for humans to satisfy basic needs is to produce enough supply of those basic needs so they can be satisfied easily. It is at this point that savings can occur and those savings can be used for future investment into capital goods to produce consumer goods more efficiently and abundantly, lowering the time preference through accumulation of real savings.
Nevada’s tax incentive deal with Tesla and most tax incentive packages put preference towards capital goods over consumer goods. This illustrates the importance of understanding time preferences of individuals, it tells economies what to produce and when. However, when tax incentives interfere it sends false signals. The result in this case is a shortage in consumer good supply (housing, daycare, etc.) which increases the price of the basic needs that all humans need to sustain life. This malinvestment prolongs real savings and deteriorates the wealth of many individuals.
Entrepreneurs have a delicate task of balancing allocation of resources to current production of consumer goods or capital goods for future production. When tax incentives or artificially low interest rates are introduced into the market it creates misinformation to the entrepreneur and typically a malinvestment into capital goods. With allocation being directed to capital goods the current production of consumer goods declines and disconnects from individual time preferences.
One of the main issues plaguing the city of Reno, where the new Tesla Gigafactory is located, is housing shortage. The affordable housing inventory, homes less than $300,000, at the end of 2017 fell below 100 homes. Many of the Tesla apologists point to this as great success and a booming economy, the “Tesla effect”. At face value it might seem that way but there is a far more complex story unfolding in the Nevada economy.
As a result, this takes valuable resources away from an economy like Reno and makes consumer goods with high demand in the present less available. To make it worse, many of the products being made by these subsidized companies are products that will not likely be demanded by consumers in the Reno market, thus, expounding the problem long term. Economist, Murary Rothbard, addressed this very error of over-investment in his book, For a New Liberty.
Once the consumers reestablish their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods (hence the term “monetary over-investment theory”), and had also underinvested in consumer goods. Business had been seduced by the government tampering and artificial lowering of the rate of interest, and acted as if more savings were available to invest than were really there.
Capital goods are an investment in the future for new more round about production. Entrepreneurs make these investments in hope they can produce more units at cheaper costs or create new units that consumers will demand in the future. Like all new investments this comes with risk and uncertainty, these capital goods remain a liability to the company until the investment proves profitable in the market. Tesla is still plugging along for now but not all companies have or will survive these large capital goods outlays. Faraday, another electric car company, that received a $300 million tax incentive package from the State of Nevada failed in the process of trying to get a new electric car to the market.
Although tax incentive packages bring a boom in the front end while the subsides are plentiful and the capital is flowing there is no guarantee the investment in capital goods will result in profitable consumer goods. It is the perfect scenario for a political deal maker. The politicians get to sign the big deal and take the golden shovel ground breaking picture with the rock start entrepreneur. By the time the market business cycle turns and malinvestment is exposed those politicians are long gone.
Another error in calculation with large subside deals is utilizing job creation as an indicator of economic prosperity. Having a job is only beneficial on the basis that the means from that job can sustain basic needs and accumulation of savings. Nevada has more jobs now but an imbalance between capital goods and consumer goods has created a less affordable environment, thus, can it be said the economy is better off?
Wealth creation and savings are a far better indicator for economic prosperity which can only occur through an increase in wages and/or decrease in living costs. Even though labor resources have become more scarce in Nevada, Tesla like deals have not increased wages. Nevada median family income (inflation adjusted) remains $7,500 less than it was in 2007. The malinvestment in capital goods has also increased living costs like housing, Reno is in the bottom ten percent in housing affordability. Nevadan’s are also experiencing rampant inflation in childcare, healthcare, and other general expenses.
Without real time preferences setting the balance of consumer and capital goods the boom is artificial and causes capital destruction over the long term. Economic development government agencies are more interested in sexy headlines and boom/bust cycles than they are about the mundane details of human action within economies. As a result, this creates a viscous cycle of income inequality and wealth destruction through malinvestment in capital goods. Understanding time preferences and the needs and wants of consumers is best left to entrepreneurs, not government agencies. Our economy would be far better off without the false signals and interference created by tax incentive packages.