Wednesday, December 09, 2009

Chart of the day II

Keynesianism isn't working:

The government keeps spending more and things keep getting worse. This should come as a surprise to no one, as the history of such stimulus is replete with failure. Government spending didn't work during the New Deal. It didn't work in Japan during the 1990s. And it isn't working now.

There are basically two ways to go about growing the economy. Either you can expand demand or expand supply. The most intuitive approach is the demand-side approach. After all, when people spend money more stuff is produced, thus employing more people and generating economic activity. Its appeal is obvious.

The problem with this approach is at least two-fold. First, while the economy may be temporarily stimulated, the additional government spending has done nothing to alter the fundamental calculus which governs economic decisions. Economic slowdowns occur for a reason. In the most recent case it is largely due to the collapse of the housing sector and entanglements with the financial sector, both aided and abetted by poor government policy. To get back on a path to growth the economy needs time to pull back and reallocate resources to more productive uses.

This brings us to the second problem with government spending meant to stimulate demand: there is little reason to think money spent by the government is put to more productive uses than had the money remained in the private sector to be allocated by market forces. Indeed, given political considerations which come into play about how money is spent, it can be safely guaranteed this money is generating less bang for the buck.

The alternative to demand-side stimulus is to encourage the expansion of the supply side of the equation. Rather than using government spending, supply-side expansion relies upon the use of incentives for businesses to produce more goods and hire more workers. While this can take the form of permanent tax cuts -- which alter the long-term calculations faced by businesses -- other options exist as well. Regulation can be eased, licensing requirements dropped. Both of these are impediments to economic activity.

Supply side stimulus is less attractive to politicians not only because it is perhaps less intuitive, but also because it reduces their power. If given the choice between weakening regulation and tax cuts -- which reduce the power of government -- or spending increases in which politicians are allowed to play the role of Santa Claus, the choice for many is not a difficult one.

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