The nature of these grants is crucial in determining whether there will be deterioration or maintenance in a given field, and it is no exaggeration to say that the deterioration of cities is a direct result of the failure of the grants economy.
When we observe the supply of particular goods, we also see the enormous impact of the grants system. Agriculture is a classic example. The market economy, under conditions of technical progress in agriculture and rising agricultural productivity, will produce a level of agricultural prices at which farmers’ incomes will be substantially below those existing in the rest of the system.
This is a dynamic effect rather than an equilibrium effect, but it is widely recognized. It arises from the fact that demand for agricultural goods has low price elasticity and low income elasticity. Therefore, if there is an improvement in agricultural productivity, it is reflected mainly not so much in an increase in agricultural production, but in a diversion of resources out of agriculture and into other occupations. Roughly the same agricultural output continues to be produced with a smaller amount of factors of production, especially labor.
However, in the exchange economy, the only way in which we can extract resources from a sector is by compressing it, that is, by granting it incomes that are below normal in such a way that people will have an incentive to leave it. But if the increase in agricultural productivity is a process that continues over a long period of time, as has happened in the Western world over two hundred years, the migration of people out of agriculture will never keep pace with the increase in productivity, and agricultural incomes will remain almost permanently depressed.
The result is the creation of a sense of injustice among farmers, which may be reflected politically in a demand for state grants. These grants may take the form either of tax reductions or direct subsidies, that is, negative taxes. This phenomenon is so widespread that it cannot be regarded as strange or accidental within the system.
Therefore, the introduction of an element that often has great practical importance, although it is difficult to include in the simple model, concerns the marginal effects on income distribution of increases in aggregate output. It is very rare, indeed almost impossible, for an increase in aggregate output or income to increase all existing incomes in the same proportion. It is therefore likely that any increase in output will have some kind of redistributive effect.
If the increase in output goes mainly to the poor, it will surely have a much more significant effect on the consumption function, both in increasing it and in shaping it, than if the increase in income goes to the rich.
We might postulate a “grant-free change” in the distribution of income as a result of an increase in total output, which would depend only on changes in products and relative prices, although this concept would be very difficult to handle statistically.
Virtually all real increases in total output have distributive effects that differ from those of a “grant-free” distribution, since any increase in effective demand will increase the demand for some commodities more than for others, and will redistribute income in favor of the producers of the favored commodities and against those of the less favored ones.
When the increase in output is the result of some kind of fiscal and monetary policy that includes an element of direct grants, the impact of this element on consumption is even greater.
The grants component of the investment function is likely to be smaller than in the consumption function, but it may nevertheless be significant. Investment structures, that is, desired accumulations of economic goods, depend not only on the expected future price structure, but also on taxes, subsidies and even, in a much smaller sense, on the decisions of private charity and foundations.
The Ford Foundation, for example, built itself a palace far grander than Henry Ford could ever have imagined living in as a private individual. However, the main effect is that of the public grants economy, and here the nature of the tax system is especially significant.
In general, grants, whether in the form of direct subsidies or tax reductions, are directed primarily toward increasing the general level of investment. However, in most cases, and sometimes in the case of goods viewed unfavorably by public opinion, such as tobacco, the grants system may serve to discourage investment.
One question that must be reserved for a later chapter is whether we should regard manipulations of the interest rate, loan rationing and other elements of monetary policy as part of the grants economy or as part of the exchange economy. In reality, this is an ambiguous case, and it has at least some of the characteristics of a grants economy, as we shall see.
