Why Government Spending Does Not End Recessions
Moving forward, the important question is why government spending fails to end recessions. Spending-stimulus advocates claim that Congress can “inject” new money into the economy, increasing demand and therefore production. This raises the obvious question: From where does the government acquire the money it pumps into the economy? Congress does not have a vault of money waiting to be distributed. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another.
Congress cannot create new purchasing power out of thin air. If it funds new spending with taxes, it is simply redistributing existing purchasing power (while decreasing incentives to produce income and output). If Congress instead borrows the money from domestic investors, those investors will have that much less to invest or to spend in the private economy. If they borrow the money from foreigners, the balance of payments will adjust by equally raising net imports, leaving total demand and output unchanged. Every dollar Congress spends must first come from somewhere else.
For example, many lawmakers claim that every $1 billion in highway stimulus can create 47,576 new construction jobs. But Congress must first borrow that $1 billion from the private economy, which will then lose at least as many jobs. Highway spending simply transfers jobs and income from one part of the economy to another. As Heritage Foundation economist Ronald Utt has explained, “The only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven.” This statement has been confirmed by the Department of Transportation and the General Accounting Office (since renamed the Government Accountability Office), yet lawmakers continue to base policy on this economic fallacy.
Removing water from one end of a swimming pool and pouring it in the other end will not raise the overall water level. Similarly, taking dollars from one part of the economy and distributing it to another part of the economy will not expand the economy.
This is basically what I have been harping on since the recession began.
I initially agreed with the first bailout, the one that was supposed to be used to buy “toxic assets” and keep the financial system running. I was OK with some corporations folding, but thought that while the economy can recover from the bankruptcy of normal companies it would be much harder for it to recover with the collapse of the financial system.
Unfortunately the Fed and Treasury changed their minds as soon as they got the funding, and the Congress was so panicked that they were ready to rubber-stamp anything that was put in front of them. It was basically the Tonkin Gulf Resolution all over again. Congress, whichever party controls it, is basically stupid and easily frightened. They’re first instinct is to “do something” and their second is to find a way to blame it all on the opposite party.