Cutting Government Will Boost the Economy

Budget sequestration is as modest a step toward cutting
Leviathan as one can imagine. Further progress will be difficult as
long as people believe that slashing the size of government
conflicts with reviving the economy. Nothing could be further from
the truth.
In his recent debate on Charlie Rose,
Nobel Prize-winning economist and New York Times columnist
Paul Krugman said that even wasteful government spending should not
be cut, because it would undermine job creation and economic
recovery. This view isn’t quite as popular as it once was, but it
is still influential.
The logic of the argument is that insufficient consumer spending
caused the Great Recession, the anemic recovery, and persistent
high unemployment. If people aren’t spending, so goes the argument,
businesses lay off workers. And when the newly unemployed workers
reduce their spending, more workers are laid off. This ripple
effect puts the economy into recession. To end the recession,
consumer demand must grow again, but it can’t grow because
unemployment is high. It’s a vicious circle: people don’t spend
enough because they don’t have jobs, but they can’t find jobs
because people aren’t spending enough.
Therefore, says Krugman, government must spend. This is why he
supports more debt. And this is why he thinks cutting spending to
rein in the deficit is precisely the wrong thing to do now. Keep
the deficit spending going to create jobs, Krugman says, and worry
about the debt later. There’ll be plenty of time for that.
If this were really how things worked, we’d be in a fix. But
they don’t work that way. Business cycles — the boom and bust —
don’t happen because consumers all mysteriously decide to cut their
spending, throwing people out of work. And since that’s not the
cause of the downturn, increased government spending is not the
cure.
In other words, the spending frenzy, the deficit, and the debt
all can be addressed while the economy is recovering. In fact,
radically downsizing government is the key to recovery.
Recessions begin because a string of large-scale business
investments prove to be unsustainable in light of real economic
conditions. Why would so many entrepreneurs make the same mistake
at the same time? Because the government and its central bank — the
Federal Reserve — create misleading signals in the form of
artificially low interest rates and (before the most recent
recession) artificially high demand for housing. These policies
fool entrepreneurs into thinking that consumers are saving rather
than spending, that is, deferring consumption until the future.
Businesses then use the easy credit for long-term
interest-rate-sensitive projects, such as housing and stages of
production remote from the consumer-goods level. Yet consumers have
not curtailed spending.
The recession sets in when interest rates rise and the cluster
of errors is revealed. The malinvestments are liquidated, and
workers are laid off. If the economy is to recover, the structure
of production must be realigned with real economic factors,
including people’s consumption/saving preferences. This is a costly
and time-consuming process because workers may need retraining,
buildings may need modifying, and machinery may need to be moved or
junked. Government policy misshaped the economy, which now must be
reshaped into something more appropriate.
Government’s only proper task is to get out of the way so that
the recovery can be as fast and painless as possible. In the past,
when government cut spending and taxes with the onset of a
recession, recovery was sure and swift. What the economy needs is
resources — savings — to recover. If the government consumes scarce
resources, they are unavailable for private efforts. And if the Fed
keeps interest rates low, it discourages saving.
Krugman and other Keynesians are wrong when they call for more
deficit spending, because that would transfer scarce capital from
recovery efforts to politicians, who can have no idea what they are
doing. Since government spending faces no market test, it is
unlikely to be what is needed. Only investment guided by the price
and profit/loss system can make things right. But that requires
government to relinquish its claim on private resources.
We can have a vibrant economy and much less government.
This article
originally appeared at The Future of Freedom
Foundation.

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Cutting Government Will Boost the Economy


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