Recent disappointing economic growth figures have brought a halt to what some had perceived as a budding economic recovery.  The narrative had been that a rapid expansion of government spending in 2009 had “stimulate” the economy into recovery.  Not surprisingly, the same people who supported government stimulus before are now clamoring for even more spending.  However, the burgeoning national debt, and lack of significant improvement in employment and economic growth has caused some to call the effectiveness of government stimulus into question.

According to the economic philosophy of John Maynard Keynes, economic recessions represent a failure of private markets to spend sufficiently for the economy to produce full employment.  In this view of the world, the “slack” spending should be picked up with government stimulus.  Thus, the view was born that the antidote to economic woes is to increase government spending.  The theory is that the increased government spending will flow through to both individuals and businesses who will spend it in turn, with the end result expected to be an increase in total spending that stimulates the economy out of recession, and into recovery.

However, there are a few key points that Keynesian theory fails to fully address, which cause problems when the extended impacts of government stimulus projects play out.  Primary among these is the fact that spending isn’t free.  In addition to this, is the principals that spending is different from productivity, employment is the means instead of the end, and that debt must be repaid.  The combined impact of these factors bring the fallacy of government stimulus into full view.

Spending Isn’t Free

The single fundamental premise of Keynesian stimulus is that government (deficit) spending stimulates economic activity.  However, what these tidy and neat models ignore is where the money they are spending will come from.  Put another way, the government cannot “create” anything.  It can only extract resources from one area and then spend them in another.

For many functions such as ensuring national security and enforcing laws, this resource extraction is absolutely necessary.  However, as the level of government spending increases, it requires that more and more capital be extracted from the private sector.  This capital can be extracted directly through taxes, indirectly through borrowing, or stealthily through inflation.  (Since the government has the ability to print money, it can finance its operations by simply de-valuing all of the currency already in circulation)

Thus, the only way that government spending can represent a net value gain is if the projects being pursued by the government are more valuable than the ones that would have been done in the private sector if that capital had not been extracted.  When we are talking about things like protecting the nation against foreign invaders or guaranteeing contract law for the purpose of smooth business transactions, this value chain is quite clear.  When tax credits are awarded to politically favored companies for politically favored projects, or people are subsidized to engage in activities that result in no net economic productivity, it quickly becomes apparent that the government is taking capital from a more productive purpose and moving it toward a less productive one.  It should not be particularly surprising that this process generates the prolific waste that many perceive as synonymous with government operations.

Spending is Different from Productivity

Another key pillar in the temple of Keynesian stimulus is the notion of spending being paramount.  The theory states that when people spend more, it will create more economic activity and more employment.  The problem with this view is that it takes the notion of production and output for granted.  More specifically, if many people are engaged in “make work” jobs that do not produce anything of significant market value, then their spending will simply result in more competition for the products and services that people actually do value.

The fundamental question in regards to economic activity is whether it is increasing the products and services that people value.  When activity is directed by market forces, it naturally gravitates toward value-positive activities since products or services that people do not value are not purchased and the firms producing them go out of business.  However, when there is no market mechanism present … as is the case with most government initiatives, then it means that the planners must ‘guess’ about what is most valuable.  To wit, these decisions are made based on political instead of rational motivations, and the net result is lots of spending, and very little net value.

When spending increases, but the total amount of products and services stays the same, the result is inflation.  It’s not hard to see how this comes about, since more spending will create more competition for the things that people actually value.  As more resources are dedicated to low-value spending, it will simultaneously result in less production of those valuable things and more competition for those things of value.

Employment is the Means, Not the End

Many times, the stated goal of government stimulus is to grow employment.  Because of this, many of the projects underwritten become “make work” jobs where there is no compelling desire by the market to pay for a project because of its superior value.  Instead, projects are driven based on what a political official thinks should be done.  Furthermore, focus on employment frequently involves working in a highly inefficient manner.

In market-based competitive situations, there is a strong incentive to utilize technology to decrease the amount of people that are necessary to perform a particular job.  Politicians see this as greedy businessmen placing profits ahead of people, but the public at large sees it as progress, when prices drop and quality increases.  The thing that most people miss is how labor markets are dynamic, and the constant advance of technology creates a constant churn of new employment opportunity.

Thus, the path to prosperity is not by employing s many people as possible.  Instead, it comes from optimizing people’s productivity.  Employment is an ingredient of production, but is not the goal in and of itself.  Failure to recognize this fundamental truth is the golden road to eternal waste.

Debt Must be Repaid

Keynesian economic models are built around the notion of deficit spending during recessionary times that is repaid when the economy expands.  Unfortunately, the “real” trend is that increases in government spending raise the baseline for future government spending.  This is how the massive government “stimulus” from 2009 created a permanent budget deficit in excess of $1 Trillion dollars per year.  Up until this point, the worst yearly budget deficit was in the neighborhood of $500 billion.  However, the baseline has now expanded to double that level of deficit for each and every year.  The “stimulus” has created a permanent structural budget deficit that the current leadership has absolutely no desire to address in any meaningful manner.

The unfortunate impact of these continual deficits is a burgeoning national debt.  And true to form, this debt must be repaid.  As the size of the debt grows beyond the ability of government to reasonably collect taxes to pay, it will become necessary to devalue the currency through inflation in order for the government to meet its financial commitments.  Thus, the fallacy of “stimulus” becomes painfully clear.  The so-called stimulus from government spending simply extracts productive resources, deploys them in a less productive manner, and then pushes the cost of that spending onto future generations.

In the end, economic growth is and always will be driven by fundamentals.  Those fundamentals are principally about figuring out how to create more with the same amount of resources.  All attempts to circumvent this simple economic law will only result in distorted economic incentives, and a destructive level of governement debt.