FoC (4) - Cost Cutting is Good

The idea that cutting costs is dangerous is the real fallacy. A good business manages costs at all times, regardless of whether the market is weak or strong. Reducing costs allows prices to fall making everyone better off because they can buy more.

In a free economy, some businesses will perform better than others. Producers who are not able to operate as efficiently will close, if they cannot catch up. The more efficient producers will be able to purchase their resources and recruit their clients. If one business has to put off staff, more efficient ones will take them on. Cost cutting pushes resources towards the most efficient producers.

Retaining staff that are not needed, buying inputs that will never be used, or producing goods that cannot be sold, never makes sense. Using the fallacy of composition argument to suggest that uneconomic producers should be encouraged to keep producing is the more serious fallacy.

Reducing costs and staff only becomes a problem after bad government and banking policies have created a false boom the economy. When this false boom grinds to a halt, every business is forced to cut back at the same time. This is not a fallacy of composition, because the uneconomic activities must be eradicated to strengthen the economy. The sad thing is that the cut backs would be unnecessary, if the government and the banks had not collaborated to produce the false boom that had caused the problem.

General Motors provides a good example of this fallacy. For the last few years, GM has been producing cars that cannot be sold at a price that covers the cost of production and a reasonable return on capital. To solve this problem, GM is now selling cars at zero percent interest. The danger is that the wrong solution to a problem can often make things better in the short term. Marketing cars with zero percent finance may sell cars in the short term, but it does not deal with the underlying problem. GM will only become a benefit to the American economy, if it can start producing cars that people want at a price they are willing and able to pay. Government assistance that enables GM to keep on operating in an inefficient way only puts off the evil day.