by Robert Williscroft

Created on: April 18, 2008

Adam Smith developed the concept in the late 18th century that in an unregulated market, supply and demand will eventually balance, guided by the "Invisible Hand" of market forces. Eventually, he said, this results in the most efficient manufacturing processes and the lowest prices. What Smith could not predict, however, was the growth of powerful governments, and their influence on this whole process.

As a general rule, government doesn't manufacture or sell anything to generate money. It just consumes money. Even when government appears to be generating money, it still is a bottom-line consumer. Salaries paid to government workers, for example, ultimately derive from taxes collected from citizens, including the government workers themselves. The money put back into the economy as paid wages is always less than that taken from it through taxes. The balance ultimately ends up back in the economy after being used to pay for overhead and infrastructure, since eventually the money is used to pay for something, somewhere. But this is always following a significant delay.

To illustrate this, take five individuals who earn $4,000 each, and tax them each $1,000. Use this money to pay a government worker $4,000, and use the remaining $1,000 to support the infrastructure in which this government employee works. Without the tax, the five individuals would, ideally, spend $20,000, making this money immediately available to the rest of the economy, where it will percolate through the economic system. After the tax, however, only $15,000 immediately finds its way into the economy. The remaining $5,000 is put on hold. It spends time in the collection process, in the accounting process, in the allocating process, in the payroll process, and eventually, $4,000 finds its way to the government employee and from there into the economy. The other $1,000 also eventually finds its way back into the economy.

There is a significant lag between the time the original five individuals received their money and spend it and the time the remainder of the money finally arrives in the economy. During this time, it's not doing anything. It just sits there. Like friction, it consumes economic energy without producing anything. It adds an unavoidable degree of inefficiency. A mine uses workers to extract raw material from the Earth, processes and sells the mined minerals, and uses part of the money to pay the workers and the rest to do other economic things, like investing in other operations,

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