A wonderful AFR article today by Art Laffer (yes, the curve man) notes the abject failure of Keynsian stimuluses in resurrecting economies from recessions – indeed Laffer’s research shows what many of us already know: a fiscal stimulus brings lower levels of output and lower employment.
It is clear, now, that a massive stimulus administered was an abject failure. It condemned America to the worst recovery in its history – including the 1930s. But when politicians make decisions while either panicked or drunk, the consequences are rarely edifying or attractive. US Treasury secretary Hank Paulson hyperventilating before Congress to pass his three-page stimulus bill granting him total authority to spend $US700 billion to save the economy was a sight to behold. Why, he even insisted the need was so urgent that there was no time for hearings, reviews or oversight. And passed it was – with some $US2.8 trillion additional stimulus funds over the coming few years. And what happened? American unemployment levels soared.
The Keynesians warned that the post-Cold War spending cuts that occurred under President Clinton would cause economic contraction – instead we had an employment boom to match all booms. Obama’s economists revved up their economic model to justify spending an additional $US830 billion in stimulus, saying it would keep unemployment low. Without a stimulus, they said, joblessness would be 8 per cent. Instead of making things better, subsequent joblessness was higher than they predicted, peaking at 10 per cent.
As my former colleague Milton Friedman often said: “Government spending is taxation.” Beyond the essential services government provides – such as roads, courts, schools, police and fire services, and the military – government spending doesn’t actually create resources. It just redistributes resources. For every beneficiary of government largesse, there’s someone who pays for that largesse. When the money the government takes from workers and producers is used to pay people and companies not to work – food stamps, unemployment insurance, bailouts, Obamacare health subsidies – it’s a double whammy.
Those who receive payments for not working have now found an alternative source of income without working, which causes them to work less. This slows the economy, not to mention the waste of human talent.
So few economists understand these basic relationships but instead they wire themselves into models that rely on tricking people into thinking there is more demand and money around than is actually the case, so that firms spend on investments and start a virtuous circle. Plausible, but the empirical evidence is in – austerity means resources allocated more productively than if they are redirected by government hand-outs. All the deficits in the US and other developed countries have done is consign the economies to zero growth at best.
Less convincingly, Laffer also argues that the US sequester actually means the US will move to end fiscal surpluses faster than other countries and will therefore recover. In 2013 the US general government spending remains at over 38 per cent of GP compared to 34 per cent pre GFC. And although government deficit( expressed as new borrowing) is down from the 13 per cent of GDP in 2008, it remains at over 5 per cent and would seem to be a decade away from a balance even if the sequester holds.