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Government Spending Cuts Help the Economy

Posted by Jeff (ILoveCapitalism) at 6:12 pm - January 4, 2013.
Filed under: Conservative Ideas,Economy,Freedom,Real Reform

A few weeks ago, a piece on Bloomberg looked at the question of whether government spending cuts hurt the economy. (Hat tip: Hot Air) First, the authors remind us that a large public debt saps economic growth:

In a paper released this year, economists Carmen M. Reinhart, Vincent R. Reinhart and Kenneth Rogoff said that periods of debt overhang — when accumulated gross [ed: public] debt exceeds 90 percent of a country’s total economic activity for five or more consecutive years — reduce annual economic growth by more than one percentage point for decades.

Over 20 years, the authors write, there can be a “massive cumulative output loss” that reduces gains by 25 percent or more. The U.S. went over the 90 percent threshold after the 2008 financial crisis…

To grow robustly, the U.S. must reduce that debt overhang. But that would mean genuine spending cuts: large enough to give us a budget surplus. And that would cause a recession, right? Maybe not:

In the 1990s, Canada, for instance, reduced debt-to-GDP ratios through an aggressive combination of actual, year-over- year spending cuts and higher taxes. The result wasn’t malaise but a burst in activity.

The same happened in the U.S. right after World War II. In 1944 and 1945, annual government spending (in 2005 dollars) averaged about $1 trillion and represented more than 40 percent of GDP. By 1947, it had plummeted to $345 billion in 2005 dollars and 14 percent of GDP. Even facing the demobilization of millions of soldiers, the economy soared and unemployment fell despite almost universal fears that the opposite would happen.

Such outcomes are not flukes. Research by economists Alberto F. Alesina and Silvia Ardagna underscored that fiscal adjustments achieved through spending cuts rather than tax increases are less likely to cause recessions, and, if they do, the slowdowns are mild and short-lived.

…[especially] when spending reductions are accompanied by policies such as the liberalization of trade and labor markets…

Read the whole thing; they cite more examples of countries who achieved growth through government-cutting measures, like Sweden, or the UK in the 1990s. There are still more examples, which they didn’t cite: the UK in the 1980s (where Thatcher’s spending cuts enabled an economic boom), the U.S. in the early 1920s (where Harding’s spending cuts did likewise), and more.

Why should that be? Advocates of Big Government – some with Nobel prizes, some in the White House and some on GayPatriot – scream at us that only growth in government (such as “stimulus” measures) can give us a growing economy.

Well, they’re just wrong. The channels are many, by which growth in government hurts the economy – and conversely, cuts to government are what would help the economy. I can’t touch on all of the channels, here. In brief:

  • – A growing government inherently threatens people with future tax hikes and/or inflation (money-printing). (As we see with Obama, today.) The threat guts business confidence (in technical terms, it lowers the NPV; of all investment efforts that don’t service the government). Conversely, under a shrinking government, the threat recedes; confidence is restored.
  • – Government does things less efficiently than the private sector. As government becomes a larger share of the economy, the economy is inherently less efficient and productive.
  • Government spending grabs economic resources from the private sector, raising private sector costs over what they would have been. That drives marginal businesses ‘out of business’. Conversely, government cuts will release economic resources back to the private sector, lowering costs for everyone and letting new/small businesses thrive.

We all know there is some “optimal size” for government spending, as a percentage of the economy. If it were 0%, we’d have anarchy: no police, no courts, no military (all of which I would rather have). And if it were 70%, 80% or more, we’d have communism, a system that always fails. The optimal size is somewhere, between those extremes. This phenomenon has a name: the Rahn Curve.

More on the Rahn Curve, perhaps, in a future post. For now, suffice to say that studies show an optimal size of 17-23% (totalling all government at all levels). If we were on the ‘wrong’ side of it, then the more government spends, the slower we are going to grow. Sound familiar? Sound like the story of the last 5-10 years? Indeed, with our government spending now over 40% of GDP, we are far to the ‘wrong’ side of the Rahn curve. The way forward lies in cutting government.

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61 Comments

  1. I thought I’d gotten NDT’s point about the DC Metro, but on further reflection, I only just now really got it: his point is that the Metro is not efficient, but rather subsidized. Levi enjoys something given to him by taking from someone else (which is basically what a government subsidy is), and mistakes that for efficiency.

    It doesn’t matter that DC Metro doesn’t turn a profit, that’s not the kind of efficiency I’m talking about. The point is that this city could not function without the Metro. The traffic around here is already some of the worst in the country, and the layout of the city streets was planned in the 18th century, so there’s not much flexibility as far as what you can do on the surface. The Metro has enabled a huge amount of economic growth that wouldn’t have been possible otherwise.

    If I’m ‘taking’ because I ride the Metro to work, than so are all the people who are driving on the highways to get to work, are they not? You’re a taker, too! You didn’t built those roads, did you? If anything, I’m actually doing those drivers a favor, improving their commutes by keeping another set of four wheels off the road, am I not? That’s efficiency.

    What’s more, I figure my wife and I are pocketing $3,000 a year by taking the Metro to work, money that we can spend on vacations or to pay down debt or invest in stocks or whatever else. Multiply that figure by a few hundred thousand riders and you’ll begin to understand what I’m talking about when I say efficiency. That’s well worth whatever operational deficit the system may run.

    They’re actually adding another line out to Dulles airport that’s going to open up later this year. That means increased property value along the route, and there will undoubtedly be a lot of profitable coffee shops and newstands and shopping centers and restaurants springing up near all the stations. There is an outdoor amphitheater called Wolftrap along the route, too. It won’t have its own station to start, but they’re leaving open the possibility of adding it as a fill-in station in the future. Want to bet that when it happens, they’ll start seeing increased attendance and ticket sales?

    There’s more. I’d estimate that about 25% of people are using some kind of portable electronic device on the Metro, and more people are doing it everyday. Hell, I carry almost a thousand dollars worth of electronics between my smartphone and tablet to pass the time. People are listening to music, people are playing games, people are reading e-books – all of this stuff costs money. There’s no doubt that many riders’ time spent commuting factored into their buying decision for these expensive gadgets. And companies know it, too – there are ads for Apple iPods and Google’s Play Store plastered all over the place. If you want to go low-tech, you’re also taken care of. In the morning, at every stop, there is somebody handing out free, advertisement-supported, daily newspapers. Somebody’s making money off that, too.

    That’s a shitload of economic activity, isn’t it? Again, efficiency doesn’t really do justice to the effect that the DC Metro has on the regional economy.

    Comment by Levi — January 9, 2013 @ 1:11 pm - January 9, 2013

  2. Sorry Levi, the private sector is perfectly capable of running that – and would do a better job.

    You’re displaying a classic fallacy: “I see government doing it, therefore it must be true that only government can do it.” Imagine if the Constitution were written with a requirement that the government provide people with shoes. Then, all this time, shoes would have been a government-chartered monopoly like the Post Office. There would only be 3 crude kinds of shoes, and they would be $1000/pair. Poor people would own only a few pair in their lifetimes. And if I came along and said “But a private shoe industry could be so much better”, you’d freak out.

    That’s a terrible comparison. Making shoes is not the same as a decades-spanning, citywide engineering project. The DC Metro cost billions of dollars and took nearly 20 years of planning and construction before there was a product to offer the public – how many private companies could have taken on that kind of risk in the 1960’s? How would this private company have raised the capital? Who is going to buy stock in a company that’s taking on massive debts with no hopes of even beginning to generate revenues for twenty years?

    You can put this to the test, if you like. The city of Cincinnati began digging a subway system back in the 20’s (maybe even earlier, can’t remember exactly), but they couldn’t finish it because of the Great Depression and the war. The city government toyed with the idea of finishing the system at various points, but there’s never been a good time for it. So…. why doesn’t a private company descend upon Cincinnati and finish this sucker up? I mean if it’s as easy as you say it is, shouldn’t there already be a branded, nationwide private company that builds and maintains subway systems in cities like Cincinnati?

    Shoes are a problem for private companies to solve. Congestion and population growth are problems for the government to solve.

    Comment by Levi — January 9, 2013 @ 4:06 pm - January 9, 2013

  3. Especially when you say “Government is sometimes good”…

    This coming from someone who considers Ayn Rand to have no philosophical equals. Yes, Ayn Rand, who advocated that our national defense budget should be funded via voluntary contribution. It’s rational to be suspicious of government and the motives of those who work in it. It’s something else to make sweeping generalizations about the role of government without any qualification, qualification that makes such discussions actually useful. I’m not on the side of anyone who cannot recognize the necessary efficiency of government and national defense.

    Comment by Ignatius — January 9, 2013 @ 4:22 pm - January 9, 2013

  4. Translation: You saw government doing it; therefore (in your mind) only government could do it.

    Explained above in my response to your shoe analogy. Some problems are too big/not profitable enough for private enterprise to be effective at solving them.

    And it wasn’t a race against the UK, but against the USSR.

    I know that. Do you think I don’t know that?

    This kind of cherry-picking is a problem around here. That was a sentence in a paragraph, and you clipped out all of the context. Here’s what I said in full:

    I mentioned earlier that Germany is committing to using more renewable energy, to which you replied, “So what? Who cares?” I don’t know what kind of response that is, given how you seemingly agree that our economy benefited tremendously from government investment in the Space Race. What if we had sat on our hands and waited for the UK to land on the moon, do you think they could have done it before us? Do you think that we’d still have the technological edge that we earned for ourselves?

    With the full context, you can understand that I was referring to an earlier conversation I had with heliotrope. But if you clip all of that and focus on one half of one sentence in order to accuse me of being too stupid to know who we were racing against in the Space Race, than you’re just wasting time and creating distractions. I was clearly offering a hypothetical, and you’re trying to pretend like a didn’t know an elementary historical fact.

    In other words: the space race was conceived as, and partly was, a defense effort. Some say it cloaked a great deal of defense spending. Which I don’t entirely hate – aren’t I always saying that police, courts and military are the 3 things I’m absolutely sure that government should do? – And which you do hate – aren’t you always saying that you want to cut defense spending? What gives? Someday Levi, you will have to choose between your loyalty to Big Government and your hatred of national defense. And on that day, you will choose your loyalty to Big Government, thus becoming a full-on miltarist and fascist.

    There’s no denying the defense element of the Space Race. But it was also a battle for people’s imaginations. We wanted to put our best foot forward and demonstrate to the world that capitalism was a better system than communism. We wanted to take a seemingly impossible problem and solve it in front of friend and foe alike. That’s the sentiment behind Kennedy’s famous line “We do these things not because they are easy, but because they are hard.” Hearts and minds, city on the hill and all that.

    I’m all for defense spending that makes sense. Lots of defense spending doesn’t make sense, and most certainly should be cut. Once again, Mitt Romney went on national TV and complained that we didn’t have as many ships in the Navy today as we did a hundred years ago. The implication there is obvious – President Mitt Romney would have thought that building more ships was a wise investment of taxpayer dollars. That’s pretty stupid. Defense at the beginning of the 20th century required lots of ships, defense at the beginning of the 21st century does not. The same is true of tanks. Tanks are for fighting tanks, and who are we going to fight that has tanks? We have plenty already, and we keep buying more. Why should we even be considering cutting social security benefits when we’re buying tanks we’re never going to use?

    Comment by Levi — January 9, 2013 @ 4:44 pm - January 9, 2013

  5. Levi you can’t honestly say we’re never going to use all these tanks we’re buying up. A couple of decades from now, a country we’ve been selling our old crappy tanks will do something we don’t like. When we invade, our fancy new tanks will be superior on the battlefield, and we will win! Then the cycle can repeat itself.

    Comment by Aaron — January 9, 2013 @ 5:07 pm - January 9, 2013

  6. This coming from someone who considers Ayn Rand to have no philosophical equals.

    You sound annoyed. I’m OK with it; it’s sort of the ‘bitchy Iggy’ that I remember.

    I’m not on the side of anyone who cannot recognize the necessary efficiency of government and national defense.

    How fortunate for me, that I have stated the positive necessity of government defense spending (while still also noting its inefficiency; the two characteristics are not exclusive; it’s a false choice to pretend that they are) in several comments, including my original post, as well as comment #6 where I explicitly stated my agreement with you, on the matter of its necessity.

    Comment by ILoveCapitalism — January 9, 2013 @ 6:33 pm - January 9, 2013

  7. I’m not annoyed at all (but if it flatters you to think I am, so be it); I’m just pointing out something humorous you stated some time ago. And I am also pointing out the necessary efficiency of government financing of national defense, not presenting a false choice. There are some areas about which we have no choice.

    Comment by Ignatius — January 9, 2013 @ 7:33 pm - January 9, 2013

  8. Actually I’ll just toss a Wikipedia link about the doomed subway Levi mentions.

    Funny thing… “Why has no private business swooped in and finished it?”

    Meier’s Wine Cellars Inc. wanted to use the subway tunnels to store wine, as well as install a bottling operation to draw tourists, but it fell through due to a lack of proper building codes.

    Yup, that’s government efficiency for you. Oh, but wait!

    In 2002 the subway tunnels were proposed as a route for a regional light rail system that would cost $2.6 billion and take thirty years to build.

    What happened here? Surely Government will save us!

    The plan was voted down by more than a 2-to-1 ratio.

    Curse those groundlings and them believing they can spend their money better!

    Comment by The_Livewire — January 9, 2013 @ 7:45 pm - January 9, 2013

  9. Well Iggy, just so you know: Rand’s position on something (even when you manage to state it accurately, which is far from certain) will never impress me, unless I happen to agree with the position after using my own mind. I don’t get into authority games. Her view may often make a useful and interesting starting point, because she was a great and original synthetic thinker. But there have been others.

    Comment by ILoveCapitalism — January 9, 2013 @ 11:09 pm - January 9, 2013

  10. Ignatius,

    I’d argue it’s not a matter of efficiency, but of loyalty. In theory, I hire a guy to protect me, he’s going to protect me. I hire a guy to protect the community, he’s going to protect me, and the community. Snopes aside, the US military pledges its’ oath to the Constitution (and of course each other in combat.) David Drake wrote about the later. That essay helped me understand, despite being best friends, despite being the godfather to his kids, my ‘little brother’ had experiences I’d never had, nor want, that put him closer to his fellow vets in some ways than me.

    A national defense works, in theory, because the people in harm’s way come from all over. Ohio vs. Michigan rivalries pale between “Us” and “Them”.

    Comment by The_Livewire — January 10, 2013 @ 10:54 am - January 10, 2013

  11. sock reset

    Comment by V the K — January 10, 2013 @ 5:40 pm - January 10, 2013

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