A simple thought experiment to illustrate why a Government cannot facilitate exchange better than Capitalism

Suppose an economy of eleven people. In this economy, 5 people have X and want Y, 5 people have Y and want X, and there is one person who knows this (each individual party is ignorant of this fact). This person recognizes a profit opportunity: he can buy X from 5 people and Y from 5 people for, say, $4 dollars each, and sell them to the people that want them for $5 each. He makes a total profit of $2 per exchange, or $10 dollars.

Now, technically this represents an inefficiency. If we all possessed omniscience, and there was no cost to us actually getting our goods to each other, we could simply exchange with one another directly. This can be, and moreso now than ever is, resolved by technology; thanks to the internet, we can cut out the middleman more and more in our exchanges. But it must also be recognized that a perfectly efficient exchange could only be achieved by omniscient beings with unlimited power to act as the please. It is impossible in the real world. Some amount of inefficiency always exist, and where it does it represents a profit opportunity that will be exploited. In this example our choices are to let the middleman profit and each of us pay a dollar to engage in our exchanges, or not engage in the exchange at all, and not get what we want.

But what if we had the Government as the middleman? Couldn’t they do it without profiting, so we wouldn’t have to pay a dollar to get what we want? In a word, no.

The reason can be illustrated simply. Suppose the Government acted as the middleman, or more specifically, the a government employee is ordered by “the Government” to do, as his job, the facilitation of our exchanges. He is ordered to buy and sell X and Y in such a way as to make no net profit: $4 each. In net, the Government makes no profit and each of us gets what we want. However, if the Government is to do this it needs to pay the employee what he is willing to work for to facilitate the exchanges. That will be, judging from the Capitalist middleman, $2 per exchange; in other words, $10 dollars. Now, he would not be willing to do it for less than that, because he could just facilitate the exchange under the table without the Governments knowledge and make that much money. So the Government has to pay him at least that much. But the Government made no profit, so how is it to pay it’s employee’s wages? The answer is that it must raise revenue through taxation-Here the difference from Capitalism becomes interesting, because the Government can tax different people different amounts through the use of force: it can implicitly tax future people by borrowing money, it can tax everyone implicitly by inflating the currency and reducing the value of their dollars, or it can simply explicitly tax people, but at different rates. But either way it has to take the same amount of money from the people in total as the Capitalist did,  but unlike the Capitalist, who got the voluntary consent of those paying him, the Government does so with or without their consent, by force. If our Government strives to be fair, it taxes all 10 people equally (and cannot tax the employee of the government without raising his pay, because if his net pay is less than $10, he has an incentive to facilitate the exchange under the table.) The net result is that all ten people each pay a dollar to engage in the exchange, which was the same exact result achieved by the Capitalist who made a profit. We introduced a Government into this process, exchange, and we failed to improve the outcome for anyone. We could have improved the outcome for some individuals only at the expense of others (by harming them). And all this resulted from rather generous assumptions about how the Government would act. In the real world, the Government does not merely fail to improve on market outcomes, it actually does significantly worse; which is to be expected, since we assumed away that the Government would, itself, constitute a use of the 10 people’s resources and an additional cost to their exchanges. Which means that since the Government failed to improve upon the exchange process, there is no justification for having it interfere in it; if it can’t actually improve it, why should it?

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