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So what if governments spend?

So what if governments spend? | Government Spending Anthony Harrington

The scale of government spending in several developed economies has thrown a sharp media spotlight onto the whole topic of government debt. The challenge, however, is to get past or to resist the temptation to indulge in apocalyptic thinking. Instead of trying to imagine the catastrophe if the UK defaults, or euroland implodes, or the US collapses under insuperable debt, we should actually be asking more restrained and sensible questions, such as, what impact on the real economy does high government spending have?

Northern Trust’s chief economist, Paul Kasriel provides the following answer in his Econtrarian comment piece, “Hey big spender?” [PDF, 91 KB].

“If the federal government spends more, it takes control of more productive economic resources, depriving the private sector of the use of these resources. The deprivation of resources to the private sector has a negative effect on productivity growth, which, in turn, depresses long-run real economic growth.”

The negative impact on the economy of high government spending is increased, Kasriel argues, if a significant portion of it is devoted to non-producers in the economy, such as pensioners, which is inevitable given the demographic trends in most developed countries (longer life for the aged, fewer births).

“The ultimate cost of this government spending, regardless of how the funds are obtained, will be a reduced per-capita rate of economic growth,” he claims. Why? Because future workers are going to be deprived of productivity-enhancing resources as more resources are channeled to pensioners. Without productivity growth, real GDP growth is hard to come by and the great mass of retiring baby-boomers are going to create a massive strain on the US economy over the next 20 years, he says. Ditto for a number of European economies.

A second unproductive spend goes on servicing debt interest. Mushrooming interest payments on prior and present-year debt severely constrain any government’s room for maneuver. In the US Kasriel is particularly critical of past US federal government policies, in particular policies that instituted new retiree entitlement programs and the general matter of funding government spending through raising debt. How the government raises the funding it needs, Kasriel argues—following Milton Freidman—is far less important than how much it raises. You can cut down as much as you like on new government spending programs, but there is not a thing you can do about the motor attached to rising levels of interest debt payments accumulated as a result of prior spending programs. Compound interest will catch up with any government in the end, he warns.

Where government can do some good with large-scale spending programs, he argues, is that such spending increases the aggregate demand for goods and services, and some of this will trickle down to increased sales for small, medium, and large businesses. In a separate article entitled: “Does anyone in Washington know what needs to be done to create jobs?” [PDF, 105 KB], Kasriel points out that only about 30% of the US Government’s $580 billion fiscal stimulus program for 2009 has so far been allocated. There is still another 70% in the pipeline, plus approximately 56% of the US tax cut fiscal stimulus making its way gradually into the economy. When all of this hits, it will have a very dramatic impact on stimulating sales and so, in turn, stimulating hiring among the US small to medium-sized business sector.

More jobs means more revenue and less outgoings for the US government and that in turn might help the US deal, at least in part, with the crushing interest burden it has built up in recent years. Taken together these two pieces by Kasriel represent a fairly rare thing from an economist, namely a pragmatic lesson in how things work that also manages to be at least slightly optimistic…

Further reading for government spending

Tags: demographics , fiscal stimulus , jobs , real economy , sovereign debt
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