Keynesian Economics: Still Failing After All These Years

I wrote this a couple of weeks ago, but didn’t post it here until I noticed that Michael Tanner of The Cato Institute agreed.

Keynesianism is still not working.

The central idea of the dominant economic philosophy in Washington, DC, is that when the private economy fails to produce enough demand, the government can and should step in to take up the economic slack. It should have been long since discredited. But like other bad ideas, people keep bringing it back.

No sane person would say we have not tried government spending to stimulate the economy. We’ve tried it over and over, and it does not work.

But still, some will beat a straw man until he cries for submission. Henry Blodgett, writing at Yahoo, noted that an important error had been uncovered in an influential economics finding.

Once the error was corrected, the “90% debt-to-GDP threshold” instantly disappeared. Higher government debt levels still correlated with slower economic growth, but the relationship was not nearly as pronounced. And there was no dangerous point-of-no-return that countries had to avoid exceeding at all costs.

The discovery of this simple math error eliminated one of the key “facts” upon which the austerity movement was based.

It also, in my opinion, settled the “stimulus vs. austerity” argument once and for all.

The argument is over. Paul Krugman has won. The only question now is whether the folks who have been arguing that we have no choice but to cut government spending while the economy is still weak will be big enough to admit that.

The straw man is twofold. First, debt is not just bad because it slows down the economy, which it does a little. Debt is bad because it eventually piles up and the interest crushes the economic life out of a nation.

Secondly, the 90% figure is important to those who identified the problem as the deficit (and taxes being too low), rather than as too much government that spends too much. Deficit and debt are symptoms of tring to spend our way out of a slow economy. As governments try to cushion the people from the effects of bad decisions or to spend their way to prosperity, they tend to develop high levels of debt. 

Spending is the problem, not the solution. And should some “unexpected” set of conditions force a rise in interest rates, the huge debt will leave us without good options.

Europe has tried “austerity” since 2008, but the United States has not. The meaning of austerity is different over there: higher taxes on the people, with only a little more spending. 

While dancing on the grave of austerity, the Keynesians sing a song of higher spending. Excess debt is fine, they chime, so high spending is nothing to worry about.

Contrary to Blodgett, all we have done since the 2010 elections is to keep the increases in government spending at bay. We are still spending an outrageous amount, and not getting anything for it.

Stimulus spending will continue to fail, because government spending, in and of itself, does not promote economic growth. There is no point going ever further into debt when doing so will not help.

If you say “A results in B,” and B doesn’t happen, then either A never happened or A does not, in fact, result in B.  In this case, if you say “Government spending results in economic growth,” and the economic growth doesn’t happen, either government spending never happened or government spending does not, in fact, result in economic growth. 

Why doesn’t government spending work? There are at least four reasons: taxation, regulation, bad aim, and dependency.

When government spends, it gets the money from somewhere: borrowing, printing, or taxation. In the end, all of these harm economic growth over the long term.

Borrowed money must be repaid with interest, resulting in taxes — and the anticipation of future taxes — that are higher than they would have been otherwise.  Printing money reduces its value, a tax on the buying power of the money people already have.

Government spending comes with regulations. This may be the worst aspect of spending, because it lasts long after the spending is done. Sometimes government gives away money apparently without strings, but show me someone who is unemployed, and I will show you a law or regulation keeping them that way.

Government seldom spends on the right things, in terms of trying to stimulate the economy.  If something were a good investment, the private sector would already be making it.  Free markets fill voids.

For instance, the federal government continues to spend money to keep home prices inflated, in order to keep people happy with their economic situation. The thought is that people who believe their homes are worth a lot will continue to pay on their mortgages and be better consumers in other areas. But that also means that some people who want to buy homes are priced out of the market. This is also why you have seen so many company layoffs when stimulus money runs out.  The market didn’t create the need for that job, easy credit and government money did.  When the money dries up, so do the jobs created. 

The government also malinvests when trying to encourage immature technology in the marketplace. Rather than waiting for market conditions to coalesce around ethanol, solar power, or electric cars, the government tries to encourage people to take them up before they make economic sense, or worse, to force their acceptance by fiat.

That’s not to say that all government spending is bad. It’s just that neither bureaucrats nor elected officials can pick the right things to spend money on to improve the economy. Even spending on infrastructure doesn’t, by itself, help the economy as a whole. The infrastructure that gets built may help the economy, or it may be a bridge to nowhere.

Finally, government spending produces dependency.  When government spends, people and companies sit around contemplating how to get the next handout. Instead of looking for a job, people tend to look in the mailbox. Rather than putting their time to productive use finding what people want to buy and selling it to them, companies focus on government grants and cost cutting. 

Even if governments print money to give away without any strings to everyone (so the right people are sure to get it), the result is dependency. Don’t take my word for it. Look around.

We have not tried cutting spending, slashing the bureaucracy, allowing markets to define technology and prices, or encouraging people and companies to make it on their own.  Until we do, the economic morass will continue.

Follow @lheal on Twitter.

Copyright FreedomWorks, 2013

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