Tuesday, January 03, 2012

The Marginal Utility of Government Pump-Priming

What has happened over the last generation is the unraveling of the Keynesian economic model.   Sadly, the political class will be among the last to accept that it doesn't work anymore because it preached "the truth they wanted to hear."     I want to briefly describe here why it seemed to work for a time and why it increasingly will not work anymore.

The key feature of the system was government "pump priming."   That is, when the private sector was in an economic slowdown, the government would take up the slack by increasing spending in order to get the economy going again.   Off course, if they taxed this money and paid as they went, it would subtract money from the private economy and cancel out their efforts.   Under Keynesian ideals, you used debt to prime the pump during these lean times.

So the government borrows money and spends it to get the economy growing again.   And under the classical Keynesian view, it almost didn't matter what you spent it on:  Digging holes and re-filling them.  Building tanks only to see them blown up in war or sit in a depot to rust.  The end results were all the same.  The important thing is that money was injected into the economy.   Even if the government did not spend it efficiently, once that dollar was injected it was in the hands of the private sector and they would spend it effectively as it cycled through the economy.

To be fair to Keynes, politicians abused his actual concept.   The idea was that the government should borrow in bad times to prime the pump, and repay it in good times, thus smoothing out the business cycle.  What a charming naivety people must have had back then to think that politicians would use their term in office to insist people take a tax hike or cut down on services to pay down debt run up by their generational predecessors!   Instead, they borrowed in bad times and failed to repay in good times.

At first, it worked like a charm.   Eventually, the debt became a constant overhang on the economy.  This is because government spending does not actually "create jobs."   In the long run, it costs jobs because government spends less effectively than the private sector.   Of course those rascals pretend that they are "investing" in these government projects, and assume that their interventions in the economy somehow improve its efficiency rather than distort it.    

But the bottom line is that government spending via debt does not "create" jobs, it only borrows them from the future, minus the cost of interest and resource miss-allocations.   Politicians point to the jobs their spending brought, but we never see the future jobs lost as a result of the politicians over-riding the market and forcing dollars to be spent in one place when the free choices of the population would, if allowed to, spend them in other places.

So the politicians found a way to put off consequences into the future and they pursued that way with reckless abandon.   As each down turn in the business cycle was short circuited by a new infusion of government largess, the government's share of the total economy ballooned.   We are now at a point where increased Keynesian injections will not stop a fiscal catastrophe, they will only make deeper the hole in which we now find ourselves.  

Consider that when government spending was only one 50th of the economy, it did not matter so much that the money was mis-allocated compared to how it would be spent in the private sector, because the private sector was the one spending those injected dollars 49 times out of 50.   The drag on the economy from the government allocating that spending less effectively than the private sector would was dwarfed by the number of times those dollars would move through the private sector.

Even if the government wasted half the money over-building highways or purchased $100 hammers for the military, that represented only a 1% loss to the total economy (one 50th of all spending half wasted), and that loss was put off into the future.  Pump priming in those circumstances seems worth it at the time.

Fast forward to now.  The government is now one third of the economy, and they are driving much of the spending that occurs in the rest of it.     When one third of the dollars in your economy are not allocated on a free market basis you are going to have enormous miss allocation of resources.  The government spending will result in a massive destruction of wealth which will be all out of proportion to any good it does getting the remainder of the economy to create wealth.  One of every three dollars is miss-spent, not one out of fifty dollars.   This gigantic miss allocation of resources,  along with the debt required from past government pump-priming, have ruined the private economy.

The Keynesian experiment was always doomed to fail as long as it is true that dollars spent by government will be spent less productively than dollars spent by individual free choice (which is to say, the market).   Those politicians who refused to pay down the debt in the good times actually did us a favor in that they compressed the time it took for the failure of Keynesian-ism to become obvious.   They reduced the number of iterations of pump priming required for it to become clear that every time government primed the pump, it wasted water and thus increase the amount of water needed for the next priming.

We have some tough times ahead of us, due to the gross mismanagement and criminal corruption of our current ruling political class.   Their blindness is not restricted to moral blindness, but is total.  They are so immersed in the Keynesian view that they will be among the last to see that it has failed.   We must liquidate our bad debt and return to a free market economy with very little government overhead in order to return to prosperity.  

It is too bad that our current ruling class holds much of that bad debt and has gotten rich through their connections to a large interventionist government.    This will make reform difficult, because the old ruling class will have to suffer the consequences for their poor decisions both politically and financially.  In a worst case scenario, they are sociopathic and self-entitled enough that rather than accept these consequences, they will clamp down on the rest of us and double-down on their poor bets.



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