Last quarter, I wrote a guest post called Does government spending help the economy? Phrased as a question, because it reviewed an Arthur Laffer article that (in my view) fell just a little short of proving its case.
Tom wants to open a restaurant. He makes the following calculations. He estimates the restaurant’s revenues at $10,000 per month. The expected costs are the following: $4,000 for rent; $1,000 for utilities; $2,000 for food; and $4,000 for wages. With expected revenues of $10,000 and costs of $11,000 Tom will not start his business.
Let’s now assume… reduce[d] government spending. Let’s assume that the government closes a consumer-protection agency and sells the agency’s building on the market. As a consequence, there is a tendency for housing prices and rents to fall. The same is true for wages. The laid-off bureaucrats search for new jobs, exerting downward pressure on wage rates. Further, the agency does not consume utilities anymore, leading toward a tendency of cheaper utilities. Tom may now rent space for his restaurant in the former agency for $3,000 as rents are coming down. His expected utility bill falls to $500, and hiring some of the former bureaucrats as dishwashers and waiters reduces his wage expenditures to $3,000. Now with expected revenue at $10,000 and costs at $8,500 the expected profits amounts to $1,500 and Tom can start his business.
Bagus’ example is exaggerated for clarity: the point is that government spending takes resources of all kinds from the private sector (whether natural, financial, human, industrial, real estate, etc.). Even if government doesn’t commandeer the resources – if government generously (or wastefully?) bids top dollar for them on the open market – matters are worse, because businesses and consumers alike are faced with higher costs. Struggling businesses shut down, or are never started. Consumers can only spend on essentials, as food and gas and housing prices are all raised, and as jobs are lost. Sound familiar?
Conversely, if government spending is cut, then economic resources are released back to the private sector. Both businesses and consumers find their costs dropping (or at least not as high as they would be). Struggling businesses survive, and adventurous people start new businesses.
Leftists are terrified of that phenomenon. They coin scary words for it, like “deflation”, to try to stampede people into supporting ever-greater government spending. But “deflation” only means, declining prices. It’s a very good thing. When people have to pay less for food and gas and flat-screen TVs, their living standards have just gone up. They can spend more on other businesses. And when businesses can pay less for real estate, and ex-bureaucrats add plentifully to the unskilled labor markets, we get more new businesses and new jobs.
Such an economy will see more loan defaults; but that, too is a good thing: Irresponsible lenders (and borrowers) are punished by their defaults. And responsible lenders (and borrowers) thrive, as economic resources are released from the terrible burden of having to service giant, uneconomic debts that can’t be repaid.
Leftists have scary words for the loan-default cycle also, like “depression”. But a depression (such as the U.S. Great Depression) only lasts beyond a year or two when, and because, government deliberately gets in the way of economic adjustment (which the U.S. government did, under both presidents Hoover and Roosevelt). The U.S. economy came roaring back from the Depression of 1920, precisely because a small-government president (Harding) allowed free markets to work quickly to clear the economy’s deadwood.
Leftists have more scare terms for people, like “lack of demand”, “liquidity trap”, and emphasizing the initial recession that must happen when we first cut government spending and fire some bureaucrats. But I can’t take the space, right now, to refute every leftist canard.
Suffice to say that Obama’s spending policies are exactly wrong for our economy. They prevent economic recovery. Leftists claim that Obama’s policies haven’t been given enough time to work. They’re right… in a different way than they think: Obama’s policies can never work. No amount of time will be enough for policies of ever-greater government spending to fix the economy.