Obama's Public Spending Program: A Very Expensive Farce

Poor Obama just cannot get his story straight. Over the last two months he has given America several proposals about the number of jobs he is going to "save" as well as "create". The great thing about 'saving' jobs is that no matter how high unemployment rises, he can and will assert that if it were not for his prodigious spending binge there would have been a further two million or more unemployed Americans. And of course he will have the full support of a thoroughly corrupt media.

That a majority of Americans apparently believe that some kind of spending plan is needed to spur recovery is a sad reflection on America's education system. What needs to be understood is that his spending plan cannot work. Full stop. The recession is the result of a boom generated by the Fed's loose monetary policy. (Nearly 6 years ago I stated that Greenspan was "once again laying the foundations for another recession". The US economy and Alan Greenspan: what is going wrong? And so it came to pass, as the Good Book puts it.)

As is always the case, despite what orthodox economists claim, booms create malinvestments which also include financial imbalances. Recession is the inevitable result and the means by which the economy can be purged of these malinvestments and imbalances, and the saving-consumption ratio restored to society's rate of time preference. In other words, the recession is the readjustment process during which the correct proportion of savings to consumption is reestablished.

Rather than hasten this necessary process, public works programs, rebates, subsidies and just about every meddling little financial scheme economic geniuses like Schumer and Pelosi can conjure up will not only retard this process, they can actually arrest it. This is precisely what Roosevelt did. (Roosevelt adopted the Hoover program and took it much further than Hoover had been willing to go.)

Now the principle objection to public works is that because it takes some time to bring them on line, their economic benefits come too late to bring about recovery. It would not matter if Obama could bring them online tomorrow, they could still do nothing to halt the recession, even if there was an enormous amount of excess capacity.

By pouring billions of dollars into these schemes, Obama will be drawing labour and capital away from other lines of production. Because capital consists of heterogeneous producer goods of varying degrees of specificity, only a very small amount of these goods could be transferred to public works programs. Then of course these projects need huge amounts of materials and skilled labour. Moreover, because capital is heterogeneous and complementary, Obama's spending programs could sink companies that would have survived the recession.

In addition, during booms the financial sector tends to greatly expand. All manner of financial intermediaries and the companies to handle them emerge. Bailing out these companies is akin to a belief that the dead can be resurrected by a continuous flow of embalming fluid; in Obama's case it is dollars - and billions of them. Dollars are money and money is used to command goods and services.

By pouring billions into these financial sinks he will ensure that resources will be directed away from the higher stages of production and into consumption. This exposes a fundamental and fatal flaw in the big-spending theory of vulgar Keynesians like Krugman. These expenditures will resolve themselves into incomes and hence spending on consumer goods. This will skew the relative price structure in favour of increased consumption and so raise the ratio of consumption to savings by attracting resources away from the higher stages of production to the stages closest to consumption. A process guaranteed to damage recovery.

Another aspect of public works programs that is largely overlooked is whether these projects are really needed. In an effort to ridicule "prudent financiers" and the need to save, Keynes cleverly wrote:

The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.
-(John Maynard Keynes, The General Theory of Employment Interest and Money, Macmillan-St. Martin's Press, 1973, p. 131.)

But there would be no point in building two railway lines when only one is needed just as there is no economic gain in building "bridges to nowhere". What the country ends up with are political monuments. Obama uses Eisenhower's interstate highway program as an example of the state promoting growth, but in doing so he misses two vital points: the highway system was not built to stimulate the economy, and it was growth that made it possible.

FDR idolaters laud the Tennessee Valley Authority as stunning example of successful government intervention in the presence of market failure. This is another Roosevelt myth. What is not generally known is that in 1921 Henry Ford laid out a similar plan for the area. Ford's proposal was frustrated by Senator George Norris - a Teddy Roosevelt Republican - who thought the project too important to be undertaken by private enterprise. In his view such projects needed to be built by and for the people. Thanks to the Neanderthal economic thinking of the likes of Norris, Ford was finally forced to withdraw his proposal in 1924.

Japan is a graphic example of the failure of a public works program to promote economic recovery. The Japanese did everything Obama proposes and more. From 1990 to 2000 they implemented a number of stimulus programs costing some 100 trillion yen. They failed dismally. The programs (or panic measures if you like) included checks to the public. These are bound to fail. What matters is not one-off payments but a stream of payments. These can only be generated by tax cuts. It is true that there were cuts but there was also a significant increase in government spending at the same time. The effect of these tax cuts were overwhelmed by the size of the increase in government spending and the continued existence of malinvestments.

The Bank of Japan dropped interest rates to zero. Instead of a surge in business borrowing there was nothing. Keynesians immediately declared that Japan had sunk into a liquidity trap. If the banks cannot lend the government must. So it poured billions into private institutions. And what was the result of this Keynesian extravaganza? By 2000 the country's debt exceeded 100 per cent of GDP, and still no recovery.

Businesses will not borrow - no matter how low the interest rate - if there are no prospects of profits. This is of particular importance where there is considerable excess capacity (malinvestments due to the last boom) and a burdensome level of debt. There is only one sure way to get a sustained recovery underway and that is for politicians to allow the market to perform the necessary surgery.

It was Hirohito and Hitler who solved America's unemployment problem, not Roosevelt and his anti-market advisors. What impressed many Americans and Europeans was how quickly the Nazis brought Germany to a point of 'over-employment'. It was really all rather simple. The Nazis ordered masses of war material, with most of the money being created by the banking system. They allowed profits to rise and encouraged reinvestment, even when it was uneconomical. The result was that from 1933 to 1940 there was a massive tide of investment in heavy industry so that by 1939, 68 per cent of the industrial workforce was employed in the capital goods industries, earning 75 per cent of industrial incomes.

Hitler bragged that from March 1933 to September 1939, Germany had spent 90 billion reichsmarks on armaments, a figure that was later confirmed as being fairly accurate. In terms of the exchange rate this amounted to $36 billion. Despite the fact that the reichsmark was over-valued relative to the dollar, the amount spent by the Nazis was still enormous and ran into many billions of dollars. Whereas in Roosevelt's America it was estimated that net private investment fell by over $3 billion.

However, any economist worth his salt would expect from these figures that despite the rapid increase in the demand for labour, real wages for German workers would have been far below the American and British counterparts. Furthermore, the massive increase in heavy industry had to create immense distortions in the production structure.

All too true. In 1939, investment in consumer goods had not only failed to reach its 1929 level, but investment in producer goods had exceeded the 1929 level by 172 per cent, with real wages being no higher - or even less - than their 1925 level. They were now about 46 per cent of the US rate and 66 per cent of the British rate. I am forever saying that it is no trick to create jobs. The real trick is to create more and more higher paid jobs so that real wages rise for everyone. Only the market can do this and not the Obamas of this world.

For those who for some perverse reason idolize Obama as well as Roosevelt and still stubbornly believe that only a massive increase in government spending can save the US economy from disaster, I have irrefutable evidence that this is pure nonsense. Following the Keynesian line, Samuelson confidently predicted in 1943 that once the war was over and government spending was slashed, mass unemployment would return on the scale of the 1930s. (Incidentally, Keynes made no such prediction.)

To the astonishment of these Keynesians, nothing of the kind happened. Between 1945 and 1947 the US government cut Federal annual spending from $95 billion to $36 billion - a $59 billion cut in two years, a staggering 62 per cent reduction. Instead of America spiraling into a depression with 8 million unemployed - as predicted - it began the longest period of prosperity in its history.

Sound economics and the lessons of history do not support the claim that government spending is the cure for recession and unemployment.

Comments

[redbaron:]

'Sound economics and the lessons of history do not support the claim that government spending is the cure for recession and unemployment.'

Perhaps this is true, but where is the responsibility of the current administration discussed in setting this trend?

This is Obama bashing, and nothing more, and the man is not even president yet.

For the past 8 years the Bushies have said 'deficiets don't matter', and now all of a sudden they become important when the administration is going away.

Jan 12 08:22 AM

[John Polomny:]

This is a common theme among the partisan, a person can't criticize Obama because you have not taken the time to check and see if Mr. Jackson has criticized Bush. I have no idea if Mr. Jackson has ever criticized Bush for his idiotic policies but that has nothing to do with the fact that the policies that Obama and his people are proposing have been tried in the past and they have never led to a sustained prosperity. I would suggest that it is government itself that is the issue. It does not matter if it is a welfare/warfare state proposed by the Dems or a warfare/welfare state proposed by the Repubs. Government wastes resources that are better allocated by the individuals that actually own them.


On Jan 12 08:22 AM redbaron wrote:

> 'Sound economics and the lessons of history do not support the claim
> that government spending is the cure for recession and unemployment.'
>
>
> Perhaps this is true, but where is the responsibility of the current
> administration discussed in setting this trend?
>
> This is Obama bashing, and nothing more, and the man is not even
> president yet.
>
> For the past 8 years the Bushies have said 'deficiets don't matter',
> and now all of a sudden they become important when the administration
> is going away.

Jan 12 09:44 AM

[Jason Rines...:]

How much of the $300 B - $700 B per year we send overseas on oil replaceable over time? I assume we can create lasting jobs on this.

How much of the electric grid can we rebuild for job creation? I assume we can create lasting jobs on this.

How many nuclear plants does $200 B buy? How many of the trucking industry can run on natural gas? I asume we can create lasting jobs on this.

How many fully electric vehicles would the U.S. consumer buy? How many can GM crank out per year, assuming an accelerated schedule. I assume we can preserve and create lasting jobs on this.

How much of the $30 B in Medicaid and Medicare fraud can we prevent with overhauls to the Healthcare/Insurance sector? I assume we can create lasting jobs on this.

How many power lines and installation of high-speed Internet access can we update, facilitate? I assume this will create lasting jobs.

Government should have money to lend alongside private capital. But government should not be setting up more 'quasi' agencies.

Jan 12 10:43 AM

[Firat Ünlü:]

Wonderful article, what America needs is productive industries/companies. In contrast to the past marginal benefit of spending on infrastructure has come down hugely. If you're India or China's West then fair play for building roads and bridges but not as an already developed country. Massive waste of time and money.

>From 1990 to 2000 they implemented a number of stimulus programs costing some 100 trillion yen.

Expected the number to be much higher, but then, all these trillions can confuse you...

Jan 12 12:13 PM

[Conan the B...:]

Give the man a break, he's retired. No one in his field gets published down under.

And Austrian Economics may shed some light on the future in the USA. I do know that no one else understands what's going on.

Greenspan made the remark last year that 40 years worth of economics learning was "flawed". Bernanke was his student.

So, any port in the storm is worth a look. IMO

Jan 12 01:09 PM

[Jubilee Year:]

Great article. Most people think we are getting something for nothing in the stimulus, like presents from Santa. In fact, it will distrupt the labor and finance markets and subsidize unproductive industries, making us all poorer, as good money is forced to chase bad. Not to mention the extra debt.

Jan 12 02:35 PM

[User 68127:]

Is Obama mentally-challenged or just cynical? Magical thinking does not make for a strong economy.

Who does he think will be the source of this "free money" that will be handed out to those that pay no taxes, and to Chicago-style "pay to play" contractors? Which is more productive, people spending their own money, or the government?

Obama's plan takes money from the most productive members of society, and gives it to the least productive element--government. Individual initiative, property rights, and freedom take it in the neck!

Is Obama mentally challenged, or just cynical? What about the people that voted for him? What about the media?

Jan 12 02:55 PM

[User 68127:]

My votes:

Obama--cynical.

Voters--mentally challenged.

Media--mentally challenged AND cynical!

Jan 12 03:01 PM

[vaughn:]

It is a fact that the monetary measures promoted by the FEd had all failed, as evidenced by the ZIRP and the swelling Fed balance sheet of trillion dollars in a matter of weeks. The monetary base explodes while the multiplier falls below 1.

Can Obama's pittance $775 billion fiscal policy succeed (less than 500 billion actual spending by fed government) to stop the falling of the housing price, unlock the credit markets and create or save 3 millions jobs? Man, who are you kidding? Bernanke?

Consumers were forced into deleverage en masse starting in September 2007 and there is no end in sight. The savings rate in 2009 may reach 6%, though low compared to those of Japan or china, the effect of which is devastating to the commerce. To reach a 6% savings rate, it could mean consumers will reduce 10% consumption, that could easily overwhelme the 500 billion fiscal stimulus Obama is proposing.

Bottom Line: Obama's stimulus plan cannot succeed. Yes, we can, fail.

Jan 13 01:17 AM

[carey_jim:]

Obama was elected by people who think he will DO something to help them economically, and a statistical analysis of the voters who elected Obama tells us that many of them were people of color and of the working class.

Public perception of the poor is that government can help them by spending money on programs designed to help them. Therefore, Obama will spend government money to help them.

Academic economists tell us that the government usually makes things worse by spending money, and that the private sector can usually do better. But, as has been duly noted by another commenter here, economists get a lot of things wrong.

It's ironic that most Democrats and Republicans, and Herbert Hoover AND Franklin D. Roosevelt, were against the socialistic plan to insure bank deposits (FDIC), proposed by a cranky, obscure Alabama Congressman, Henry Steagall, in 1933. It passed anyway and, miraculously, the Supreme Court let it stand in 1935, probably because it was generally accepted that it did what no one expected it do do, even Henry Steagall, it saved the banking industry.

Economic measures which can harm the economy overall, such as a steep rise in the minimum wage, can still help very large groups of poor people.

There are more poor people than rich people and occasionally they vote for their self-interest, even if it harms the rest of the economy.

It looks like the poor people care more about themselves this time around than the overall health of the economy. Not surprising.

Jan 13 12:12 PM

[k9s-4-k8:]

Most of the jobs that Obama's spending spree will create aren't permanent jobs. They think this spending will somehow prime the pump. I think it is more likely our economy will re-emerge without any stimulus at all. Inefficiencies must be purged from the system. When that purging is done, our capitalist system will lead us out. Unfortunately, we aren't allowing all of the purging necessary for a truly renewed economic rebound. We're propping up business in the hope of avoiding the purge. This will only delays it for another day. Additionally, it introduces even more moral hazard into the system. Faulty governmental policies gave us moral hazard and their cure is more.

Jan 13 02:57 PM

[Economicos:]

Indeed a very good article. Unfortunately our politicians who have poor quantitative skills as well as poor economic insight fail to understand the the free market must purge out the imbalances via a recession.

Jan 15 01:14 PM

[shootpar2001:]

The author could have left the name 'Obama' out and that would not change things. The statements on capital flows are correct.
This is not Obama bashing, it is Keynesian politician bashing!!
Let's leave the politicians out of this; they are irrelevant bystanders in the larger picture of the economy.
Their intrusions cause these interuptions in the economic cycle (I'll give you that), but they do not 'make-it-all-better' or 'cause a downward cycle'.



On Jan 12 08:22 AM redbaron wrote:

> 'Sound economics and the lessons of history do not support the claim
> that government spending is the cure for recession and unemployment.'
>
>
> Perhaps this is true, but where is the responsibility of the current
> administration discussed in setting this trend?
>
> This is Obama bashing, and nothing more, and the man is not even
> president yet.
>
> For the past 8 years the Bushies have said 'deficiets don't matter',
> and now all of a sudden they become important when the administration
> is going away.

Jan 17 12:04 PM