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Three Ways to Speed Recovery from the Economic Crisis

  • Chile Economic Crisis Recovery
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Fostering a speedy recovery from the current economic crisis in Chile depends on freeing up entrepreneurs and others to act freely and create wealth in the marketplace. This will depend on lessening regulatory burdens, controlling public spending, and lowering taxes. Understanding the Austrian school view of economic action and entrepreneurship holds the key to understanding the way out of the crisis.

Here’s why:

Unlike the Keynesian and Chicago schools, which study economics in mathematical terms as if people were numbers, Austrian school economists focus their research program on the essence of social phenomena: individual human action (Hülsmann 1999; Backhouse 2000). The Austrian school considers economics as part of a general science of human action (praxeology) that is understood as the innate creative and entrepreneurial ability of people. Human action as an entrepreneurial function implies the ability to perceive profit opportunities and the ability and willingness to take advantage of them. As Mises argued, “in any real and living economy, every actor is always an entrepreneur” ([1949] 1966, 253). Entrepreneurship is the driving force of the dynamic processes of voluntary interactions and exchanges that characterize life in society.

Kirzner suggests that the scope of entrepreneurial alertness “refers not to the ability to see what exists, but to the necessarily speculative ability to see the future. Such metaphorical alertness may consist of the vision of creating something in the future” (1985, 7). Alertness involves human action that restructures the entire map of the ends and means of individuals as they act in their respective contexts. Alertness allows the entrepreneur to notice new profit opportunities to improve his condition, that is, creativity does not need prior means. Entrepreneurship creates knowledge ex nihilo, either new knowledge (speculation) or knowledge that existed but has been overlooked until now (arbitration). Alertness creates an idea in the entrepreneur’s mind, but his human action, guided by that idea, requires the use of goods to achieve ends. The entrepreneur can only speculate ex ante about the effectiveness of his action, but the outcome of his alertness can only be verified ex post. Alertness also implies serendipity, which is the ability to take advantage of opportunities that arise by surprise, without being deliberately pursued, and act accordingly.

People learn how to carry out specific actions (know-how) and acquire practical behavior patterns (Huerta de Soto, 1992). These actions help entrepreneurs articulate their knowledge and improve alertness through a dynamic process of “learning by seeing” and “learning by doing.” As Mises wrote, “the market process is the adjustment of the individual actions of the various members of society to the requirements of cooperation” ([1949] 1966, 259). Market prices communicate information about exchange relations based on the relative scarcity of goods and services subjectively valued by each actor as a seller or consumer, participating in the market or refraining from doing so. Market prices require the prior existence of private property. Prices reflect the historical relationships of exchanges that help human minds make a rational economic calculation, that is, the subjective estimate that people in monetary units make about the possible results of their actions. The economic calculation is reflected in accounting and expectations, which serve as a guide for entrepreneurs on what to produce, how to produce, and in what quantity. Although the control of production is the task of entrepreneurs, consumers are sovereign and have the power to enrich the poor and impoverish the rich. Entrepreneurs propose new goods and services on the market, but consumers are free to choose the best or the cheapest.

The prices, the ability, and the will to use this knowledge are essential to saving the available resources. This fact favors the productivity of resources and the increase in income, which allows the accumulation of additional resources (Bylund 2016). The free market tends toward social coordination in the sense that entrepreneurs can only prosper if they adjust their intellect to identify and solve the problems of others. Therefore, economic progress is the expansion of alternatives open to people (Bauer and Yamey 1957). The free exercise of the entrepreneurial function is the basis of economic progress and has no borders; human creativity has no limits; in a virtuous process of technological change to solve increasingly complex human problems.

Entrepreneurship stimulates a long-term vision to adopt ideas and take risks (Foss et al. 2007). The dynamic process of intertemporal coordination is influenced by the price of time, known as the interest rate. The interest rate guides entrepreneurs to determine which stages of the production process are relatively more profitable to invest in. When people increase their savings level, the "supply of loanable funds" increases, and the "interest rate" decreases. This makes entrepreneurial projects relatively more profitable in the production stages furthest from final consumption. That is, investment in capital goods grows, understood as the goods or services that the actor considers subjectively necessary to produce goods or services closer to final consumption (Manish and Powell 2014). The increase in previous voluntary savings fosters economic progress. because the incentives of entrepreneurs (investment projects of greater complexity and maturity time) tend to coordinate with the dispositions of consumers (consume more in the future). Genuine savings encourage sustainable investment and the creation of more and better goods and services open to people. The more intensive production of capital goods gives rise to more accessible technologies to meet the requirements of people (for example, industry, transport, education, health, social security, or the environment).

Consider the case of Robinson Crusoe, who has just arrived on an island (Böhm-Bawerk 1959, 2, 102–18). He is dedicated to the collection of coconuts, as it's the only means of subsistence. If he does not have capital goods, Crusoe must climb the palm trees to collect the coconuts directly with his hands. However, he perceives that a wooden rod could help him hit the coconuts on top of the palm tree to make them fall faster and more safely. Crusoe saves some coconuts for the full four days that he estimates it will take to create his wooden rod, reducing his consumption below its potential level. After creating the wooden rod, Crusoe can collect more coconuts in less time and has increased his productivity. He has more time available for other valuable purposes to him (for example, building a more comfortable and safe shelter or changing his food and clothing). All savings produce capital goods, although initially they are consumer goods (such as coconuts) that remain unconsumed (or unsold). Capital goods (such as the coconuts) are gradually replaced by more advanced ones (such as the wooden rod). The entrepreneurship and investment in capital goods, financed with genuine savings, are vital to healthy and sustained economic progress. As Huerta de Soto explained:

Thus, the key importance of not disregarding anyone’s entrepreneurship. Even the humblest people, those of the lowest social status or most lacking in formal knowledge, will exclusively possess at least small bits or pieces of knowledge and information which can be of decisive value in the course of social events. From this standpoint, it is obvious that our concept of entrepreneurship is of an essentially humanistic nature, a concept which makes economics, as it is understood and advanced by members of the Austrian school, the quintessential humanistic science (2008, 25).

Alternatively, if Crusoe followed only interventionist recipes of the sort supported by the Keynesian school and others, he could only consume coconuts until they were finished (which produces an inexorable crisis). Furthermore, increased risks of coercion and confiscation (for example, political instability, lack of public order, coercive institutional arrangements, uncontrolled inflation, risk of default, taxes, and confiscatory regulations) would make productive entrepreneurship increasingly difficult or even impossible. If the environment is not favorable to entrepreneurship, the level of saving and investment of local and foreign entrepreneurs will be lower and will focus on short periods (Bylund and McCaffrey 2017).

HOW TO ENSURE A HEALTHY AND SUSTAINED ECONOMIC RECOVERY?

How do we ensure a healthy and sustained economic and social recovery from our brewing economic crisis? Our proposals are consistent with our theory of economic progress and can be reduced to three general guidelines, which must be applied together since they are mutually reinforcing:

1) Eliminate legal barriers to entry into entrepreneurship to streamline the allocation of productive factors (natural resources, labor, capital, and entrepreneurship) to the activities most required by people, and promote the dynamic process of saving and investment for the identification and solution of human problems. This aims to respect private property, establish freedom of contract (a society based on contractual ties), limit the interference of politicians in the market process.

2) Confiscatory relief for families and enterprises. This reform implies the elimination of the first and second category taxes on small and medium-sized enterprises (SMEs) for the first two years of activity; the reduction of the business tax from the current 27 percent to 15 percent (i.e., reverting to the 2000 tax rate); and the elimination of the value-added tax (VAT) from the basic basket, of inheritance, allowance, and donation taxes, of investment taxes, and of housing taxes (also called "contributions"), along with seeking autonomy for the municipalities to set the level of municipal taxes (i.e., land taxes, commercial patents, and the casino tax). Lowering the tax burden on people ensures higher degrees of freedom to dispose of the fruits of their effort, in addition to facilitating the undertaking of saving, investment, and capital formation. Increasing investment per capita increases people’s productivity and real wages.

3) Ensure a structural balance and prevent fiscal deficit and indebtedness. A drastic reduction in public spending is recommended, especially “political-bureaucratic spending” (for example, ministries, secretaries, and other state agencies, the salaries of public officials, state goods and services, arbitrary subsidies to enterprises and pressure groups), which represents about half of total spending (see the Estadísticas Fiscales (Fiscal Statistics) page on the Dirección de Presupuesto's (Budget Directorate) webpage). This reform seeks to keep a structural balance between state revenues and expenditures. Furthermore, it is proposed to modify the structural balance law from requiring a 0 percent surplus to one of 2 percent in order to promote state savings and avoid public debt. This project conjectures that the more the size of the public sector is reduced, the more scope there will be to reduce taxes and corruption, which is inherent in the existence of the state.

SOME ANSWERS TO THE CRITICISMS

Proponents of greater interventionism have articulated numerous justifications for government coercion and the arbitrary confiscation of the efforts of others. Among them two stand out:

1) Politicians often argue that “public spending cannot be touched.” If public spending is reduced, they claim, the poorest people will be unprotected. This statement is false. First, politicians often resort to this argument to hide behind the poor, allowing them to preserve their caste privileges by parasitically living on taxpayer money. Paradoxically, 50 percent of taxes collected in Chile comes from the VAT, which is the most regressive tax. Therefore, to a large extent politicians’ salaries come from the money of the humblest people. Second, our proposal only targets political and bureaucratic spending. Well-evaluated social programs and aid to education are not considered. It would be interesting, furthermore, to focus on “social spending” in the most productive areas: job training and entrepreneurship. Third, our proposal benefits people in general, and especially the poorest, with better job opportunities, higher incomes, and opening a range of alternatives for them to satisfy their requirements more cheaply and efficiently.

2) The other argument is that, compared to developed countries, “taxes, debt, and public spending in Chile are low” and yet these low levels have had no benefit for most Chileans. It is therefore suggested that the levels of taxes, debt, and public spending be increased. However, the most basic empirical evidence reveals that this claim is unfounded. Although Chile was one of the poorest countries in Latin America until the 1970s, the “lukewarm market-friendly reforms” of the 1980s have contributed to its current position as the region’s leader in human development, economic freedom, doing business, and perception of corruption. Chile’s GDP multiplied 5.5 times between 1990 and 2017, while North America's only did so 2.5 times, the European Union's 2.8, Hong Kong's 3.5, Singapore's 4.2, Japan's 2.2, New Zealand's, and Australia's 2.8. Chile’s economic and social debacle, in fact, was generated precisely by the Keynesian, interventionist, and socialist recipes of the last decade.

The time has come to cast off the interventionist restraints on entrepreneurial innovation. It is time to change the culture of coercion and arbitrary confiscation for a culture of entrepreneurship, genuine savings, and social cooperation. Chile has a unique opportunity to be a benchmark of freedom and progress in the world and, once and for all, to eliminate poverty and become a more prosperous, just, and peaceful country.

REFERENCES

Backhouse, R.E. 2000. “Austrian Economics and the Mainstream: View from the Boundary.” Quarterly Journal of Austrian Economics 3, no. 2: 31–43.

Bauer, P.T., and B.S. Yamey. 1957. The Economics of Underdeveloped Countries. Cambridge: Cambridge University Press.

Böhm von Bawerk, E.R. 1959. Capital and Interest: Positive Theory of Capital. Illinois: Libertarian Press.

Bylund, P.L. 2016. The Problem of Production: A New Theory of the Firm. New York: Routledge.

Bylund, P.L., and M. McCaffrey. 2017. “A Theory of Entrepreneurship and Institutional Uncertainty.” Journal of Business Venturing 32, no. 5: 461–75.

Estadísticas Fiscales. Dirección de Presupuesto, Ministerio de Hacienda, Gobierno de Chile (website), Accessed Apr. 14, 2020. https://www.dipres.gob.cl/598/w3-propertyvalue-2132.html.

Foss, K., N.J. Foss, P.G. Klein, and S.K. Klein. 2007. “The Entrepreneurial Organization of heterogeneous Capital.” Journal of Management Studies 44, no. 7: 1165–86.

Gopinath, Gita. 2020. "The Great Lockdown: Worst Economic Slowdown since the Great Depression." IMF Blog, Apr. 14, 2020. https://blog-dialogoafondo.imf.org/?p=13190.

Huerta de Soto, J. 2008. The Austrian School: Market Order and Entrepreneurial Creativity. Cheltenham and Northhampton, UK: Edward Elgar.

———. [1992] 2010. Socialism, Economic Calculation and Entrepreneurship. Cheltenham and Northhampton, UK: Edward Elgar.

Hülsmann, J.G. 1999. “Economic Science and Neoclassicism.” Quarterly Journal of Austrian Economics 2, no. 4, 3–20.

Manish, G.P., and B. Powell. 2014. “Capital Theory and the Process of Inter-temporal Coordination: The Austrian Contribution to the Theory of Economic Growth.” Atlantic Economic Journal 42, no. 2: 133–42.

Miller, T., A. Kim, and J. Roberts. 2020. Index of Economic Freedom. Washington, DC: The Heritage Foundation.

Mises, L.E. [1949] 1966. Human Action: A treatise in Economics. Chicago: Henry Regnery.

Transparency International. 2020. Corruption Perceptions Index 2019. [Berlin]: Transparency International. https://www.transparency.org/cpi2019.

United Nations Development Programme. 2019. Human Development Report 2019. New York: United Nations Development Programme. http://hdr.undp.org/sites/default/files/hdr2019.pdf.

United Nations. 2020. "The Coronavirus Will Lead Us to Recession and Economic Slowdown." United Nations (website), Mar. 14, 2020. https://news.un.org/en/story/2020/03/1470891.

World Bank. 2020. Doing Business 2020. Washington, DC: World Bank. http://documents.worldbank.org/curated/en/688761571934946384/pdf/Doing-Business-2020-Comparing-Business-Regulation-in-190-Economies.pdf

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