Nothing Sooner

Charles Riley of CNN/Money recently posted a piece titled, “Doh! A Bad Time for Spending Cuts?,” in which he frets over the impact that a reduction in federal spending might have on the economy. In the article Mr. Riley quotes Martin Baily, senior fellow at the Brookings Institution, who says,

“If we did make significant cuts over the next few years, it would put a drag on the recovery.”

That’s hard to imagine.

In the first place – what recovery? The Bureau of Labor Statistics just published the June job numbers – all 18,000 of them. And to add insult to injury, they also revised down the numbers for April and May (May numbers having been overstated earlier by roughly 200%). The official unemployment rate, U3, was bumped back up to 9.2%. The U6 rate, a broader measure of unemployment, now stands at a whopping 16.2%.

If this is what massive government spending does for an economic recovery, then I say the sooner we get rid of it the better off we’ll all be.

In the second place – who really believes Washington will actually cut spending? According to Mr. Riley’s article, any spending cuts would be phased in over the next decade or so - which is to say they won’t happen at all. The most any Congress can do is control its spending in the present session (and as history has shown, it usually can’t even manage that much). No Congress can restrain future sessions from doing whatever they feel is politically expedient at the time – including repealing any laws passed by earlier sessions that attempt to bind them to any sort of fiscally responsible behavior.

And let’s clarify our terms here. When you or I talk about cutting our spending, we actually mean spending less money in absolute terms. For example, if I spend $1,000 in September but only spend $900 in October, I’ve cut my spending. When politicians talk about cutting spending, however, they usually mean increasing their spending at a slightly reduced rate than they would otherwise prefer. So when Obama projects a $9 trillion annual deficit over the next ten years but then settles for an $8 trillion annual projected deficit instead, he claims a $1 trillion “spending cut,” even though spending in absolute dollars has gone up from one year to the next.

After the current debt-ceiling “debate” theatrics are over, which version of the term do you think we’ll be left with? Will next year’s budget be smaller than this year’s, or larger?

Semantics aside, the CNN/Money article makes a number of Keynesian assumptions that deserve to be examined more closely. The core idea, of course, is that government is (and should be) the prime mover in the economy. When aggregate demand falls, government steps in to spend money to make up the difference – thus taking money from taxpayers so that the government can do that which the taxpayers themselves have freely chosen not to do.

In the case of Obama’s 2009 American Recovery and Reinvestment Act, a significant chunk of that money went to state and local governments in an attempt to shield them from the unpleasant consequences of their own bloated budgets and fiscal irresponsibility. In essence the Federal government acts as the “heavy” by indirectly taxing current and future citizens and then funneling the money back to the states, which are spared the unpleasant task of shaking down the voters directly.

As Reason’s Tim Cavanaugh reports, for example, the State of California is getting almost a billion dollars from the ARRA to shore up its insolvent unemployment insurance fund – all because California made it easier for people to go on welfare. (If California were a separate country, this kind of thing would be handled by the IMF).

Such are the realities of a politically-driven, command-and-control economy. Money does not flow to economically rational projects. It flows to politically desirable ones instead, most of which are economically irrational. The wealth-destroying results should not be surprising. In fact, economists Timothy Conley and Bill Dupor have attempted to quantify the level of wealth destruction that may be attributed to the Obama stimulus program. According to their survey,

“…the ARRA created/saved approximately 450 thousand state and local government jobs and destroyed/forestalled roughly one million private sector jobs. State and local government jobs were saved because ARRA funds were largely used to offset state revenue shortfalls and Medicaid increases rather than boost private sector employment. The majority of destroyed/forestalled jobs were in growth industries including health, education, professional and business services.”

Saving state and local government jobs is a dubious proposition even in the best of times. During a protracted recession it becomes even more difficult to justify maintaining the parasitic class at the expense of the productive class - particularly when that maintainence comes at a cost of two private sector jobs lost for every one government job saved.

Given the devastating effects that massive government spending has had on our economy, the answer to Mr. Riley’s original question is clear. Now is the perfect time for spending cuts. No time like the present! According to a recent Reason-Rupe Poll, many Americans agree: 69% of those polled considered it “very important” to reduce the national debt. 17% said it was “important,” and another 10% said it was “moderately important.” And 84% want federal government spending cuts to be part of the solution.

Evidently the average American citizen is smarter than the average Keynesian economist.

It is said that one of the most influential proponents of the Austrian school of economics, Ludwig von Mises, was once asked what the government should do to overcome a recession. His answer was, “Nothing. Sooner.” And broadly speaking, this was the approach taken by the US government in every recession, depression, or panic prior to the Great Depression. Not surprisingly, whenever the government pursued a laissez-faire approach, those downturns were comparatively shallow and short-lived, usually ending within 12-18 months. As economic historian Thomas E. Woods, Jr. wrote in his article titled, “The Forgotten Depresssion of 1920,”

“The conventional wisdom holds that in the absence of government countercyclical policy, whether fiscal or monetary (or both), we cannot expect economic recovery — at least, not without an intolerably long delay. Yet the very opposite policies were followed during the depression of 1920–1921, and recovery was in fact not long in coming.

The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent. No wonder, then, that Secretary of Commerce Herbert Hoover — falsely characterized as a supporter of laissez-faire economics — urged President Harding to consider an array of interventions to turn the economy around. Hoover was ignored.

Instead of ‘fiscal stimulus,’ Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third.

The Federal Reserve's activity, moreover, was hardly noticeable. As one economic historian puts it, ‘Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction.’ By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.”

It was not until the government’s experiments with massive interventionism, starting with Herbert Hoover, that depressions became “great.” The Hoover/FDR New Deal policies followed what would become the Keynesian playbook, spending unprecedented amounts of money to “stimulate” the economy. And what was the result? Historically high and intractable rates of unemployment, coupled with a massive public debt. It was not until the end of World War II – when the government slashed federal spending and eliminated many of its New Deal and wartime wage and price controls – that prosperity returned.

Much like CNN’s Charles Riley and countless others today, the Keynesians of the time all warned that steep cuts in the federal budget would send the economy back into recession after the war. It didn’t happen. The deep reduction in government spending and the general (though by no means complete) relaxation of government interventions in the marketplace freed up scarce resources for private-sector use, setting the stage for an economic boom the likes of which has not been seen since.

So which method should the government pursue in the face of the current recession? The hands-off approach that has historically allowed the economy to recover quickly and with less pain? Or the Keynesian approach, which has mired the economy in brutal and long-lasting stagnation?

For my part, I’d prefer the government do nothing – sooner.