After the 2007-2009 global financial crisis, fears of ballooning public
debt and worries about the drag on economic growth pushed authorities in some
countries to lower government spending, a tactic that economists now think
may have slowed recovery. Note that in the United States the total debt to
GDP ratio stood at 349 in Q1 this year.
In a paper presented at the Kansas City Federal Reserve’s annual economic
symposium on August 26 2017, Alan Auerbach and Yuriy Gorodnichenko from the
University of California suggested that “expansionary fiscal policies adopted
when the economy is weak may not only stimulate output but also reduce
debt-to-GDP ratios”. (Fiscal Stimulus and Fiscal Sustainability, August
1,2017, UC – Berkley and NBER).
Some commentators are of the view that these findings may be welcome news
to central bankers who face limited options of their own to combat a future
downturn, given existing low interest rates and low inflation rates in their
economies. "With tight constraints on central banks, one may expect
— or maybe hope for — a more active response of fiscal policy when
the next recession arrives," the University of California researchers
wrote.
These findings are in agreement with Nobel Laureate in economics Paul
Krugman, and other commentators that are of the view that an increase in
government outlays whilst the economy is relatively subdued is good news for
economic growth.
Can increase in government outlays strengthen economic growth?
Observe that government is not a wealth generating entity as such
— the more it spends, the more resources it has to take from wealth
generators. This in turn undermines the wealth generating process of the
economy.
The proponents for strong government outlays when an economy displays
weakness hold that the stronger outlays by the government will strengthen the
spending flow and this in turn will strengthen the economy.
In this way of thinking, spending by one individual becomes part of the
earnings of another individual, and spending by another individual becomes
part of the first individual's earnings.
So if for some reason people have become less confident about the future
and have decided to reduce their spending this is going to weaken the flow of
spending. Once an individual spends less, this worsens the situation of some
other individual, who in turn also cuts his spending.
Following this logic, in order to prevent an emerging slowdown in the
economy’s growth rate from getting out of hand, the government should step in
and lift its outlays thereby filling the shortfall in the private sector
spending.
Once the flow of spending is re-established, things are back to normal, so
it held, and sound economic growth is re-established.
The view that an increase in government outlays can contribute to economic
growth gives the impression that the government has at its disposal a stock
of real savings that can be employed in emergency situations.
Once a recessionary threat alleviated, the government may reduce its
support by cutting the supply of real savings to the economy. All this
implies that the government somehow can generate real wealth and employ it
when it sees necessary. Obviously, this is not the case.
Given that the government is not a wealth generator, whenever it raises
the pace of its outlays it has to lift the pace of the wealth diversion from
the wealth-generating private sector.
Hence the more the government plans to spend, the more wealth it is going
to take from wealth generators. By diverting real wealth towards various
non-productive activities, the increase in government outlays in fact
undermines the process of wealth generation and weakens the economy’s growth
over time.
The whole idea that the government can grow an economy originates from the
Keynesian multiplier. On this way of thinking an increase in government
outlays gives rise to the economy’s output by a multiple of a government
increase.
However, is it possible that an increase in government will give rise to
more output as popular wisdom has it? On the contrary, it will impoverish
producers.
Producers are forced to part with their product in an exchange for goods
and services that are likely to be on a lower priority list of producers and
this in turn weakens the flow of production of final consumer goods.
Not only does the increase in government outlays not raise overall output
by a positive multiple, but on the contrary this leads to the weakening in
the process of wealth generation in general. According to Mises,
…there is need to emphasize the truism that a government can spend or
invest only what it takes away from its citizens and that its additional
spending and investment curtails the citizens' spending and investment to the
full extent of its quantity.
Contrary to our University of California researchers and commentators such
as Krugman, at no stage of the economic cycle can an increase in
government outlays be supportive to economic growth. On the contrary, what is
required is to cut government outlays as much as possible, thus leaving more
wealth in the hands of genuine wealth generators.
A cut in government outlays is great news for wealth generators and to the
economy. It is of course bad news for various artificial forms of life that
emerged on the back of increases in government outlays and cannot survive
without the ongoing support from these outlays.
