Here’s Friedrich Hayek discussing the negative consequences of economist’s presumption that they can control macroeconomic outcomes — from his 1974 Nobel prize speech The Pretense of Knowledge:
… the very measures which the dominant “macro-economic” theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate.
What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.
There’s a lot to reflect on from the perspective of the inflation concerns in a post-Covid world. But I think this deliberate misallocation of resources also finds an analogy in the way government buys weapon systems.
Consider a world where commercial technology is racing forward. It presents more effective tools and skillsets to the world. Weapon systems should be changing all the time to reflect these new realities, but that would cause some programs to see inflation. Reduced production rates or instability increase costs. DoD pays a price based on cost.
Ultimately, the higher costs of “legacy” weapons is offset by the dramatic improvements or lower costs of the “new” systems. Capital and labor skill are, after all, moving to more productive sectors. Inflation is a sketchy concept because different prices are going different ways.
Usually, defense officials try to plan their way out of the resource allocation problem. When one program is ramping down, the labor force of the contractor can then be rolled onto the next-generation version of that system. That presumes that the next-gen system won’t really require adaptation to new tools and skills like the commercial sector. DoD keeps pumping money into companies that perpetuate the past in order to prop up jobs, and the misallocation builds up until other nations leveraging commercial tech burst the military bubble and DoD needs industry to rapidly reallocate resources — driving high prices.
Over the last few years, we’ve seen an effort by defense officials to move budgets out of big platform buys and into new “innovative” developments to fit within a topline. Ostensibly, this is the effort to reallocate resources to higher valued. It should also signal to industry that they need to adapt along with demand. Yet Congress almost always increases procurement of specific systems. This prevents the loss of jobs in districts. They also make it so difficult to start new projects that the old ones are protected.
Again we have a misallocation of resources that will build up until it cannot any longer. It is always hard for government officials and politicians alike to refrain from protecting old, unproductive sectors — whether that’s in the economy or in the military.
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