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Why Government Spending is not the Answer

Why Government Spending is not the Answer

November 12, 2012 8:13 pmComments are Disabled

Since Obama just won (congrats btw), we have some time to accept that America just made a resounding endorsement of Keynesianism. This is not a good thing. I can only assume that most Americans don’t understand the danger of government spending, or that Mitt Romney was an exceptionally bad messenger for liberalization. The latter is certainly true; the former is probably mostly true. Excuse this post for its generalities, but what matters here are the concepts.

There are two main arguments against government spending.

The first argument is that governments tend to spend money much less efficiently than individuals do. To paraphrase Milton Friedman, very few people spend other people’s money better than they spend their own. There is an undeniable truth to this matter. Think about market efficiency with distributed buyers and sellers, all trying to maximize utility individually, as opposed to purchases made by consensus, whether it’s on textbooks or social spending like welfare. It is impossible for a consensus of buyers to maximize utility for all individuals in that group as effectively as each individual can maximize utility for him/herself. The sellers of whatever it is being purchased only have to sell to one customer, which greatly lowers their incentive to create a consistently good product. Especially if that one customer comes with an exclusive contract, and you can create political pressure to keep the customer if jobs are at stake.

So whereas the money might very well end up in the pockets of contractors who hire workers and create jobs, these jobs don’t necessarily have to be productive. It was Keynes who gave the example of the government paying people to dig holes and fill them up. Certainly, this would be government spending that created jobs, but would it be good for the economy? If you take a labor theory of value, that the wealth of a society is the sum value of the goods and services the society produces, then that isn’t the case. It is also apparent from a historical perspective that command economies are far outperformed by free ones. People simply work harder and produce more if they are working for themselves and not for others. This generates more value which generates more wealth which generates more growth, prosperity, and jobs.

The second argument against government spending is that there really is no such thing as government spending. The government doesn’t have any money on its own; it only has money that it borrows through debt, raises in taxes, or creates via inflation. For the government to spend money in the economy, it needs to get money from the economy. No additional value is created; the cycle is only perpetuated. Frederic Bastiat, who developed the notion of opportunity cost, said it best in his essay That Which is Seen and That Which is Not Seen. It is easy to see the benefits of government spending when it arises (contracts going to construction workers, teachers, etc), but much harder to see the tradeoff of where that money is not being spent: money that would have circulated through the economy had it not have been paid to the government in taxes. The exact example Bastiat used, in fact, was of a natural disaster sweeping through a town and destroying buildings. Arguments will be made, he said, that the economy will be helped by the jobs necessitated by the cleanup and rebuilding. But these arguments ignore the money that would then not be spent on the economy had the disaster never come through in the first place. The fact is, a natural disaster destroys value, and that’s that.

Public spending is not really good for growth, and anything that can be taken care of by the private sector should be. There are obviously public goods that cannot be efficiently managed privately, like roads and bridges, but these make up a fraction of the actual government spending today on growth. In general, increased public spending does not create growth, it merely recirculates money through the economy much less efficiently.

What private individuals “hoarding” all their money and not spending it (as during a recession)? Doesn’t that necessitate government spending to stimulate the economy? Well, even if the money is sitting in someone’s bank account, it is still part of the US economy–it is leant out by banks to small businesses, it is invested in pension funds, bonds, etc…unless the money is under a mattress it is being useful. But should we decide to tax “non-useful” money, I certainly wouldn’t want to be the person who had to figure out which money was being useful and which wasn’t for each individual, would you? Mind you, a lot of people save money for retirement, or to pass on to children, and that’s not money I would call non-useful; I would consider it quite immoral to tax that money. Yet tax it we do, since our tax code considers all taxable income to be fairly fungible. The so-called “cash pile” exists because of a credit crisis–people with money are hesitant to invest it or lend it or spend it because they are unsure what the future of the economy will be. Certainly, the government stepping in and starting to tax the cash pile will not make investors more confident to start spending again; more likely, people will start stashing the money overseas.

What about things that people absolutely need? Doesn’t the government have an obligation to provide these things if the market can’t? Well, let’s look at what we mean by “need.” The fundamental concept of economics, that of scarcity, takes as a supposition that society doesn’t have the resources to meet our wants and needs. In other words, our wants and needs are unlimited. For example, it is hard to see a refrigerator as anything less than an absolute necessity today, yet it did not exist for most of human history. The brilliance of the free market is it allows individuals to maximize their own utility, to trade for the things that they want and need the most, trading off with the things they don’t need as much. When the government steps in to provide for solutions to “market failures,” it can have the adverse affect of creating market failure.

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