The US Government's Spectacular Failure

Spectacular failure. These words came to mind as the dismal employment data for June were released on July 8. After the biggest spending binge in peacetime American history, the unemployment rate is stuck above 9%, while in May fewer than 20,000 jobs were created in what was once a vibrant US economy. Adding in discouraged workers drives the combined rate to 16.2%. Wage rates fell, as did the average workweek.

It may get worse. In a US Chamber of Commerce survey of small businesses earlier this month, 64% of the executives surveyed reported no plans to add workers, while 12% had plans to cut jobs. Only 19% said they planned to add employees.

Yet, promoters of President Obama’s strategy to rely on government spending to boost employment say it isn’t so – that all of the increased spending produced more, rather than fewer jobs. Any reduction in government spending, therefore, would threaten the fragile recovery these very same policies have produced.

This view was boldly defended by Princeton Economics Professor Alan Blinder in his recent Wall Street Journal Op-Ed: “The GOP Myth of ‘Job-Killing’ Spending.”

In the article, Blinder asks a very simple, but powerful question: “How can the government destroy jobs by either hiring people directly or buying things from private companies? For example, how is it that public purchases of computers destroy jobs but private purchases of computers create them?”

The first possibility – that the taxes necessary to purchase the computers destroyed more jobs than were created – is quickly dispatched by noting that the rapid increase in spending of the past two years has been financed by increased deficits, not higher taxes.

How could the government borrowing $800 billion to finance increased spending, tax credits, rebates and other non-marginal tax rate reductions and then spending it not create jobs, Blinder asks. Clearly, the stuff the government buys has to be produced by job holders. And handing out money to families through tax rebates, credits and the like, surely leads to them spending more than they otherwise would.

The answer is as simple as double-entry bookkeeping. Every dollar that was borrowed by the government was taken from the private sector, which no longer had the money to invest or spend. For example, study after study has shown that tax rebates do not work because typically they are roughly offset by increases in the savings rate, blunting any hoped for increase in aggregate demand. But of course: someone had to buy the incremental debt issued by the government instead of spending it on goods and services, or on other investments!

Here is the key point. The government has no resources of its own. It can only spend what it first takes from the private sector, either through taxes or borrowing. The net cash flow into the economy through deficit spending is therefore zero, nada, nothing.

Not so fast, points out Blinder. Since the Federal Reserve has kept interest rates low, no such crowding out could take place. Or, in my words, since the Fed purchased all of the debt, no money was taken from the private sector at all. Effectively, all of the new spending power was created out of thin air by the Fed’s printing press.

What this analysis overlooks is the sudden increase in inflation produced by the Fed’s easy money policies. For the 12 months ending May (the latest data available), the Consumer Price Index has gone up 3.6%, including a 37% increase in gasoline prices. Thus, every dollar of income now purchases on average 3.6% fewer goods and services. In addition, 3.6% of the nominal wealth of the American people and all other dollar holders has been effectively confiscated by government through the debasement of the dollar, further depressing private sector economic activity.

The final argument, that the size of the deficit is producing uncertainty which is depressing business investment is refuted by Professor Blinder by pointing out that business spending on equipment and software has “skyrocketed 14.7%” over the last four quarters, roughly five times faster than overall GDP growth.

But, that begs the question of why companies are not investing in the most precious resource of all, new employees. It also ignores the fact that more than $200 billion of capital has fled the US for better climes since the beginning of the recovery.

Economic activity occurs, and jobs are created through voluntary exchanges. Thus, when a computer is purchased in the private sector, both parties are made better off – otherwise the exchange would not have occurred. The resulting economic surplus is the source of increased wealth, economic activity and job creation.

However, when the government purchases the computer, it is financed through government exactions of one form or another. At the end of the day, every dollar spent is taken either directly through taxation or borrowing, or indirectly through inflation. As Milton Friedman said, government spending is taxation.

When money is taken from the private sector and given to public servants to spend on our behalf, these constitute involuntary, one-sided exchanges. More often than not, coerced, one-sided exchanges make one person worse off more than they make another person better off. This economic deficit squanders resources and thereby reduces opportunities for exchanges elsewhere in the economy. Thus, for every job governments may create, more than one other job is either destroyed or never created in the private sector.

None of this should be a surprise. After 8 years of the previous, record peace time effort to stimulate the economy through government spending, then Secretary of the Treasury Henry Morgenthau in 1939 told the House Ways and Means Committee:

“We have tried spending money. We are spending more than we have ever spent before and it does not work…We have never made good on our promise. I say after eight years of this administration we have just as much unemployment as when we started. And an enormous debt to boot!”

No truer words could be spoken today.


Charles Kadlec,
for The Daily Reckoning

The Daily Reckoning