The Origin of Government Intervention Part 1: National Security

The bailouts of General Motors and Wall Street banks stirred a hornets' nest. Advocates of limited government have decried these actions as the inevitable consequences of government interference in the economy. Proponents of active government, on the other hand, argue that the process of federal deregulation enabled GM and certain commercial banks to become 'too big to fail,' allowing those corporations to hold the economy hostage. The question is: who's right?

Well, as I argued in my previous article [1], a constructive answer requires us to ditch the ideological nonsense. And to that end, I wish to dedicate the content of this article to discussing an aspect of economics that seems to escape most mainstream debate in the US: the relationship between economic policy and national security. If we are to understand how ideas of government intervention entered into American political discourse, we must start by examining the international position of the US after the Revolution.

When the American colonies were thrust upon the world stage as independent states in 1783, the international system was—as it still is today—defined by anarchy (a lack of world government). This particular form of international relations has specific consequences for the internal composition of states, especially as it pertains to the relationship between government and the private sector.

With no recourse to an authority above themselves to settle disputes, an anarchic international order forces all states to provide for their own security. This requires the establishment of individual military institutions and the requisite means to support them. Support, in this context, entails a sustainable access to sufficient capital to fund the operations of military units, farms to feed them, factories to produce clothing and equipment, and raw materials to supply the factories. All of this, of course, is in addition to the needs of the domestic markets of each state.

Because power is not distributed equally among actors in a state of anarchy, all governments find themselves in a perpetual contest for strategic advantages. This competition creates what is known as the security dilemma: a situation in which any increase in the security of one state is a direct threat to the security of other states in the system. So if, for instance, nation A expands the size of its military forces or seizes territory rich in natural resources it lacks, nations B, C, and D are forced to counteract these potentially destabilizing moves. This is achieved by either forming an alliance against nation A or pursuing individual policies that bring each of them into parity with it. If equilibrium is not reached between these actors, the more powerful state (nation A) will be able to pursue its interests at the expense of the security of B, C, and D.

Separation from Great Britain left the US ill-prepared to compete in this cutthroat world of power politics. The American economy was largely agrarian, dependent upon factories and banks in Europe (mainly Great Britain) to supply them with manufactured goods and liquid capital. This arrangement was largely the product of the British approach to colonialism. In theory, the mother country and its colonies were bound together in a symbiotic relationship, each supplying the other with the materials it lacked. However, in practice the American colonies needed the mother country far more than it needed them.

North America was but one source among many from which the British government could obtain raw materials for its domestic market. American colonists, on the other hand, could only obtain manufactured goods and loans from Great Britain. While one reason for this relationship had to do with British laws that restricted trade outside the empire, the reality was that Britain had the world's premier industrialized economy.

Information on factory machinery was a closely guarded state secret and individuals with this specialized knowledge were prevented from traveling abroad. Furthermore, the British government had access to public credit through a national bank, enabling it to subsidize private institutions it deemed vital to its security. These measures, combined with exclusive access to raw materials from its colonies, gave the British Empire a virtual monopoly on industrial production which, in turn, made it a formidable military juggernaut.

It was with this picture of international relations in mind that Alexander Hamilton described the state of US security in his Report on Manufactures (1790). A constant and increasing demand on the part of American states, he writes,

for the commodities of Europe, and only a partial and occasional demand for their own, in return, could not but expose them to a state of impoverishment(...)the regulations of several countries, with which we have the most extensive intercourse, throw serious obstructions in the way of the principle staples of the United States. [2]

In other words, by striking out on their own, the United States were outside the government-supported industrial system which had made American society possible. As a result, "obstructions" to trade--such as tariffs and colonial monopolies--designed to maximize the economic security of Great Britain, were now undermining the American economy. This problem was compounded by the protectionist policies of other powerful European countries.

This brings us to the heart of this discussion. In an international system where powerful states can renege on agreements with impunity and take what they want by force, it is suicidal for a weaker state to place its economic security at the mercy of stronger ones. In the 18th and 19th centuries, the US was very weak indeed. Without sources of capital investment and industrial production which was free from foreign interference, Americans would be unable to field and maintain military forces comparable to those of Europe.

As a consequence, if the US ever ran afoul of its European competitors, the economic obstructions mentioned above and the military capabilities they afford would be used to bully the United States into subservience. In such a context, only a reasonable level of economic self-sufficiency could enable Americans to retain their sovereignty. In part 2 of this series, I will expand upon this logic by examining the relationship between the urgent need for industrialization in the US and early government intervention in the American economy