The modern defense of small government, which is the defense of capitalism, begins with an almost simultaneous discovery in three different countries by Carl Menger, Leon Walras, and William Stanley Jevons (all between 1870-73). Their breakthrough involved a recognition of the fact that the value of a good or service depends entirely on utility (see below). At the time, this stood in contradiction (most obviously) to Marx's conception of value, which was labor-based.
The labor theory held that hours of labor were what invested an object with value. But followers of Marx were daunted by a theoretical objection called the "paradox of value," which pointed (for example) to the problem of stumbling upon a raw diamond, which was not the product of any labor hours, on the side of a mountain. Despite the fact that no labor went into producing the diamond, it's value was far greater than the value of (say) a dissertation, which may have taken 1200+ labor hours.
To answer, the "marginalists" presented an interesting scenario (I'm making this up, but it's along the lines of what they'd describe): Man A is stumbling through a desert, lost, about to die of thirst, when he stumbles upon Man B. Both men are wearing tattered clothing, and both are miles from an oasis. Man A is wearing a 3-carat diamond ring, but has nothing else. Man B has no ring, but has a full bottle of water. Despite the typical market values of the diamond and the glass of water, in this situation the water is clearly more valuable -- consequently, Man B will not trade his water for the diamond. So while Marx defined value as a combination between what he called "use-value" and "labor-value," the marginalists redefined utility (which is subjective) as the sole source of value.
Marginal utility refined these imaginary scenarios with difficult equations, but the crux of the matter involves a recognition that value is not inherent, but subjective. For those defending laissez-faire style government, the importance of understanding subjective value theory cannot be understated. In the layest of lay-terms, this discovery in economics might be understood as corresponding to a Nietzschean style revolution in ethical values: what were taken for hundreds of years previously to be unchanging and eternal (objective) values were reassessed in Nietzsche's proto-postmodernist worldview as being entirely constructed and therefore changeable (the timing of Nietzsche/Menger is not, I think, a coincidence). For a more theoretical description of all of this, libertarians would typically recommend Ludwig Von Mises' giant 1949 treatise, Human Action. The entire book is available for free (Austrians like Mises tend to oppose the notion of "intellectual property," incidentally), and I strongly recommend the introduction, which is easy to read and includes no mathematics.
The reason all of this (and trust me, this is a SHORT, short version) is so important is when we arrive at the practical questions of government. If individual people are understood to value goods and services differently, then the question of "distribution" becomes very complicated. To highlight the differences in the two (big & small gov't) approaches, imagine the extremes: on the one hand, laissez-faire free trade; on the other, soviet-style communism. In the market, prices function as indicators -- sort of like pressure valves. If there is great demand and low production of a certain good, the price will increase until (theoretically) some enthusiastic soul decides he can produce that good and turn a profit that he finds, subjectively, worthwhile... distribution problem solved. On the other hand, the czar has no direct indicators that works like the price system. He is faced with all sorts of questions: how many dolls should we produce for our children? How much oil should we produce? How many of our fields should be used for farming (and which foods?), how many should be used for factories (of what kind?), etc. Not to mention what qualities should our products (say, public education) have? Inevitably the sheer volume overwhelms the czar. For more on prices as necessary data, click here.
Of course, what we have in reality is a mixed-bag -- some government control, some intervention. Most importantly, we do have prices, and, at least in America, nobody is talking about turning away from the market altogether... isn't that good enough? This is the problem we're faced with today. The short defense of small government in a case like the auto industry in our mixed-economy situation is that intervention makes economic decision more uncertain: should you buy a Ford? The question "Do you think the government will bailout Ford again in two years?" is more difficult to answer than "What is Ford's financial situation?"
The two key concepts here are "spontaneous order" (see Hayek) and "creative destruction" (see Schumpeter). The capitalists look at an economic situation like Detroit and see a bloated, corrupt, broken industry. Just as the archetypal gothic inbred families of 18th century English novels were becoming outmoded and superceded, the auto industry (say the capitalists) should be allowed to fail. "Creative Destruction" is simply the process of letting the market do what it does... the procedure for an insolvent business is simply bankruptcy (Note: concerning the 3 million jobs lost: capitalists will point out that the rate of unemployment has been more or less stable in this country for a hundred years. People lose jobs, and new jobs are created, if only because there is a flood of cheap labor on the market in the aftermath. Hundreds of large corporations have failed in American history, and yet unemployment hovers around 5%. The "special objection" seems to stem from the sheer size of an industry like Detroit's, but if it's true that the bigger-they-are-they-harder-they-fall, should we just "get it over with," or let it get even bigger? Once you enter the "bailout" game you can't stop.).
For "spontaneous order," compare an unregulated phenomena like the internet or book publishing to a heavily-government-ordered organization like the (legendary) Post Office--or the DMV, or AMWAY, or your local health center, or public education. The idea that we can simply "incentivize" new industries is based on a kind of deceptive shuffling of the deck. The odd thing is that it IS actually possible to incentivize new industries, but it is always less efficient. A quick story to make my point (from a paper I wrote on Roger Williams, America's first Libertarian, sort of):
The fur trade was not at all alone in its becoming a target of the church. Although the higher-ups saw themselves as trying to assist merchants in spiritual protection, the fact is that these interventions were economic disasters waiting to happen. One of the most interesting examples was the “maximum wage” controversy of the 1630s. Because labor in the New World was extremely scarce, workers could demand very high wages and expect to find compensation. The conservative Gov. Winthrop, however, was not willing to let economics run its course; perhaps he was trying to artificially keep capital in the hands of the few. In any case, he complained in 1633 that, “the scarcity of workmen had caused them to raise their wages to an excessive rate” (qtd. in Rothbard 254). Here again we are confronted with that odd phrase: excessive rates. How was the governor able to recognize these rates as “excessive?” What would have been “just” rates? However he determined the proper cost of labor, Gov. Winthrop imposed a maximum wage control in Massachusetts and, just as raising minimum wage inevitably causes unemployment, setting maximum wage always leads to labor shortages. In addition to trying to fix wage rates, the confused Massachusetts oligarchy tried to respond by also fixing the cost of consumer goods – mostly notably corn, which was the “major monetary medium of the North” (Rothbard 256). Bernard Bailyn summarizes the debacle nicely: “still insisting on the theory of universally equitable wage- and price-levels,” the General Court was despairing of its own regulations (33). By 1635, the theocracy gave up the inefficient and largely unenforceable price and wage-fixing, but undertook a new and equally ineffective measure:
…under the cloak of a desire to ‘combat monopolizing,’ the Massachusetts government created a legal monopoly of nine men—one from each of the existing towns—for purchasing any goods from incoming ships. This import monopoly was to board all the ships before anyone else, decide on the prices it would pay, and then buy the goods and limit itself to resale at a fixed five percent profit. (Rothbard 257)In his discussion of the import monopoly, Bernard Bailyn focuses on the impossibility of enforcement, arguing that it would have been unrealistic to hope that the merchants would only sell to these nine buyers when others were willing to buy and perhaps even pay more (34). It must be understood that all of this – hypocritically or not – was part of the more general ideology that suggested that officials could “use the State’s means to make men worship rightly” (Garrett 191). We are likely, in retrospect, to assume that the officials were playing at market for their own gain, using the rhetoric of insistence on religious piety as their cover. But the powerful question formulated by Roger Williams was not “is there a just price,” but “by whom are these admonitions to be given” (Bloudy Tenent 33). In short, who is qualified to know the just price or the just wage in every situation?
Yes, "Maximum Wage." And: see how the state becomes the dispenser not only of goods and services, but also of "spiritual" and ethical values? The notion of the "Just Price" is fun to explore -- developed by Aquinas, it was the Catholic church's "check" on injustice in economics for almost 500 years... The point is just what I tried to explain at the end: the problem of "big government" is always the same: who is qualified to know, and how will they know? Seems John Winthrop was unqualified. Certainly not Henry Paulson. Can we trust Lawrence Summers? Who's the new auto-czar going to be? Will he know better than the Japanese auto-market what cars to make in 2010? What should the minimum wage be, and does it matter that raising it will cause unemployment?
Two points to conclude: a small-government attitude is fundamentally suspicious of utopian discourse, based on the assumptions that resources are limited, and values are subjective (no single policy could answer to everyone's values...). Secondly, everything I've presented here is an amateurish representation of a truly enormous body of literature that simply cannot be "done justice" in a blog post. To get a basic education in libertarian economics would require reading Menger, Von Mises, Schumpeter, Freidman, F.A. Hayek (nobel prize winner), and Murray Rothbard (not to mention a deep knowledge of American and soviet economics in the 20th century). I genuinely don't say this to establish a kind of "You're-too-uneducated-to-question-this/this-is-best-left-to-experts-view" tone, but only out of a genuinely felt sense of ethical obligation to the economists I've studied. To conclude:
It is important to remember that government interference always means either violent action or the threat of such action. The funds that a government spends for whatever purposes are levied by taxation. And taxes are paid because the taxpayers are afraid of offering resistance to the tax gatherers. They know that any disobedience or resistance is hopeless. As long as this is the state of affairs, the government is able to collect the money that it wants to spend. Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom. --from Ludwig Von Mises' Human ActionP.S. -- anyone interested enough to read my 20-page paper on Roger Williams, morality, freedom, and economics is welcome to... we'll arrange that via email.