Saturday, February 07, 2009

Manna from heaven

Government doesn't spend money in the same way that a lot of people do. When government spends money it doesn't open up the piggybank and let the dollars flow, it just takes money from some people and gives it to some others. It doesn't truly spend, it simply reallocates. Therefore, for government expenditures to make sense the money being spent on the government project has to be at least as equally worthwhile as what it otherwise would have been spent on.

For example, I am willing to forgo $10 -- roughly the cost of a movie ticket -- to ensure that our roads don't have potholes. I am less willing to make that tradeoff, however, if it is being spent on building a golf course.

Understanding this is vital. If government spend $1 billion and creates a few thousand jobs people might hail that as a great development. What they don't see, however, are the jobs that weren't created because businesses had to pay $1 billion in taxes that they couldn't invest in their companies. What's worse, the money spent by the government on jobs are less likely to be viable in the long-term and have less benefit to the economy because if the investments require government money to succeed it is a good sign that they aren't that economically viable, otherwise they wouldn't have to go to the government in the first place for funding.

We all know this intuitively, with most of the products we use on a daily basis the product of investment by the private sector, not government.

All of this is particularly true in the context of the debate over the stimulus package:
Mr. Obama is now endorsing a sort of reductionist Keynesianism that argues that any government spending is an economic stimulus. This is so manifestly false that we doubt Mr. Obama really believes it. He has to know that it matters what the government spends the money on, as well as how it is financed. A dollar doled out in jobless benefits may well be spent by the worker who receives it. That $1 of spending will count as economic activity and add to GDP.

But that same dollar can't be conjured out of thin air. The government has to take that dollar away from someone else -- either in higher taxes, or by issuing new debt in the form of a bond. The person who is taxed or buys the bond will have $1 less to spend. If the beneficiary of that $1 spends it on something less productive than the taxed American or the lender would have, then the net impact on growth will be negative.

Some Democrats claim these transfer payments are stimulating because they go mainly to poor people, who immediately spend the money. Tax cuts for business or for incomes across the board won't work, they add, because those tax cuts go disproportionately to "the rich," who will save the money. But a saved $1 doesn't vanish from the economy, unless it is stuffed into a mattress. It enters the financial system, where it is lent to others; or it is invested in the stock market as capital for businesses; or it is invested in entirely new businesses, which are the real drivers of job creation and prosperity.
If everyone understood this the stimulus package would be laughed out of Congress.

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