September 9, 2010

Once Again, Government Spending Can't Spark Growth

Justin Katz

John Kostrzewa mentions, as if it should be a surprise, that temporary tax gimmicks have been as unable to spur the economy as giving away loads of money:

The federal housing tax credit was supposed to be the bridge between a dead real estate market in early 2009 and a recovery this year.

The idea was that an $8,000 credit would stimulate sales and stabilize prices, forming a floor under a housing market that had been sinking for three years.

For awhile, it seemed to be working.

But when it expired last month, and the private housing market was left to stand on its own, another reality hit home — the federal tax credit had become a bridge to nowhere.

Used this way — especially by a government already running deficits — tax credits are little more than government giveaways. Economically speaking, they're good, as far as government giveaways go, because at least they reward some sort of activity, but they're still just a limited drop of resources.

In that, such credits are in keeping with the flawed and failed approach that the Democrats have been taking to stimulating the economy. Essentially, Obama and Co. have been gambling that the private sector would come up with something as government hand outs bridged the economic gap. Back in 2009, I likened the method to adding water to a pond in the hopes that it would overflow its bounds somewhere and expand.

There are two problems with this strategy:

  • The government, by its nature, must take money from one area of the pond in order to dump it in another.
  • The areas that it has sought most rapidly to fill — maintaining or expanding money in the public sector and in select, struggling industries like housing, finance, and automobiles — were a problem precisely because they were artificially high.

Kostrzewa cites uncertainty as the root cause of continuing malaise, but that's more of a subsidiary cause. The free market thrives on uncertainty and risk. What makes the current uncertainty insidious is that it is the result of government usurpation of market mechanisms. In other words, it's not that people are uncertain about what will happen in the future — which they always are — but that they're uncertain about the very rules of the economic game under the micromanagement of a capricious government that's easily manipulated by special interests.

At this point, the only way to change that dynamic — barring a surprise breakthrough like another Internet — will be a plausible mea culpa by the federal government for its actions over recent decades, the last two years most of all. New policies should lower taxes permanently and withdraw the government's various fingers from the economy. And the only way for such a turnaround to be plausible will be in conjunction with major turnover in elected offices.

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Yes, consider the anemic Chinese economy sadly limping along at 8% growth per year, fueled largely by government spending.

However, the economic stability or boom in China is not caused by consumer spending. The average and typical Chinese consumer is as cautious as any other consumer in the world during moments of economic crunch. In fact, ‘private consumption has been steadily declining for some time, going from more than 60 percent of GDP in 1968 to 36 percent of GDP in 2008.’

In China, the ‘real big spender is the government.’ China’s economic recovery is said to have been bought by the state. After all, China’s Communist Party has nearly $2 trillion in reserves. With a stimulus plan to the tune of 4 percent of GDP, or twice as much as that of the US, China can swim comfortably in the proverbial rough seas of global recession without having to borrow from anybody.

The Chinese government has been pumping funds into investments in infrastructure such as rail lines and roads, among others. Since the start of the year, government spending has been up by 30 percent. Government funds have also been poured into the construction of new community centers, convention halls, and sports facilities, as well as refurbishing and reviving idle factories, retraining workers, and augmenting income aid to local governments that have been hard-hit by the recession.

The whole question is spending on what? Bank bailouts and tax cuts for the rich have clearly failed to create jobs for average Americans, however infrastructure spending is a good idea, long past due for the supposedly progressive Obama administration.

Posted by: Russ at September 9, 2010 11:14 AM

Comparing us to China? Russ, I'm guessing you'd also be ok with paying US workers at the same rate that China does, right? And you'd be ok if the skies in our biggest cities looked the same as Beijing? That's ok too?

Or do you want to keep cherrypicking?

Posted by: Patrick at September 9, 2010 11:19 AM

To put Patrick's response a bit more specifically: Russ's error is in his pronoun. The question isn't "spending on what," but "spending with what."

Clearly my commentary presumes a free society. If a government manages to so exploit its people as to have trillions of dollars in reserve, then putting some of that money back into circulation could have a stimulating effect, because the economic damage was done in taking it. Where a government must borrow from the future or initiate the confiscation, then that will have a suppressing effect.

Posted by: Justin Katz at September 9, 2010 12:08 PM

Russ, I'm afraid that arguing what we should be emulating China's economic policies is a bit like saying that because a baby grows 50% in its first year that we should all be on a steady diet of breast milk. There's a crucial bit missing from that analysis.

Posted by: Mario at September 9, 2010 2:24 PM

Merely pointing out that government spending can and does spark growth, especially in an economic downturn where consumer spending is on the wane and especially when the spending is for concrete improvements like infrastructure. That's evident to anyone not totally under the sway of rigid, free market fundamentalism. Interesting take btw on how taxes in a democracy are more oppressive than Chinese quasi-capitalist state run economy (it's like watching a fringe-right pretzel making contest!).

Me, I'm happy to acknowledge when markets work well and> where they fall short. For instance, consider this from yesterday in that socialist rag, HBR, from Dan Ariely.

Where the Free Market Fails: Online Dating

Posted by: Russ at September 9, 2010 2:51 PM

"Where a government must borrow from the future"

... in this case, borrow from the future via a country that is not necessarily that government's ally and certainly doesn't reflect that government's purported values in some critical areas.

Yet another ill-advised practice (the accumulation of massive debt being another) that the Obama admin has taken to heights hitherto not scaled by prior administrations is the continued diminishing of human rights via ingratiation with Beijing, "necessary" in the administration's eyes to keep our biggest creditor placated. But such a "necessity" would not be so great if the admin hadn't wanted to borrow so much money for so much questionable spending.

Posted by: Monique at September 10, 2010 4:05 AM

... I would be notably remiss if I did not add that, as the body with control over spending, Congress, including specifically the entire Rhode Island delegation, is even more culpable of putting ill-advised borrowing ahead of human rights.

Posted by: Monique at September 10, 2010 4:11 AM

Making false claims about government spending's ability to create economic growth, no matter how loudly, is not the same as proving them.

Perhaps our resident Liberal Fascist terrorists have stronger credentials as economists than do Thomas Sowell, Milton Friedman, and Frederic Bastiat?

I doubt it.

Posted by: BobN at September 10, 2010 12:12 PM

What a revelation! By the same thinking, sales of anything (services, products, whatever) can't possibly stimulate the economy because "by its nature, [it] must take money from one area of the pond in order to dump it in another." How clear it is to me now!

Meanwhile, back on planet earth. I thought this was an interesting take on tax cuts as panacea for all ills.

But of course revenue is not what these tax cuts are really about. Politics is. It was Irving Kristol’s Public Interest that gave supply-side economics its own favorable hearing in any kind of remotely respectable academic journal before Ronald Reagan embraced it in the presidential campaign of 1980. He admitted in 1995 he "was not certain of its economic merits but quickly saw its political possibilities."

And just what were these possibilities? To attack the "fundamental assumptions of contemporary liberalism that were my enemy…. Political effectiveness was the priority, not the accounting deficiencies of government." Writing in Financial Times in 2010, columnist Martin Wolff goes into greater detail regarding these political benefits as they have revealed themselves during the previous three decades. "The political genius of this idea is evident," he writes:

Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?” How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification—the argument from incentives—for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state. In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage.

Posted by: Russ at September 10, 2010 3:13 PM

"Resident Liberal Fascist terrorists?" Someone needs to cut down on the Glen Beck. As to the rest of it(and from the same link above)...

Hank Paulson, President Bush’s secretary of the treasury: "As a general rule, I don't believe that tax cuts pay for themselves."

No response necessary unless you think you know more about the economy that Paulson!

Posted by: Russ at September 10, 2010 3:19 PM

here's Russ extolling the Chinese.
Isn't Russ our resident environmentalist/global warmimg "expert"etc?
I guess it's inconvenient for him to discuss the massive damage the Chinese have been inflicting on their own envoronment and that of the world.
WE need to run everything on wind/solar,but the Chinese know how to use coal responsibly,hey,Russ?
Typical leftist hypocrisy.

Posted by: joe bernstein at September 11, 2010 5:45 AM

No response is necessary because of the obvious irrelevance of the quote. And Hank Paulson made his reputation as a trader, not as an economist, so he's no authority.

Who does this Russ guy think he is, putting conditions on other peoples' right to post comments here? Sounds like an authoritarian without authority to me.

Posted by: BobN at September 11, 2010 10:30 AM

Russ is some kind of poobah at RIF.I guess he thinks he has editorial authority here also.
He's also a Democrat ward committeeman -whoopee do!!

Posted by: joe bernstein at September 11, 2010 6:35 PM
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