Does Government Spending Create More Economic Growth? (Spoiler Alert: No, Silly!)

Authored by Frank Shostak via The Mises Institute,

After the 2007-2009 global financial crisis, fears of ballooning public debt and worries about the drag on economic growth pushed authorities in some countries to lower government spending, a tactic that economists now think may have slowed recovery. Note that in the United States the total debt to GDP ratio stood at 349 in Q1 this year.

In a paper presented at the Kansas City Federal Reserve’s annual economic symposium on August 26 2017, Alan Auerbach and Yuriy Gorodnichenko from the University of California suggested that “expansionary fiscal policies adopted when the economy is weak may not only stimulate output but also reduce debt-to-GDP ratios”. (Fiscal Stimulus and Fiscal Sustainability, August 1,2017, UC – Berkley and NBER).

Some commentators are of the view that these findings may be welcome news to central bankers who face limited options of their own to combat a future downturn, given existing low interest rates and low inflation rates in their economies. "With tight constraints on central banks, one may expect — or maybe hope for — a more active response of fiscal policy when the next recession arrives," the University of California researchers wrote.

These findings are in agreement with Nobel Laureate in economics Paul Krugman, and other commentators that are of the view that an increase in government outlays whilst the economy is relatively subdued is good news for economic growth.

Can increase in government outlays strengthen economic growth?

Observe that government is not a wealth generating entity as such - the more it spends, the more resources it has to take from wealth generators. This in turn undermines the wealth generating process of the economy.

The proponents for strong government outlays when an economy displays weakness hold that the stronger outlays by the government will strengthen the spending flow and this in turn will strengthen the economy.

In this way of thinking, spending by one individual becomes part of the earnings of another individual, and spending by another individual becomes part of the first individual's earnings.

So if for some reason people have become less confident about the future and have decided to reduce their spending this is going to weaken the flow of spending. Once an individual spends less, this worsens the situation of some other individual, who in turn also cuts his spending.

Following this logic, in order to prevent an emerging slowdown in the economy’s growth rate from getting out of hand, the government should step in and lift its outlays thereby filling the shortfall in the private sector spending.

Once the flow of spending is re-established, things are back to normal, so it held, and sound economic growth is re-established.

The view that an increase in government outlays can contribute to economic growth gives the impression that the government has at its disposal a stock of real savings that can be employed in emergency situations.

Once a recessionary threat alleviated, the government may reduce its support by cutting the supply of real savings to the economy. All this implies that the government somehow can generate real wealth and employ it when it sees necessary. Obviously, this is not the case.

Given that the government is not a wealth generator, whenever it raises the pace of its outlays it has to lift the pace of the wealth diversion from the wealth-generating private sector.

Hence the more the government plans to spend, the more wealth it is going to take from wealth generators. By diverting real wealth towards various non-productive activities, the increase in government outlays in fact undermines the process of wealth generation and weakens the economy’s growth over time.

The whole idea that the government can grow an economy originates from the Keynesian multiplier. On this way of thinking an increase in government outlays gives rise to the economy’s output by a multiple of a government increase.

However, is it possible that an increase in government will give rise to more output as popular wisdom has it? On the contrary, it will impoverish producers.

Producers are forced to part with their product in an exchange for goods and services that are likely to be on a lower priority list of producers and this in turn weakens the flow of production of final consumer goods.

Not only does the increase in government outlays not raise overall output by a positive multiple, but on the contrary this leads to the weakening in the process of wealth generation in general. According to Mises,

…there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.

Contrary to our University of California researchers and commentators such as Krugman, at no stage of the economic cycle can an increase in government outlays be supportive to economic growth. On the contrary, what is required is to cut government outlays as much as possible, thus leaving more wealth in the hands of genuine wealth generators.

A cut in government outlays is great news for wealth generators and to the economy.

It is of course bad news for various artificial forms of life that emerged on the back of increases in government outlays and cannot survive without the ongoing support from these outlays.

Comments

CuttingEdge Tue, 09/05/2017 - 11:49 Permalink

I think it was when Hillary came out with something along the lines of "Governments create jobs, not businesses" that it was plain to see she was batshit fucking crazy.

Stuck on Zero YUNOSELL Tue, 09/05/2017 - 12:13 Permalink

One very bad effect of government spending is removing highly productive members of society from productive jobs. Hundreds of thousands of skilled engineers, line workers, managers, and technicians work in defense and inane government programs. They could be out there making something useful for society.

In reply to by YUNOSELL

Retired Guy Stuck on Zero Tue, 09/05/2017 - 15:17 Permalink

The idea is that when the economy is not using resources, as in the great depression, the government can build productive projects like hoover dam. This sound idea has morphed into the government can do anything like rebuild homes in a flood plain or a great border wall that surely won't work as planned. Is productive vs useless really that hard to understand?

In reply to by Stuck on Zero

Itinerant Stuck on Zero Tue, 09/05/2017 - 15:55 Permalink

That may be true, but it simply isn't true that government spending does not generate wealth. Public outlays for roads, canals, harbors, transportation, not to mention libraries, research, and education do generate wealth. The internet came about due to spending on university research. All wealthy countries in the world are doing well because they have a great deal of public assets which improve the quality of doing business and lower the costs. Don't believe it? Try setting up a company in Mozambique. Very low wages. But communications, transit, quality of your hires, poor banking, poor public institutions, poor market access, turn trying to do business into a nightmare. Compare the US to Europe or China, and you will see how troublesome it is when the electricity is not guaranteed and all the infrastructure is performing poorly, generating extra costs to do business.Besides, Keynes never argued that more and more government spending would lead to more and more wealth. He simply stated that counter-cyclical spending could even out the booms and busts, because no private party had the wherewithal to save (tax) in boom times and to spend during busts. Booms and busts are harmful to capital accumulation and the less amplitude they have, the better for real progress. After all, booms are created largely by speculation.

In reply to by Stuck on Zero

brucyy Itinerant Tue, 09/05/2017 - 21:06 Permalink

Government does not generate wealth ,  it borrows or use taxation , then pay contractors to do the job , while paying themselves and their bureaucrats friends in the process. There is nothing magical about it.The question is not really , wether or not infrastructure investments help business operating normally. It does. 100%. There's a questions though. How does your roads , canals , harbors , universities look like with a combined national debt of around 18 trillions bucks and sky high taxes ?I kid you not , for that price range if better be fucking world class , top of the line , premium motherfucking smooth as fuck golden plated road and all kids around the block would be Phd's.Problem is , Infrastructure wise , education wise , and many other things , Mozambique is not that far off . So more questions arise :Where is the money going ? Who knowsWhere are my taxes going ? Who knowsWhere can i get a receipt or find any kind of real accountability ? Who knowsDo i have a choice ? NoDo i want a more powerful gov taking more decisions ? Mmmmh. 

In reply to by Itinerant

LawsofPhysics Tue, 09/05/2017 - 11:56 Permalink

What a load of horseshit. DEFINE "GOVERNMENT" Point of FACT;  The 2007-2008 financial crisis was caused by the PRIVATE institutions of BANKING AND FINANCE NOT "GOVERNMENT"!!!We should have let all these fuckers DIE/GO BANKRUPT.Instead, we CONTINUE TO LET THEM COIN OUR MONEY AND BUY OUR "REPRESENTATION".Roll the motherfucking guillotines and return to a democratic republic already!!!  NOTHING changes otherwise.

Withdrawn Sanction LawsofPhysics Tue, 09/05/2017 - 12:49 Permalink

"Point of FACT;  The 2007-2008 financial crisis was caused by the PRIVATE institutions of BANKING AND FINANCE NOT "GOVERNMENT"If you think the 2 are separable in this day and age, you're simply not paying attention.  The banks need govt to help hide their many crimes (manipulation, front-running, fraud, conspiracy, etc. that net mere fines but no jail time for guilty bank execs).  The govt needs banks to float the bonds that finance their many crimes (wars of choice, mass surveillance, unjust imprisonment, etc.).  The 2 are joined at the hip and are thus indistinguishable from one another.   They are both purveyors of the application of force on innocent people; so, distinguishing between the two, other than for academic accuracy, is a distinction without a difference.  

In reply to by LawsofPhysics

Ubuntuuser LawsofPhysics Tue, 09/05/2017 - 20:35 Permalink

Start voting for people in the federal and state governments who support the formation of a state bank similar to what North Dakota did in 1919 with the Bank of North Dakota. California is already starting a process to form a state bank there. Unfortunately I don't support most of the policies the CA state government has supported but I do support their initiative for a state bank.
https://youtu.be/P4zCCT5EzGM

In reply to by LawsofPhysics

falak pema Tue, 09/05/2017 - 11:59 Permalink

ANother Von Mises cop-out.Witness the "wealth generation" that the private sector banking network has created since asset pumping and cheap money as debt became the driving force of private capitalism where small government was "dogma"... except for creating wars and monopoly games in RM scamming all over the world. The same private sector monopolies or oligopolies who scammed RM and sold guns in exchange were fed by the bankster greasing of the wheels of world economy via easy liquidity.These von Mises shills have NEVER heard of the 1929 crash that sunk Pax Britannica's hold on gold exchange and never heard of 2008 crash that sunk Pax Americana in private generated debt based on outright scamming.So what wealth have the scions of global capitalism generated in a nation that was built by the ROBBER BARONS  of the 1860s and onwards industrial revolution, in a land that knew no boundaries having emptied it of its indigenous population-- last of the Mohicans.

Last of the Mi… Tue, 09/05/2017 - 12:01 Permalink

They tyranny of liberalism always destroys free markets. It's based on select intervention rather than a level playing field for ALL. A graph of the market capitalization of Amazon vs Fed QE over the last 10 years tells it all. Politicians always have the attitude that it is under their control, thus you come to me, the one in power, for economic gratification. It is the originating point of corruption. Come see me and we'll talk in the back, rather than the same rules and laws for all.

Goatboy Tue, 09/05/2017 - 12:16 Permalink

It depends which government. Unlike private entities, governments can be pressured to behave and function for the betterment of society.If only we could know who is really behind this Miser plutocratic propaganda and what is their goal. Spreading of knowledge and informing the public is certainly not.

Blue Steel 309 Goatboy Tue, 09/05/2017 - 13:11 Permalink

Way to promote the Big Lie. Maybe the biggest lie in contemporary political discourse

In reality, the purpose of all post-feudalism western governments is best defined as applying "pressure" on private entities to behave and function for the betterment of society.

Any government that exceeds that will turn into a corrupt totalitarian state eventually.

In reply to by Goatboy

Blue Steel 309 Tue, 09/05/2017 - 13:15 Permalink

Always be skeptical when an appeal to authority is made without reference to the legitimacy of that authority in context. It is a logical fallacy and a cheap rhetorical gimmick. In this case it was "Novel Laureate...". As is that institution has ever had any real legitimacy. It has been a political tool (even for the chemistry and physics) since the beginning, serving to reward and punish dogma more than achievement. You can find stark examples of this almost every year, meaning it is not anecdotal but systemic. Awards are over-rated in general, but they serve a purpose.

vikingvista Tue, 09/05/2017 - 13:36 Permalink

What is the best empirical support defenders of the fiscal multiplier can give? In other words, how closely do retrospective empirical multipliers match the prospective models? I've looked a little (and what I've found ought to be very discouraging to a Keynesian), but I'm not an economist writing about this topic, so I'm sure I've missed something.

Radical Marijuana Tue, 09/05/2017 - 14:58 Permalink

Authors associated with the Mises Institute love their false fundamental dichotomies,such as "consumption versus production."Human beings live as toroidal vortices engaged in entropic pumping of environmental energy flows. Any group of human beings necessarily transform energy. Hence, they do NOT "produce" anything, but ONLY consume more concentrated energy sources by dissipating those. Due to the imperatives of the history of warfare, civilization has developed to be able to do that as fast as possible, while simultaneously promoting the perspective that doing so was "productive."The production of destruction controlled production, which is how and why governments became the biggest forms of organized crime, dominated by the best organized gangsters, namely, the banksters, whose frauds are enforced by governments, in order to enable exponentially more "money" to be made out of nothing as debts, in order to "pay" for strip-mining the natural resources of the planet as fast as possible, which has been increasing at about an exponential rate due to the advancing technologies enabled by the series of industrial revolutions.Due to the ways that people like to think by taking for granted the favourite false fundamental dichotomies, it is politically impossible to develop better dynamic equilibria in the "production" which is actually nothing but "consumption." The impossible ideal of endless exponential growth of production (and reproduction) almost completely dominates the public realms, despite that endless exponential growth is absolutely impossible.One author writing about economics I relatively respect is Steve Ludlum.http://www.economic-undertow.com/2015/07/03/euro-margin-call/Euro Margin Call"... the brouhaha in credit markets is a symptom, not the disease. Analysts must observe carefully the larger trends and connect the dots. The problem is not a matter of adjusting the model but with the model itself. Industrial enterprise does not offer a return. Capital and value — and purchasing power — are converted into waste, what stands for ‘wealth’ is a measurement of the wasting process. Our economy has bloated into a monstrous organism that consumes everything and puts nothing back. The disease is the reaching of planetary limits; access to water, fuel, minerals, soil fertility, waste-carrying capacity and credit. Capital resources are being allocated by rationing access to loans. No credit = no resources, taking place under everyone’s nose is "Conservation by Other Means." ... The world falls apart, nobody has an idea what to do about it. ...""Waste" is another term to refer to entropy or evil.Social pyramid systems reversed the meaning of"entropy," and therefore, reversed what "waste" is,so that a fundamentally fraudulent accounting is"what stands for ‘wealth’ is a measurementof the wasting process ..."... By inserting an arbitrary Minus Sign into theentropy equations of thermodynamics, as well asinformation theory, the understanding of ALL ofthe human energy systems was also REVERSED.Of course, we did NOT reverse entropy itself,rather we reversed the ways we perceive that.Human beings necessarily live asentropic pumps of energy flows,BUT, the biggest bullies havepromoted the bullshit storieswhich INVERTED "entropy,"as the most ABSTRACT of ways thateverything we are doing expressesBizarro Mirror World, and variousWonderland Matrix sorts of traits.Many articles correctly see "we" "live in a Looking Glass world!"Realistic solutions require "we" go THROUGH the Looking Glass!However, most grossly understated the degree to which that is so, and therefore, grossly overstated what the possible "solutions" could be. Of course, that is totally common on Zero Hedge, where most of the content continues to make no efforts to go through sufficient intellectual scientific revolutions to more fully comprehend the degree to which civilization has been based on the history of warfare, and that money is measurement backed by murder.HUMAN BEINGS, WHO ARE STILL BASICALLY MONKEYS OR APES, NOW USEELECTRIC AND ATOMIC ENERGY TO ACHIEVE THOSE PRIMATES' PURPOSES.Authors associated with the Mises Institute, in particular, tend to present superficially correct analysis that the established systems are wasting resources as fast as possible, through the mechanisms of the about exponential increase in "credit," as "money" made out of nothing as debts. However, those Mises Institute authors are typical in the ways that they still take almost completely for granted perceiving political economy in ways which use the DUALITIES of false fundamental dichotomies, and therefore, propose and promote bogus "solutions" based on impossible ideals.From a sublime point of view, human beings ALREADY participate perfectly as manifestations of general energy systems. However, natural selection pressures have driven the development of Globalized Neolithic Civilization to become almost totally based on public governments enforcing frauds by private banks, and the big corporations that grew up around those big banks. EVERYTHING is publicly presented in the most absurdly backward ways possible, and that includes how there are almost nothing but various controlled "opposition" groups which surround the central core of banker dominated governments. The Mises Institute, as one of those controlled "opposition" groups, routinely generates articles which take for granted the biggest bullies' bullshit-based world view, which has become the banksters' bullshit-based world view, with such false fundamental dichotomies as "production versus consumption."

UnKeynes Tue, 09/05/2017 - 14:59 Permalink

the more it (government) spends, the more resources it has to take from wealth generators."REALLY?Not if they can CREATE AS MUCH $$$ AS THEY WANT TO, OUT OF THIN 1'S AND 0'S !!!!!DUH !!!WHICH IS WHY THEY DO IT THAT WAY.  THEY ARE STEALING THE VALUE OF OUR SAVINGS THROUGH A GRADUAL DEVALUATION OF THE CURRENCY, AND IMPOVERISHING THE REST VIA ZERO-EQUIVALENT "INTEREST RATES" ON DEBT.