US Economic “Growth, Deficits, and the Future” (J.D. Foster – Heritage Foundation)

Following is an article by J. D. Foster, Ph.D., who is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation (http://www.heritage.org/).

 J.D. Foster, Ph.D., The Heritage Foundation

Foster’s article addresses the anticipated impact of further government spending (i.e., fiscal stimulus) upon the U.S. economy, in the short run and beyond.  Foster provides a counter-argument to the recommendations and justifications of Economist Paul Krugman for further government spending.  The crux of the article is that the most healthy approach to helping the U.S. economy to recover from the current recession is not by increased fiscal stimulus, but rather by reducing taxes at all levels of the economy to encourage growth in private, nongovernment business.

Following are some noteworthy selections from the complete article (here).  (Bold, italicized,  and underlined text are provided by myself to draw attention to key thoughts in Foster’s article.)  

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“Growth, Deficits, and the Future”

by J.D. Foster, Ph.D., The Heritage Foundation
WebMemo #2150, December 3, 2008

—
Paul Krugman, in his article in The New York Times on December 1, “Deficits and the Future,” discusses deficit spending reflecting both the weakening state of the economy and his response to the changed political climate in Washington, D.C.  Krugman tells a good story, but in calling for even more spending he misses the punch line badly. Tax rate reduction, not another dose of deficit spending, is the key to a stronger economy.

Globally, and certainly in the United States, an intense debate is underway as to the proper magnitude of fiscal stimulus programs to “jumpstart,” “jolt,” or otherwise stimulate national economies as the global economy slides into a deep contraction. For some, a big boost to government spending is the natural solution, especially since they can identify so many “unmet needs” awaiting federal largesse. Neither desperation nor opportunism justifies ineffective and misguided action. These troubled times demand policies that work.

Fiscal Stimulus That Works

The global economic downturn looks to be quite deep. Even optimists do not foresee the recession that began in the United States at the end of 2007 to end until the second half of 2009. Naturally, the focus is on a government response, as though all solutions come from Washington. And, naturally, the response from Washington is to do what Washington excels at: spending money.

……

Suppose for a moment that the fiscal stimulus is effective in pumping up aggregate demand. The budget deficits under current policy for 2009 through 2011 are already around $1 trillion for each year, not counting the budget effects of the various financial bailouts. Put those figures in perspective: In dollar terms, the largest federal budget deficit ever was recorded in 2004 at $413 billion. As a percent of the economy, the largest was 6 percent in 1983. Even before any new policies, the deficit in 2009 is already an astonishing 8 percent of gross domestic product or more. If deficit spending stimulates the economy, then a $1 trillion deficit should suffice to launch a rapid expansion. If $1 trillion is not enough to end the recession, then another $500 billion in deficit spending surely will not do any better.

No Downsides to Deficit Spending?

… The (often wrong) conventional wisdom is that Congress will pass a fiscal stimulus plan of a half trillion dollars or more early in 2009, including some mixture of extended unemployment insurance benefits, food stamp spending, relief to the states, highway spending, and whatever other ingredients can be tossed into the fiscal goulash.

Krugman argues that there can be none of the traditional crowding out of private investment when government increases its borrowing (driving the deficit up from a trillion dollars). There may be none of the traditional downsides, but there are none of the promised upsides, either. The simple fact is that when government borrows a dollar, either the dollar was borrowed at home (reducing domestic consumption or investment) or it was borrowed from abroad, thereby increasing the trade deficit. Either way, the increase in aggregate demand from government spending is matched by a reduction in aggregate demand from the private sector.

Investing for the Future

The economy is weak and weakening, so prudent, effective fiscal stimulus is certainly called for. But that does not mean increased spending. At a minimum, it means making the tax relief enacted in 2001 and 2003 permanent–especially the reductions in individual income tax rates, the reduction in the dividends tax rate, and the reduction in the capital gains tax rate. Threatening rate increases is no way to stimulate an economy, as Krugman notes in his editorial. …

Keeping current tax policy is not stimulus; it is the elimination of a threat. True stimulus means cutting individual and corporate tax rates to encourage entrepreneurs to start new businesses and existing businesses to invest more. The economy is certainly weak today, but business startups and investment are about the future. Current economic troubles will pass and the economy will regain its strength. Lower tax rates will encourage businesses to prepare better now for future growth and in so doing will bring about a future of stronger economic growth. An effective fiscal stimulus means cutting tax rates–not because of the resulting higher deficits but because tax rate cuts improve the incentives for workers, investors, and producers to do more, thus stimulating the economy.

The Grand Teton Mountains, Wyoming, USA (www.ohranger.com)

 

Critical View of Keynesian Economics (Peter Boettke – The Austrian Economists Blog)

Following is an article on “The Legacy of Lord Keynes” by Peter Boettke of George Mason University, one of the authors of  “The Austrian Economists” Blog (here) .  Here is a link to the full article:

http://austrianeconomists.typepad.com/weblog/2008/11/the-legacy-of-lord-keynes.html

 The Austrian Economists (economics.gmu.edu)

In this article, Boettke is critical of the fruits of Keynesian economic policies as practice in various countries since 1940.  His view is consistent with the “Austrian School” of economics which in general is very supportive of free market economic policies with limited government interference.  Correspondingly, this school of economic thougth typically takes a very dim view of the effectiveness government fiscal intervention upon economic growth.  

As you can deduce, Austrian economists are typically NOT in favor of the types of government fiscal intervention being practiced in these days.  For more on this train of economic thought I would encourage you to visit such websites as the Ludwig von Mises Institute (http://mises.org/), the CATO Institute (http://www.cato.org/), The Heritage Foundation (http://www.heritage.org/), The Foundation for Economic Education (http://www.fee.org/) and other free market economics-oriented websites.

My own personal leaning is in this “free market”, limited interventionist direction.  That said, I surely respect such capable economists as Greg Mankiw and Larry Summers.  Lets hope that capable and sound economic advice is provided to the incoming administration in regards to policies that will truly promote long term economic growth in the U.S., with as much limitation as possible in the debt leverage of the U.S. government upon the U.S. economy.

Following are a few pertinent exerpts from Peter Boettke’s article taking a critically constructive view of Keynesian economic practices.

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The Legacy of Lord Keynes

By Peter Boettke, George Mason University, pboettke@gmu.edu

….

“The problem with economics since 1940 has been the thorough victory of Keynes throughout the democratic western nations.  We have Keynesian theory, the development of Keynesian inspired data collection, the “testing” of Keynesian theory via Keynesian data with the purpose of providing tools for Keynesian policy.  This exercise survived the Monetarist and New Classical intellectual challenge, and it survived the Supply Side revolution in policy.  All that remained was an oscillation between liberal and conservative Keynesianism, never a serious challenge to the paradigm of Keynesian policy manipulation of the economy.”

“Instead of reading Keynes one more time with feeling, I would suggest an alternative reading experience. (Or at least an additional one)  Start with Henry Hazlitt, ed., The Critics of Keynesian Economics, move on to Hazlitt’s The Failure of the “New Economics”, graduate to W. H. Hutt’s The Keynesian Episode, and then read closely Buchanan and Wagner’s Democracy in Deficit and then Higgs’s Crisis and Leviathan and War, Depression, and Cold War.”

“Sincerely, you want to know what is going on in 2008 — it is the consequence of the bad economic ideas of Lord Keynes that have led to the victory of Keynesian policy (of either the liberal or conservative variety) since 1940.  We are living through the consequences of Keynes’s ideas. The Soviet Union had to confront the legacy of Marxist-Keynesianism in the 1980s, and we are dealing with the consequences of Social Democratic-Keynesianism in the 2000s.”

“Hayek warned us about the “tiger by the tail” problem of inflation and Buchanan warned us about the destruction of the “old-time fiscal religion” due to Keynesianism.  Yes, Marxism and Social Democracy caused serious problems as they reflected a breakdown in restraints on the power of government, but we have to also recognize the fundamental role that Keynesian ideas on economics and economic policy fed into this shift from constitutional democracy to social democracy throughout the 20th century in the West and the policy reality of conspicuous production for “growth accounting” in the Soviet Bloc nations after the Industrialization Debate in the 1920s, the Collectivization of the 1930s, and Five-Year Planning system from Stalin to Brezhnev. Keynesianism represented the pushing open of an already opened door to fiscal and monetary irresponsibility and opportunistic politicians left and right walked right through.  I am sure stating this sentiment this way will qualify me as a “wing-nut” in Brad De Long’s classifications, but instead of admitting my “wing-nutness” I would rather we have a serious discussion of the consequences of Lord Keynes with respect to world-wide fiscal imbalance associated with intergenerational accounting and world-wide inflation as governments attempt to meet those obligations through monetization of debt.  Somehow I doubt that will take place in our current intellectual and policy context.”

 

—

 

“Keynes isn’t the intellectual solution to our current woes, his ideas are one of the primary reasons we are in this mess in the first place. He was wrong in 1936, he was wrong in 1956 and 1976, and he is certainly wrong in 2008 and will be wrong in 2036.  Bad economic ideas result in bad economic policy which in turn result in bad economic consequences, and that simple linear relationship is true across time and place.  Until we come to grips with the implications of this, we will not understand the consequences of Lord Keynes for our economic future let alone the economic future of our grandchildren.”

The Canadian Rockies (here)

“Far-Reaching Reforms Can Wait” According to Robert J. Samuelson

In a December 1st article, Newsweek business and economics writer Robert J. Samuelson (background info) addressess the issue of whether or not the Administration of President-elect Barack Obama should aggressvely pursue various major reforms immediately in early 2009, or wait until the U.S. economy recovers. 

 Robert Samuelson’s weekly column explores political, economic and social issues. He began his journalism career in 1969 and has held positions at The Washington Post, The National Journal, and Newsweek. Samuelson has won numerous awards, including The Gerald Loeb Award for Best Commentary in 1993, 1986 and 1983 (Source for picture and description, Investor’s Business Daily Editorials- here)

Samuelson’s opinion on the preferable public policy / economic policy course for the Obama Administration to take is consistent with the title of the December 1st article, i.e., “Far-Reaching Reforms Can Wait“  The full article can be found at the following web address: http://www.realclearpolitics.com/articles/2008/12/obamas_hard_choice.html

Following are some key exerpts from the article, with underlines and bold text on areas that I personally think are most important to consider ….

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Far-Reaching Reforms Can Wait

By Robert Samuelson, Newsweek, 12/1/2008

WASHINGTON — As he assembles his economic team, Barack Obama faces a central strategic decision that only he can make. Starting with his “economic stimulus” plan, will he focus mainly on reviving the economy and relieving the financial crisis? Or will he use the economic crisis as a vehicle to advance a more ambitious social and economic agenda? The two approaches are at odds. The first aims at building political consensus and economic confidence; the second would intensify political conflict and economic uncertainty.

The decision ought to be easy. Every new president is assaulted by his own supporters, who want him to put their particular agendas atop his “to do” list. That’s already happening, as Obama allies clamor for speedy action to provide universal health insurance, combat global warming and support trade unions. But Obama — and the nation — would be better served if he concentrated for his first year on stabilizing the economy while patiently laying the groundwork for more far-reaching proposals.

The hallmark of this economic crisis has been its capacity to surprise: the desperate plight of the Big Three U.S. automakers is the latest reminder. We can expect more surprises, because the U.S. and global economies continue to weaken at a worrying pace. Consumer confidence has plunged. In October, U.S. factory orders for durable goods (machinery, autos, appliances) dropped 6.2 percent. Abroad, signs are no better. Worldwide manufacturing production is declining at an 8 percent rate. Germany is in recession; China’s growth has slowed sharply.

Against this backdrop, the parallel pursuit of crisis management and sweeping domestic reform is at best distracting. In practice, it may be politically poisonous. Superficially, the two objectives can be made to seem compatible. Obama can plug “green” investments as a way to restore job growth; he can tout a more efficient health-care system as a way to control health costs. But these rhetorical debating points obscure as much as they reveal.

Any program to refashion the energy and health-care sectors — to take these obvious candidates — would be complicated and contentious. Some producers and consumers would win; others would lose. Proposals would create massive uncertainties for businesses and raise the probability of higher costs. To succeed in curbing greenhouse gas emissions, for example, any “cap and trade” program must involve higher energy prices.

The notion that “green” investments would be large, permanent net creators of jobs is mostly a mirage. Somehow these investments must be paid for. If that happens through higher prices, higher taxes or cuts in other government programs, then “green” jobs will mainly substitute for other types of jobs. As for curbing health-care costs, that’s desirable. The trouble is that the first effect of Obama’s health-care program would probably be the opposite. Expanding insurance coverage would initially raise health spending, as greater demand for medical care met a (relatively) fixed supply of doctors, hospitals and clinics.

Obama won the election, and in normal times, his campaign agenda ought to be front and center. But these are not normal times, and what’s most important now — as he repeatedly emphasizes — is to prevent the recession from feeding on itself. This is a clear danger. Consumer spending (70 percent of the economy) has declined for five consecutive months. Eroding tax revenues may result in state budget deficits between $200 billion and $250 billion through mid-2011, estimates the Center on Budget and Policy Priorities, a liberal advocacy group. Required to balance their budgets, states face increased taxes or large spending cuts.

The compelling case for a big “economic stimulus” package is that it would cushion these and other spending declines. The odds are that any package will include the following: some direct payments to states; a renewed extension of unemployment benefits; tax cuts — reflecting Obama’s campaign pledge — of $500 for most single workers and $1,000 for most two-earner families; spending for infrastructure (roads, bridges, schools and, perhaps, windmills). Obama wants Congress to pass a stimulus package soon after his inauguration. Assuming he gets his wish, it’s then that he must make his crucial choice.

The temptation will be to press ahead with a “bold” legislative agenda — to ape the New Deal. This would be a mistake. The psychology of bruising legislative battles will not bolster confidence. The country does need to face its health and energy problems as well as deficit-ridden federal budgets. But trying to do too much too soon risks doing none of it well. We — and he — are caught up in a web of contradictions. In the long run, we need to discipline our appetite for health care and energy; we need to reconcile our desire for government benefits and our willingness to be taxed. But Obama’s first job is to avert an economic freefall.

Copyright 2008, Washington Post Writers Group

 The Andes of South America (amonty.wordpress.com)

Of “loose money and credit generated by the Fed”

Jeffrey A. Tucker, editor of Mises.org (http://mises.org/) has written an article titled ”Business Cycles, Not Our Fault“  In this article, Tucker argues that the real cause of the current calamity in the U.S financial system is “loose money and credit generated by the Fed”.  It is an interestingly relevant and thought provoking article.  Some relevant exerpts are presented below.  The full article can be found at the following web address: http://mises.org/story/3226 

—

“Business Cycles, Not Our Fault”

By Jeffrey A. Tucker, November 21, 2008

“We are told that the economy has tanked because foreigners invested too much in the US, that foreigners saved too much money, that we all lived beyond our means, that greedy capitalists fed our materialist instincts until we popped, or any combination of the above. Or maybe business cycles are just like weather, cold one season and hot the next. Regardless, it is the government that must come to the rescue with the usual combination of cockamamie schemes.”

“Discovering the Austrian business cycle theory, then, is a revelation, because through it, you learn how the whole business traces to loose money and credit generated by the Fed. The money is pumped into the capital-goods fashion of the day, in this case housing. The whole sector becomes overbuilt and unsustainable and it turns, tanking many other affected sectors. The only answer to the problem is not more of the poison that caused the problem but a real liquidation.”

 

Source: Welker’s Wikinomics website (www.welkerswikinomics.com)

—

“Lord Lionel Robbins wrote in 1934. His book called The Great Depression, ….. (in it he) presents the Austrian theory in a very precise way, and documents how the Fed and the Bank of England inflated the money supply and loosened credit in the latter half of the 1920s, leading to the bust. His is a cautious treatise in some way.”

“After all, he was blaming the central bank — not exactly a position that was politically wise — and we aren’t just talking about the equivalent of a blogger today. He was Lionel Robbins, the most influential economist in Britain until Lord Keynes stole the show with his whiz-bang policy ideas. And why? Robbins counseled letting the bad investments wash out of the system. Keynes thought you could use the state to rev the bad back to life.”

—

“The Theory of Money and Credit” by Ludwig von Mises (First edition, 1912)

“As another example, and really the definitive one, Ludwig von Mises himself was writing all throughout the late twenties and early thirties about the business cycle. He nails it all in essay after essay: the credit expansion, the malinvestment, the folly of counter-cyclical policy, the dangers of protectionism and reflation, and so much more. These essays could all be written today, and what is also impressive is Mises’s focus on theory. He never makes empirical claims that aren’t backed up by an attempt to explain the theoretical apparatus behind the analysis.”

 Economist Ludwig von Mises (1881-1973)

—

“All of this leads up to Rothbard’s America’s Great Depression, the book that is often cited as the one to show that the episode was caused not by the market but by the central bank. It is getting all new attention today. But if you follow his citations, they lead right back to Garrett, Robbins, and Mises — three of the observers of the time who saw precisely what was happening. They had to be ignored by the New Dealers, for they utterly demolish the case for stabilization policy.”

 

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For other information on economics that is running counter to the present stream of thought in regards to appropriate and needed government policy actions in response to current economic crises around the world, I encourage you to visit website for “The Ludwig von Mises Institute” (http://mises.org/).

Have a great Thanksgiving Holiday!  Here is an appropriate economic cartoon for your holiday meditations.

 

 

 

 

 

 

 

 

Source: Economist Stefan Karlsson’s Blog (here)

Mount Kilimanjaro, Tanzania, African Continent (19,340 feet in elevation)

Economist Greg Mankiw re: Proposed Fiscal Stimulus: $280,000 per job

Congratulations and thanks to Harvard Economist Greg Mankiw for his recognition of the cost per job for the proposed fiscal stimulus package of President Elect Barack Obama.  Following is the web address for the article….

http://gregmankiw.blogspot.com/2008/11/280000-per-job.html

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Monday, November 24, 2008

$280,000 per job

The Washington Post reports:

Facing an increasingly ominous economic outlook, President-elect Barack Obama and other Democrats are rapidly ratcheting up plans for a massive fiscal stimulus program that could total as much as $700 billion over the next two years….Obama has set a goal of creating or preserving 2.5 million jobs by 2011.

 

Let me amplify the last point with a rough back-of-the-envelope calculation. The average weekly earnings of production and nonsupervisory workers is about $600, or about $60,000 over a two-year period. Granted, labor income is only about two-thirds of national income, and we have to add a few supervisors into the mix. So let’s say each job created means $100,000 of extra national income. If we are generating $100,000 of income with $280,000 of government spending, the multiplier is only 100/280, or 0.36. By contrast, traditional Keynesian models suggest a multiplier closer to 2.0.

Dividing one number by the other, that works out to $280,000 per job.

What is going on here? Logically, it must be one of three possibilities:

1. The fiscal stimulus is going to be much smaller than is being reported.
2. The new administration is setting a low bar for itself when it comes to job creation.
3. The Obama team believes in very small fiscal policy multipliers.

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Greg Mankiw’s Blog address is http://gregmankiw.blogspot.com/

 

 

Thanksgiving Proclamation by Abraham Lincoln (1863)

Lincoln’s Thanksgiving Proclamation

Washington, DC—October 3, 1863

The year that is drawing toward its close has been filled with the blessings of fruitful fields and healthful skies. To these bounties, which are so constantly enjoyed that we are prone to forget the source from which they come, others have been added which are of so extraordinary a nature that they can not fail to penetrate and soften even the heart which is habitually insensible to the ever-watchful providence of Almighty God.

In the midst of a civil war of unequaled magnitude and severity, which has sometimes seemed to foreign states to invite and to provoke their aggression, peace has been preserved with all nations, order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere, except in the theater of military conflict, while that theater has been greatly contracted by the advancing armies and navies of the Union.

Needful diversions of wealth and of strength from the fields of peaceful industry to the national defense have not arrested the plow, the shuttle, or the ship; the ax has enlarged the borders of our settlements, and the mines, as well as the iron and coal as of our precious metals, have yielded even more abundantly than heretofore. Population has steadily increased notwithstanding the waste that has been made in the camp, the siege, and the battlefield, and the country, rejoicing in the consciousness of augmented strength and vigor, is permitted to expect continuance of years with large increase of freedom.  No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Most High God, who, while dealing with us in anger for our sins, hath nevertheless remembered mercy.

It has seemed to me fit and proper that they should be solemnly, reverently, and gratefully acknowledged, as with one heart and one voice, by the whole American people. I do therefore invite my fellow-citizens in every part of the United States, and also those who are in foreign lands, to set apart and observe the last Thursday of November next as a day of thanksgiving and praise to our beneficent Father who dwelleth in the heavens. And I recommend to them that while offering up the ascriptions justly due to Him for such singular deliverances and blessings they do also, with humble penitence for our national perverseness and disobedience, commend to His tender care all those who have become widows, orphans, mourners, or sufferers in the lamentable civil strife in which we are unavoidably engaged, and fervently implore the imposition of the Almighty hand to heal the wounds of the nation and to restore it, as soon as may be consistent with the divine purpose, to the full enjoyment of peace, harmony, tranquillity, and union.

In testimony whereof I have hereunto set my hand and caused the seal of the United States to be affixed.

Done at the city of Washington, this 3d day of October, A.D. 1863, and of the Independence of the United States the eighty-eighth.

Original Thanksgiving Proclamation by President George Washington (1789)

General Thanksgiving

By the PRESIDENT of the United States Of America
A PROCLAMATION

 The original Thanksgiving Proclamation (here)

WHEREAS it is the duty of all nations to acknowledge the providence of Almighty God, to obey His will, to be grateful for His benefits, and humbly to implore His protection and favour;

and Whereas both Houses of Congress have, by their joint committee, requested me “to recommend to the people of the United States a DAY OF PUBLIC THANSGIVING and PRAYER, to be observed by acknowledging with grateful hearts the many and signal favors of Almighty God, especially by affording them an opportunity peaceably to establish a form of government for their safety and happiness:”

NOW THEREFORE, I do recommend and assign THURSDAY, the TWENTY-SIXTH DAY of NOVEMBER next, to be devoted by the people of these States to the service of that great and glorious Being who is the beneficent author of all the good that was, that is, or that will be; that we may then all unite in rendering unto Him our sincere and humble thanks for His kind care and protection of the people of this country previous to their becoming a nation;

for the signal and manifold mercies and the favorable interpositions of His providence in the course and conclusion of the late war; for the great degree of tranquility, union, and plenty which we have since enjoyed;

– for the peaceable and rational manner in which we have been enable to establish Constitutions of government for our safety and happiness, and particularly the national one now lately instituted;

– for the civil and religious liberty with which we are blessed, and the means we have of acquiring and diffusing useful knowledge;

– and, in general, for all the great and various favours which He has been pleafed to confer upon us.

And also, that we may then unite in moft humbly offering our prayers and fupplications to the great Lord and Ruler of Nations and beseech Him to pardon our national and other transgressions;

– to enable us all, whether in public or private stations, to perform our several and relative duties properly and punctually; to render our National Government a blessing to all the people by constantly being a Government of wise, just, and constitutional laws, discreetly and faithfully executed and obeyed; to protect and guide all sovereigns and nations (especially such as have shewn kindness unto us); and to bless them with good governments, peace, and concord;

to promote the knowledge and practice of true religion and virtue, and the increase of science among them and us; and, generally to grant unto all mankind such a degree of temporal prosperity as he alone knows to be best.

GIVEN under my hand, at the city of New-York, the third day of October, in the year of our Lord, one thousand seven hundred and eighty-nine.

(signed) G. Washington

Source: The Massachusetts Centinel, Wednesday, October 14, 1789

Past Government Fiscal Stimulus Efforts Have Not Helped the U.S. Economy

Following is an article on the failure of past efforts in the United States to stimulate the its economy using Keynesian-style government expenditures (i.e., fiscal stimulus).  This article was written by Daniel J. Mitchell, Senior Fellow (here) at The Cato Institute (http://www.cato.org/). 

This article is particularly timely given the announced intentions of new administration of President Elect Barack Obama to pursue a government expenditure / fiscal stimulus package early in 2009 as part of a solution to problems in the U.S. economy (here).  According to Mitchell and many other notable economists, such attempts to revive economies in the past via government expenditures have been ineffective at best, and may have actually prolonged recessions and depressions in the past.

               

Following is the article as printed in “Pajamas Media“

http://pajamasmedia.com/blog/myth-government-spending-stimulates-the-economy/

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Myth: Government Spending ‘Stimulates’ the Economy

 

It’s just an excuse for politicians to dole out other people’s money. 

November 21, 2008 – by Daniel J. Mitchell

   

 

 

Whenever the economy stumbles, politicians and interest groups commonly argue that government spending should be increased. Based on a theory known as Keynesianism, this increase is supposed to boost economic performance. Yet the notion that bigger government leads to more growth is both theoretically unsound and empirically false. This strange theory was first put forth back during the 1930s, when America was suffering from a deep downturn. An economist named John Maynard Keynes argued that the economy could be boosted if the government borrowed money and spent it. According to this Keynesian approach, this new spending would put money in people’s pockets, and the recipients of the funds would then spend the money. This would, according to the theory, “prime the pump” as the money began circulating through the economy. The Keynesians also said that some tax cuts — particularly lump-sum rebates — could have the same impact since the purpose is to have the government borrow and somehow put the money in the hands of people who will spend it. 

So is this the right recipe to boost a flagging economy? Keynesian theory sounds good, and it would be nice if it made sense, but it has a rather glaring logical fallacy. It overlooks the fact that, in the real world, government can’t inject money into the economy without first taking money out of the economy. Put more bluntly, Keynesianism only looks at one-half of the equation. It conveniently ignores the fact that any money that the government puts in the economy’s right pocket is money that is first removed from the economy’s left pocket. As such, there is no increase in what Keynesians refer to as aggregate demand. The bottom line is that Keynesianism doesn’t boost national income, it merely redistributes it.

The people who lend the money to government generally are not the same people who get money in their pockets because of the new spending or tax rebates, but that’s not important. The Keynesian theory is based on the notion that there will be an increase in overall spending power, yet that clearly is not the case. Some advocates of this theory get a bit more creative and say that Keynesianism works because it increases consumer spending rather than the money sitting idle. But money that is unspent by consumers does not sit idle. It winds up in the banking system someplace and is used to finance investment spending. So-called stimulus programs, at best, shift how national income is used so that more gets consumed rather than invested, but at noted earlier, there is no increase in overall economic output.

It is worth noting that government could finance new spending through inflation. Thankfully that option doesn’t seem to be on the table since almost all politicians now realize that it would be foolish to mimic the disastrous policies of basket-case economies such as Argentina and Zimbabwe.

The real-world evidence also confirms that Keynesianism is a failure. Indeed, it was a failure even before Keynes published The General Theory in the mid-1930s. In his four years, Herbert Hoover was a poster-boy for big government. He increased taxes dramatically, including a boost in the top tax rate from 25 percent to 63 percent. He imposed harsh protectionist policies. He significantly increased intervention in private markets. Most important, at least from a Keynesian perspective, he boosted government spending by 47 percent in just 4 years. And he certainly had no problem financing that spending with debt. He entered office in 1929 when there was a surplus and he left office in 1933 with a deficit equaling 4.5 percent of GDP. Needless to say, Hoover’s big-government Keynesian experiment was not very successful since growth went down and unemployment went up.

  President Franklin Delano Roosevelt

Unfortunately, other than being a bit more reasonable on trade, Roosevelt followed the same approach. The top tax rate was boosted to 79 percent and government intervention became more pervasive. Government spending, of course, skyrocketed – rising by 106 percent between 1933 and 1940. This big-government approach didn’t work for Roosevelt any better than it did for Hoover. Unemployment remained very high throughout the 1930s and overall output did not get back to the 1929 level until World War II.

Other Keynesian episodes generated similarly dismal results, though fortunately never as bad as the Great Depression. Gerald Ford did a Keynesian stimulus focused on tax rebates in the mid-1970s. The economy did not improve. But why would it? After all, borrowing money from one group and redistributing it to another group does nothing to increase economic output. Tax cuts only boost the economy if they reduce the tax penalty on work, saving, and investment — i.e., lower tax rates, not gimmicks.

More recently, George W. Bush gave out so-called rebate checks in 2001 and 2008, yet there was no positive effect in either case. And Bush certainly was a big spender, yet that didn’t work either. Not that this should be a big surprise. Surveys of the academic literature reveal that even left-wing international bureaucracies are producing research showing that bigger government hurts economic performance by misallocating national resources.

Japan’s experience also shows the foolishness of Keynesianism. Throughout the 1990s, Japanese politicians tried to use so-called stimulus packages to jump-start a stagnant economy. But the only thing that went up was Japan’s national debt, which more than doubled during the decade and now is far above even Italy when measured as a share of GDP. The economy, not surprisingly, remained stagnant.

   

If Keynesian spending doesn’t make sense from a theoretical perspective, and also fails every time it is tried in the real world, why do politicians keep trying the same approach? Your guess is as good as mine, but the answer probably has something to do with the fact that politicians love to spend other people’s money, and Keynesianism is a convenient rationale.

Dan Mitchell is a senior fellow at the Cato Institute, and co-author of Global Tax Revolution: The Rise of Tax Competition and the Battle to Defend It.

Gary Becker (Nay) and Richard Posner (Yea) Debate U.S. Auto Industry Bailout

Gary Becker – a highly respected economist, and Richard Posner, an esteemed lawyer and former judge, debate the benefits and costs of the U.S. government bailing out the U.S. auto industry on “The Becker-Posner Blog” (http://www.becker-posner-blog.com/index.html).  

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A. Gary Becker - Opposing a U.S. Auto Industry Bailout

Gary Becker, 1992 Nobel Prize Winner in Economics (Dr. Becker’s website), presents his reasons for being against a U.S. Auto Industry bailout (here) in a blog entry titled “Bail Out the Big Three Auto Producers? Not a Good Idea-Becker“.  Following are a few key exerpts…

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“If GM is not bailed out, the company claims it will be forced into bankruptcy within a few months, and Ford’s situation is only slightly better. GM is blitzing Congress, President Bush, and President -elect Obama with pleas for a bailout, followed by a warning that bankruptcy will also hurt auto suppliers throughout the nation that depend on GM’s business. GM is also claiming that bankruptcy will put major financial pressure on the Pension Benefit Guaranty Corp, the federal agency that insures benefits to retirees in the auto industry as well as to million of other workers.”

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“Nevertheless, I believe bankruptcy is better than a bailout for American consumers and taxpayers. The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits. Only a couple of years ago, GM was paying $5 billion per year in health benefits to retirees and current employees because their plans had wide health coverage with minimal co-payments and deductibility on health claims by present and retired employees. In those days, the UAW was one of the most powerful unions in the US, and it bargained aggressively with the auto manufacturers, carrying out strikes when its demands were not met. When the American auto industry began to face tough competition from Japanese and German carmakers, they were saddled with excessive pay to their workers, and vastly excessive pensions and health benefits to their current and retired workers.”

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“Is GM “too big” to fail? I do not believe the company is too big to go into a reorganization-which is what bankruptcy would involve. Such reorganization would abrogate its untenable labor contracts, and give it a chance to survive in long run. A bailout, by contrast, would simply postpone the needed reforms in these labor contracts, the business model of GM, and its management.”

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B. Richard Posner - Supporting a Bailout of the Big 3 U.S. Automakers

Richard Posner (Judge Posner’s website) presents his reasons for being in support of a U.S. Auto Industry bailout (here) in a blog entry titled “Bail Out the Detroit Auto Manufacturers? Posner’s Comment“.  Following are some of Richard Posner’s thoughts on the subject…

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“Becker has laid out the case for refusing to bail out GM, Ford, and Chrysler. It is a powerful case, and if the drop in auto sales that is driving these companies toward insolvency had occurred two years ago, there would be in my view no case, other than a political one, for a bailout. But in the current financial crisis, I believe a bailout is warranted, provided that the shareholders and managers of the companies are not allowed to profit from it.”

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“The major problems with allowing the automakers to be forced into bankruptcy within the next few months are three, all arising from the depression that the nation appears to be rapidly sinking into. The first problem is that the companies might have to liquidate, because they might be unable to attract the substantial post-bankruptcy loans that they would need to enable them to remain in business. The credit crunch–less politely the near insolvency of much of the banking industry–has made that industry unable or unwilling to make risky loans, and loans to the auto companies after they declared bankruptcy would be risky.”

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“Second, not only the size of the automakers, but peculiarities of the industry, would cause bankruptcy to greatly exacerbate the nation’s already dire economic condition. In the very short term, the automakers would probably stop paying their suppliers, which would precipitate a number of the latter–already in perilous straits because of the plunge in the number of motor vehicles being produced–into bankruptcy. Many of the suppliers would probably liquidate, generating many layoffs. At the other end of the supply-distribution chain, consumers would be reluctant to buy cars or other motor vehicles manufactured by a bankrupt company because they would worry that the manufacturer’s warranties would be unenforceable. So more dealerships would close, producing more bankruptcies, liquidations, and layoffs. With the demand for the vehicles made by the Detroit automakers further depressed and the supply-distribution chain in disarray, the liquidation of those companies would begin to loom as a real and imminent possibility. Liquidation of the automakers would produce an enormous number of layoffs up and down the chain of supply and distribution. Such prospects reinforce the unlikelihood that a reorganized industry could survive on debtor in possession loans.”

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“The U.S.-owned auto industry may be doomed; it may simply be unable to compete with foreign manufacturers (including foreign manufacturers that have factories in the U.S.); or a reorganization in bankruptcy may be the industry’s eventual salvation. But the automakers should be kept out of the bankruptcy court until the depression bottoms out and the economy begins to grow again. …  Any bailout, however, should come with strict conditions, to minimize the inevitable moral hazard effects of government bailouts of sick companies. The government should insist on being compensated by receipt of preferred stock in the companies, on the companies’ ceasing to pay dividends, and on caps on executive compensation, including severance pay.”

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Some Comments

As economists say, this reasoned discussion of the pros and cons of this issue is “good stuff”.  Generally, I would side with Becker in thinking that the inexorable and ongoing economic pressures upon a noncompetitive economic enterprise such as the U.S. Auto Industry essentially doom it to perpetual unprofitability and eventual economic inviability. 

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From an individual point of view, I have never in my life bought anything other than a General Motors or Ford automobile.  However, now that “the veil is completely pulled back” in regards to the noncompetitive position and future inviability of these two companies who are so heavily dominated by noncompetitive union labor contracts and costs, I as a consumer wish that now I had the local option of at least considering the purchase of a Toyota, Honda, Kia or Nissan. These are the companies that are competitively positioned to survive in the current economic downturn, and to prosper beyond that. And they are not mortgaging the future of my children in this country by seeking to deepen the U.S. government’s debt at the present time.  Good will capital is a precious thing to preserve among your customer base. It could be that the Big 3 U.S. automakers are squandering their public goodwill with their intranscience over dealing with their noncompetitive labor cost issues. 

 

 Mount Hood, Oregon (www.summitpost.org)

 Another picture of Mount Hood (www.weiss-miller.com)

U.S. Auto Industry Noncompetitiveness – Higher Labor Costs

From an Economics Blog titled “Carpe Diem” (http://mjperry.blogspot.com/) comes the following information on wages earned by the Big 3 U.S. auto makers (i.e. Chrysler, General Motors and Ford) versus the “Japanese Transplants” (i.e. Toyota, Honda and Nissan).  Kudos to Dr. Mark J. Perry, a professor of economics and finance in the School of Management at the Flint campus of the University of Michigan.

See the following post in Carpe Diem for the full story (here). Note the $29 per hour pay gap between the U.S. based automakers and those originating in Japan with plants in the U.S..  These types of cost differentials are one of the primary reasons for the non-competitiveness of the U.S. automakers in Detroit. 

 

Daniel Ikenson of the CATO Institute also has a strongly written article on this issue at the Cato@Liberty blog.  See “A Cancer on the Big 3″ (here).  Here is a selected quote from his aricle…

“Why is GM (and Ford and Chrysler) seeking taxpayer subsidies when Toyota, Honda, Nissan, Kia, BMW, Daimler, Hyundai and other foreign nameplate producers, who are facing the same contracting demand and credit crunch quietly weathering the storm, are not? Because the latter have costs structures that haven’t been made obsolete and uneconomic by ludicrous union demands.  And, of course, they make cars that Americans want to buy.”

 

Swiss Alps (Eiger Glacier) (travel.webshots.com)