Why less government spending would mean less economic trouble

Posted: June 25th, 2010 by Militant Libertarian

Many economists say deficit spending is crucial to keeping the economy moving. But history tells a different story.

by Robert Higgs, CSM

Though our current economic troubles are complex, many mainstream economists have endorsed the simplistic Keynesian theory that massive government spending will produce jobs and prosperity.

From such Keynesian thinking have flowed the “stimulus” and bailout measures that have increased the size and power of government and added trillions of dollars to the public debt. The federal deficit has jumped from about 3 percent of gross domestic product (GDP) in fiscal 2008 to about 10 percent of GDP in fiscal 2009 and 2010. The government now forecasts deficits in the neighborhood of $1 trillion per year for the next decade.

Politicians, who are always looking for plausible rationales for their insatiable spending, borrowing, and power-grabbing, had never abandoned Keynesianism, so they have been elated to find economic “experts” again confirming their self-interested inclinations. Indeed, several prominent economists, such as New York Times columnist Paul Krugman, are urging Washington to spendeven more, lest the economy slow.

But what does history teach?

History teaches that temporary surges in government spending give people money that, for the most part, they save or use to reduce debt, rather than setting in motion an upward spiral of income, expenditure, real output, and employment, as envisioned by John Maynard Keynes, the British economist whose theory spurred massive government interventions in the economy from the 1930s onward.

History also teaches that government “emergency” spending tends to fatten the coffers of the politically connected. Thus, much of the so-called stimulus spending has served only to increase the pay and benefits of government employees, transferring income from the private sector to the government sector, and reward groups, such as the United Auto Workers and low-income home buyers, for their support of the Obama administration.

One aspect of the current crisis that has come as anything but a surprise to students of history is that the politicians (in the words of President Obama’s chief of staff, Rahm Emanuel) have not allowed this crisis “to go to waste.” The past two years have witnessed one power-grab or institutional takeover after another, including AIG, Fannie Mae, Freddie Mac, General Motors, and Chrysler.

Under the Troubled Assets Relief Program, the Treasury has taken ownership positions in hundreds of large banks by purchasing preferred shares and warrants. Virtually all residential mortgage lending now ultimately springs from the secondary market and guarantees provided by Fannie, Freddie, Ginnie Mae, the Federal Housing Administration, and Veterans Affairs.

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