Understanding Stimulus Spending

Economics Economics Questions
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1

I understand the need for sound money. That hit me as clear as a punch on the nose, so there’s no need to go into that at all. What I want to do is understand why carefully targeted ‘stimulus spending’ is necessarily bad, both under a gold standard and under fiat money. I’m going to present a simple situation where it seems that stimulus spending might be helpful, and ask you all to critique it. Hopefully from that I can get the same appreciation that I have for the need for a gold standard. I’m not interested in the ‘morals’ of my case as such at this particular point, just the ‘economic efficiency’. Anyway, here we go…

Imagine a country where levels of car ownership are very low and there are not a lot of big roads. The government decides that a nation of vehicle owners and a network of roads spanning the country would be a good thing to have because the economy could really flourish if the producers of goods that were currently only able to be sold locally could get their wares up and down the country and to the docks and airports to sell them abroad etc. They could see that this would potentially give a lasting boost to the economy, so they agree to give it a go. They build a factory in order to start producing cars, and start a road building project. They hire a range of people with a range of abilities to cover everything from digging the roads to designing the electronics for the car etc. They hire these people from wherever they can get them – the unemployed from their own population as much as possible, but also from abroad if they need to.

Anyway, the whole thing takes a few years, but at the end of it they have a road network and they virtually give the cars away to the population in order to get them moving. Hey presto! The population can suddenly get a lot more done for a lot less effort.

It’s obvious that if the government that attempted the scheme outlined above was on a 100% gold standard it could only pay for the things it wanted to do with wealth already looted from the population via taxes. However by building the roads/cars etc. it is in fact ‘giving back’ the taxed money, albeit redistributed in a different form and in different portions to which it was taken. In effect the government has run a kind of ‘forced savings’ scheme to build up capital and then subsequently – using its power to force things through - it has co-ordinated use of the capital in a way that would have been very hard for the private sector to manage. The result being a road and vehicle network that really does open up the possibility of expanding the economy greatly by overcoming one of the biggest barriers to growth (cheap and fast movement of goods), and also a reduction in unemployment because project requires much labour to complete and then to maintain and service afterwards in the form of fuel stations, vehicle maintenance, road repairs etc.

However the crux of my question comes when the government running a fiat currency does the same thing, but prints money to pay for the project. By printing money it is robbing the existing holders of money by devaluing the currency, but it is robbing them ‘for their own good’, in that it is exchanging the stolen wealth for capital that will quickly help the victims to more than recover the wealth lost in the devaluation of their currency holdings. In this way, is running the printing presses really a ‘stimulus’ for the economy, and the Keynesian idea true (even if only in one very narrowly defined scenario?

So, over to you please…

2

There are two possibilities for your theoretical scenario:

  1. Some private investors are eager to build that infrastructure. In that case, of ocurse, the govt totally unneccesary. And as experience of every govt project in the history of man tells us, the govt will do the job badly and wastefully. So why have them do it?

  2. Nobody wants to touch this scheme. Since the govt wants to do it, but no private business group, local or foreign, in the whole wide world has any intererst whatsover in building this road, it makes one think. If it’s so great, why don’t the locals build it at their expense, as has happened in the past? It doesn’t matter why, if nobody wants it, we can assume there is some reason.

I give you the govt bureocrat. His goal in life is to collect his salary from the public till. He is responsible to no one. He will lose nothing if the road is wasted money but gain plenty by building it. And to think he knows better than everybody else, well that’s stretching reality a bit, no?

Also, once the people have been bled dry to build this road, how will they afford cars?

I guess the real q here is, how can big projects get done that will bring nobody a profit?

Big projects can get done by people with big money. There are plenty of millionaires and billionaires DYING to find a new way to make a buck.

And why will these roads bring nobody a profit? A toll can be charged to use them.

“But we wanna use it for free.”

“Oh really. And do you think the money taken from you by the govt before the road was built, and afterwards for its upkeep and repair [if they bother to do the upkep and repair, which is questionable] is less than what you will pay for it in tolls? Hahahaha.”

“But the govt will make people who never use the road pay for it, not just the guys who use it.”

“Oh, so that’s what you mean by forced savings. Making people pay for a road they won’t use. Way to make the economy grow.”

Son, what you need is a dose of the classics: http://jim.com/econ/

A short free readable book that will enlighten.

3

It’s your first post here…welcome.

I will take you at your word that you understand the need for sound money. I think it would be more accurate to say that one understands the consequences of sound money vs. the consequences of fiat money, but hey, just an opinion. To address your post.

What you describe is nothing more than an interventionist or socialist scheme (your use of the word “scheme” is probably the only thing that is correct in the plan you outline). I’ve had exactly the same conversation with someone else several months ago, his scheme was to build pipelines to deliver oil to those who don’t use oil in their existing economy. The flaws in the scheme you describe are many and severe.

Bottom line: The scheme will not accomplish the things the central planners set out to accomplish. They may possess the power to inflict their plan on the economy, but they do not understand, and will likely never understand, why their plan is destined to fail.

Perhaps it would be more constructive, and efficient, if you could explain why the plan would work. In other words, enlighten us as to your economic understanding. Otherwise, folks here could attempt to disentangle the spaghetti bowl of economic fallacies, sentence by sentence, present in the scheme but that is a long and painful process.

4

To understand why your analysis is incorrect, you must first understand the role of the price mechanism and the profit/loss constraint. Prices are formed by the interplay of individuals freely exchanging in markets (mutually beneficial exchange). They reveal information to other market actors about the societal value placed upon all goods, so that they can be allocated towards efficient uses (satiate desires of the population). So, for example, the champagne fields of France can be used for a myriad of different employments (schools, hospitals, parks, or whatever), but it is perfect for champagne production (fertile soil, perfect climate, ect). And since the production of champagne yields the highest rate of return for that land (highest profits), champagne producers are able to pay higher rent prices relative to other, less efficient productions. High rent prices, then, tell other market actors that their intended use of the land is inefficient relative to those who want to use it for its most efficient (known) employment (in this case, the production of champagne).

A government bureaucrat does not know anything about champagne; he doesn’t understand what kind of climate/soil is necessary for the production of fine champagne, and may disregard its value. He may decide to use that land for, say, a park. But that unique piece of land, again, is perfect for producing champagne, and parks can be built anywhere. Thus when a government official, by decree, decides to build a road over that piece of land, he makes his people poorer. The road could have been built elsewhere, and now entrepreneurs are unable to produce a very highly demanded good, which they could export and exchange for other goods they need for survival.

The essential point, then, is that prices reveal efficient economic activities to market actors; profit assures that inefficient employments come to an end, so that the trapped resources are released back into the market, so that they can be reallocated towards warranted economic activities. When you’re profitable, the market is telling you, “good job, keep it up!” And when you’re making losses, the market is essentially telling you that you are a drain on the economy. The government is not bound by this profit motive; it does everything by decree, and is accountable only to the majority (every 4 years) who are ill-equipped to make reasonable voting decisions, and who lack the necessary incentive structure to do so (not a real check).

Thus, if such a road was truly an economically efficient endeavor, private actors, who wish to maximize profit, would do it themselves. The fact that the government does something that no one else thinks will be profitable only tells you that such an endeavor is not truly efficient. Furthermore, in order to build the road one must take away resources (raw materials, various capital goods, labor, and land) from other economic employments. All such resources are scarce, and all of them have varying degrees of productivity which are contingent upon their employments. The government, then, is dragging away resources from other, more warranted employments, towards one which is relatively (or absolutely) inefficient (reducing the marginal productivity of resources).

You must consider the opportunity cost, that is, what did we lose in order to build this road? What could the laborers have been doing if they were not trapped in this employment? The American government could tomorrow decide to build a hyper-sonic train system which can take you from NY to CA in half an hour. But what would it cost us to actually complete this endeavor? How many resources would we have to sacrifice in order to do this? How many people would be taken away from other economic activities in order to satisfy some bureaucrat’s sci-fi fetish?

Here are some concrete examples: (1) during WW2 the government had to take away resources from the economy in order to build bombs, tanks, jets, etc. The American people had to do without basic commodities (bread, butter, ect). The American people suffered because the government demanded their resources for other employments. (2) The German autobahn is truly a wonderful example of German engineering. But when one travels on it, one finds that its average daily traffic is less than that of a small village road. Economically speaking, it was one giant waste of resources. Both (1) and (2) made society poorer.

Also, building this road does not automatically or necessarily mean that car production will go through the roof. This is essentially the “build it and they will come” fallacy, which ignores scarcity. You must realize that scarcity exists; we don’t have an infinite amount of resources. Again, I don’t oppose building roads; I oppose economic inefficiency.

“Socialism, like the ancient ideas from which it springs, confuses the distinction between government and society. As a result of this, every time we object to a thing being done by government, the socialists conclude that we object to its being done at all.” – Frédéric Bastiat

5

Welcome Griff

If building a certain road was truly “good for business”, that is, it satisfied a need, it would be profitable to build and operate. Just like any other thing that is “good for business”, like advertising, people would pay to get it. The government then doesn’t build demanded roads, it builds roads where they are not profitable, thus do not satisfy a social need that justifies the cost.

Quite the opposite!

When the government spends money it extracts resources from the economy. These resources would have been used to fullfill consumer demands, but now are consumed to fulfill the government’s demands.

The government road is “what is seen” but what would have been created from those resources had the government not commandeered them is “what is not seen”. Bastiat, What Is Seen And What Is Not Seen

A good example is war production during world war II. How did the government build all those tanks and bombers? They did it by buying private resources. Factories that once built cars and airliners began building tanks and bomber, and for the duration of war virtually no cars were built. The only way the government can create anything is by preventing the creation of something else.Government spending, then, only causes poverty, the same poverty felt during war rationing.

If a country lacks a road system and is not creating one(like the third world), it is because there is something else that they lack and need even more than roads. (Maybe food, clothing, or housing) Forcing them to build roads will only prevent them from attaining those more important things.

6

I should have read your post before posting. Nice choice of example. [:P]

7

OK, thank you everyone. I’m getting there. Now I understand that a road network would eventually appear organically (Is that the rigth word?) if the need were there. After all, throughout history people have found ways to get from ‘A’ to ‘B’. What I’m saying is that, by observing history, we can see that making a bigger pool of customers more accessible helps the economy. So if the government builds a road (perhaps even taking into account local land use in the form of Champagne fields etc.), it might be doing more quickly what would naturally occur over a much longer period of time anyway? I realise that, also by observing history, we can see that government estimates of the people’s needs are mostly wide of the mark, but some things occur so often, in so many places throughout history that even a monkey could see that they were a good idea.

Also the most important part of the question (for me at least) was never touched on (i.e. the fiat currency/stimulus bit), and actually whilst laying in bed last night I had some further thoughts: If the government that is running the scheme under the fiat currency prints the money to pay for it, would not the large capital increase that is created by the time and effort of the people building the machinery, roads etc. (and being paid with the printed money) equal or exceed the value of the currency created, thereby offsetting inflation and leaving the ordinary citizen holding the currency no worse off after the print run (once the work had been completed at least) than he was before?

8

free lunch fallacy.

superiority by accident…

the monkey has the pretense of knowledge

the opposite. if we set aside such things as accidental miracles, the cost of the governments schemes is the crowding out of the private sector from performing actually economically rational production.

9

There is no doubt at all that the state’s record of economic planning is disasterous, and that no doubt even if they got some things right, the weight of evidence is against them (a broken clock is right twice a day), but in this case could they be doing the right thing. You live in the UK I suspect, and so do I. I love our winding network of country roads, but there’s no doubt that if you want to get somewhere quicker you go on the government built motorways. The difference this transport network could make to the delivery of time-sensitive products (food etc.) is very large. That doesn’t obviously make it morally right to do it, but it ‘seems’ to be more efficient.

Also what about the question regarding printing money and capital creation offsetting inflation? I presume that my understanding of capital is correct in that it is created when someone ‘mixes his labour’ with something (i.e. turns a pile of stones into a house, some bits of plastic and wire into a TV etc.?) Obviously if I’m wrong about this then I need some help!

10

How about the history of things done by govts? Always a fail.

Yeah it might. But for sure it will cost ten times as much.

Some things like “What debacles govt projects look like.”

And it’s not just a coincidence. There is a REASON why govts fail always. They are gambling with house money. What do they care if they pay $1,000 for a hammer? It’s not coming out of their pocket. On the contrary, it’s usually done to help a friend out.

If we assume that if not for govt giving people a kick in the behind they would sit and do nothing, maybe. But that is not the case. Had govt stayed out of the way, people would have used the resources spent on road building [which they didn’t want] to make things they do want The plus of having the machinery and roads is offset by NOT having things that would have been produced had the govt stayed out of the way.

Also, printing money is always a minus. Because all the money already in existence loses value. Had the road been built without printing money, we would have the road without inflation. Had the road not been built and money not been printed, we would have new things people really want instead of an unwanted road, and no inflation.

Bottom line, the road may offset the cost of inflation, but the road itself was not “free”. It came at the cost of something else that was not built. Better to have the road without inflation. Best of all to have no unwanted road, soemthing people really want instead, and no inflation.

11

Don’t you think the food industry would have figured this out? In other words, if there was a need, it would have been built without the govt doing it, cheaper and better. So it’s not more efficient.

Why do we need to print money to get something done? That capital could be created with out printing money. The reason the govt prints money is because that way they dont have to pay for what they do, and dont have to borrow money or tax people to have money. So it’s great for the govt, but it’s very bad for everyone with money in their pocket. Because when more money is printed the existing money becomes worth less. In other words, it’s a hidden tax on everyone [even people who won’t use the road].

An earlier post does the math about the road is not wotrth the inflation.

Sounds right to me. But I think that “capital” has a technical meaning in economics that would make a TV not capital, but a consumer good.

From Wikipedia:

  • Capital (economics), a factor of production which is not wanted for itself but for its ability to help in producing other goods
12

Welcome!

First of all I want to applaud you for how well written your piece was. It was succinct, very well organized, the punctuation was excellent and you went through your points coherently. I like how you took care to rebut or address potential responses, this makes things run smoothly so that we do not waste our time addressing points you are familiar with.

Now to address your points, think of this situation: on the free market nobody does jumping jacks for a living. That industry is does not exist. Does that mean the government should tax us and create that industry? Of course not, if that industry does not exist it means there is no demand for it. If there is no consumer demand it makes no sense to prop up that industry. It can only benefit those in that industry at the expense of those subsidizing it.

Also, google the broken window fallacy, every dollar the government spends on roads necessarily implies a dollar less that can be spent on another sector of the economy. The dollar that would have been invested in something else is now being invested in roads.

Acting man always seeks to better his situaton, so, if a road network is half as benefiical as the authorities claim, it would be there already. If it does not exist it means this society does not demand it.

The responses above address your question very well so there is no point in me repeating what they have to say.

13

Thank you all for replying, and thank you particularly to ‘smiling dave’ who made things clearest regarding the money printing issue in his recent post.

Let me try and draw a conclusion or 2. Please comment if necessary:

Short of using slave labour, getting the unemployed to do something/anything is not going to create wealth, merely divert resources away from something else, although the unemployed person might not see it like that.

This immediate result off this ‘diverting’ effect might be fairly harmless (i.e. if resources are diverted away from leisure pursuits) or catastrophic (if resources are diverted away from food production), but the underlying thngs (like the sudden unemployment of people in the leisure industry) are still there and still harmfull, at least to them).

14

YW [:)]

Your last post with its two conclusions sounds right to me. I’m wondering about slave labor though. Hopefully that will remain academic.

Sounds like you are ready for the great enlightenment, contained in the short free classic Economics in One Lesson

15

Thanks again. Yes, the slave labour point was academic :slight_smile: That actually raises another question, regarding unemployment. I don’t know if it is much to do with Austrianism, but I’ll ask anyway:

Would it not be better to pay the unemployed a subsistance wage (not necessarily through government handouts - maybe through private charities) to do something rather than having them sit idle? Surely unemployment in the sense that I understand it is worse than finding something for them to do in that a person sitting doing nothing is consuming someone’s resources, whereas at least if they’re out litter picking or something, there is some offsetting of that consumption?

So if we’re stuck with welfare (as we certainly are under the democratic system) then ‘workfare’ would be much more just than simple handouts?

16

Then they wouldn’t be unemployed if there was a need in litter picking.

I imagine many of the unseens that the gov’t destroys potentially are in litter pick up. When I take my walks around here there are lots of old dumps full of metals and other items that if collected and recycled might have been cheaper for some people to do it this way. I know of at least two warehouses that have opened up around me that deal in what was one man’s junk but appear to be others treasure like railroad ties, old windows, etc… They’re not junk yards but have lots of old stuff and their businesses appear to have taken off and doing very well. They both had started very small but in about a year or two for both of them they have grown in size and I usually see consumers there. The businesses themselves have expanded their own warehouses and store fronts as it appears from to an outsider that they are reinvesting in their business with accumulated capital.

It’s the unseen’s that I wonder about. All that the gov’t marginalizes that possibly were profitable but the gov’t through it’s interventions keeps such potential businesses from not sprouting.

17

If some kind person wants to give his money away to an unemployed person, and asks for him to clean his yard in exchange, yes that’s better than giving it away for free, sure. Cause now he has a clean yard.

As for being stuck with welfare under democracy, a few random thoughts:

Democracy has been around longer than welfare, which is pretty recent. I think Bismark invented it

I do remember there being a quote by some ancient Greek fellow that democracy works until people realize they can just vote themselves other people’s money.

But that can’t last forever either. The pie gets smaller and smaller because of welfare and other benefits. Look at what’s happening to Greece, and the state of California, and many other places. They voted themselves huge pensions and wages [if you work for the gov’t] and ran out of money to pay for it. The USA voted for Social Security and Medicare, which is bankrupting them. They started with a larger pie, but it’s gonna be all gone in a very few years.

18

Understanding Stimulus Spending…

Stop. There is no understanding. There is no stimulus. There’s definitely spending, a whole lot of it. The whole thing is a Keynesian Ponzi Scheme. You’ll realize this when you’re handed the bill for all this “free” money.

19

greengriff,

What you describe is not a “Keynesian” stimulus per se, but merely fiscal policy more broadly. Although a stimulus may be pursued with an expanded fiscal policy, not all expansions to fiscal policy constitute a stimulus. The difference is that a stimulus is only suggested under particular macroeconomic conditions: specifically, a relative increase in money demand alongside sufficiently sticky prices.

What you describe is merely an instance where government spending could possibly be good for the economy, irrespective of particular macroeconomic conditions. Certainly there exist theoretical possibilities in which such spending could be beneficial, but the propensity for such a theoretical possibility to actually occur is normallu very low–all kinds of assumptions regarding the knowledge (or good luck) of central planners, the degree of corruption in the political process, and the long term consequences of greater assertions of government action must be made, to name but a few.

20

Why don’t they have roads and cars in the first place?

Maybe, maybe not. Who are politicians to say?

So what was not built instead?

What would these people have been doing instead? Who would have been employing them instead?

Why were the people unemployed?

There just seems to be way too many assumptions with this scenario. The assumptions seem to be that these roads and cars don’t exist because of a market failure. It does not address if or why there was a market failure in the first place. It also assumes that resources are just sitting there idle. But government has to take from the market to give back to the market.