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again with the armchair economics

In recent days Paul Krugman has linked to a variety of articles from several years ago by conservative economists proving mathematically that government spending cannot possibly create economic activity or jobs: see the National Review's David Freddoso interviewing the Heritage Foundation's Brian Riedl, and Eugene Fama's article arguing against government bailouts and stimulus. In both cases, the argument boils down to this:

  1. Government spending has to be paid for by government borrowing.
  2. Government borrowing crowds out borrowing by private corporations.
  3. When private corporations can't borrow, they have less capital to invest in expansion and job creation.
  4. Therefore every dollar government spends to "stimulate" the economy is one less dollar the private sector will spend to stimulate the economy, so the net effect is, and mathematically must be, zero.

One problem with this reasoning is that, since it's based on mathematical equations, it works equally well in the opposite direction: every dollar the private sector spends on stimulating the economy is one dollar less that the government can spend on stimulating the economy, so private-sector investment also cannot possibly create economic activity or jobs. I don't think that's the conclusion the Heritage Foundation wants people to reach.

Another problem is the last step of the reasoning, from "capital available for investment in expansion" to "capital invested in expansion." This relies on the old right-wing assumption that the availability of investment capital is a necessary and sufficient condition for job growth, so if we just make life cushy enough for investors, job growth will inevitably happen.

That assumption may actually hold in an economy that's running at capacity. But (as some of you may have noticed) we're not in that economy, and haven't been for years. If your factory is running at 60% capacity due to a lack of demand, it makes no sense for you to expand it, no matter how much capital you have. You might invest in automation so you can produce the same number of widgets with fewer employees, or you might invest in building a factory abroad so you can produce the same number of widgets with cheaper employees, or you might invest in buying your competitors and building a monopoly so you can make more profit on the same number of widgets... but none of those "investments" sells more widgets, and none of them creates jobs. The only thing that will create jobs in a depressed economy is customers.

Riedl: "Therefore, again, there is no net increase in aggregate demand. It just means that one group of people has $800 billion less to spend, and the government has $800 billion more to spend." The second sentence is correct, but the first is wrong: transferring money from people who aren't using it to create jobs to people who will use it to create jobs leads to more jobs. The Heritage Foundation can't see that, because they define "job-creator" as "investor"; the thought of a consumer creating jobs, or an investor not creating jobs, is as nonsensical to them as 2+2=5. This is capitalism. Not the economic theory with Adam Smith's name attached to it, but "capitalism" the religion, akin to Buddhism or Catholicism: a worship of capital to the exclusion of anything else.

Riedl: "The simple fact is that the only way to create economic growth is to increase productivity. Redistributing money from one group of people to another doesn’t create productivity or economic growth." No, there's another way to create economic growth: replace unemployed people (who have a productivity of roughly zero) with employed people.

Of course, Riedl and Fama both said in 2009 that government spending would inevitably cause skyrocketing interest rates and inflation, both of which (almost five years later) have yet to show up. So I have my doubts about their mathematical certainties.

ETA: see this post on the NY Times "economix" blog about the lack of investment over the past few years.


armchair economics

And if you use money (quite probably government) to turn an unemployed person into an employed person that employed person uses his new income primarily for consumption thus putting the money back into the economy again and again.... The industry owner with extra capital to "invest" but with too few consumers to purchase will do as you say -- invest to increase profits, not by increasing production and hiring, but by increasing efficiency or finding cheaper workers (going abroad). This feeds a downward spiral.

It all seems fairly obvious. But as you say, when capitalism -- free markets -- is a religion then reason goes out the window. And it's not as if capitalism, now or ever, has ever actually wanted "free" markets. Instead, the U.S. government has a long history of actively supporting business interests.