Government As The Homeowner, Revisited: To Scrap Or To Invest?

Consider a homeowner who owes a typical mortgage on a house and makes just enough to keep up with the bills and maybe every once in a while treat the family to something nice like a dinner out or a trip to the zoo.

Does it make sense for that homeowner to sell the car he uses to get to work in order to pay down the mortgage faster?

How about if he skips paying for the annual licensing for his field of employment (required for his career) to pay down the mortgage faster?

In order to pay down that mortgage faster, does it make sense for that homeowner to stop buying food for the kids, getting reasonable check-ups and other medical attention as needed, and keeping the house warm enough that the pipes won't freeze?

Should the homeowner cut out all trips to the library for books for the kids so as to save on gas and send bigger mortgage payments? How about toys? Should the homeowner never buy a toy again until the mortgage is payed off, even if it's a just started 30 year mortgage and he has a newborn with no toys beyond a single teething ring?

Does any of that really, truly make sense?

How about investments? Should the homeowner stop contributing a modest sum to his retirement plan and an education savings plan for his kid? Even if both of those investments are expected to have a return higher than the interest on the mortgage?

And if the homeowner can reasonably expect to get significantly higher pay from investing in his career, what then? Let's imagine this homeowner could put $1,000 on his low interest home equity line and get training and certification that on average increases a certified individual's pay by $1,000 a year. Would it be more sensible, rational, and responsible for the homeowner to get this certification or to avoid taking on a little bit more debt?

Our government is this homeowner. Our debt is this manageable mortgage.

When we're at full employment -- unlike now -- there would be no certification we could expect to be a safe bet to increase our income steadily. But we're not there. Not even close.

When we're well below full employment on account of a consumer demand shortfall -- like now -- just about any additional spending we have the government do can typically be expected to add to commerce and help push us that little bit closer to full employment. That means higher revenues. And that's without even focusing it into the most useful spending, which we can and should do to get the most bang for the buck by spending on adding to infrastructure, R&D, and other investments known to build the most revenue.

It should already be an obvious choice. But unlike the homeowner, the government gets an additional win by investing that spending in increasing revenue. Since additional employment means less unemployment, medicaid, and other liabilities, the government reduces its costs by increasing its revenue. That's not just a win-win ... it's a no-brainer. It's stunningly obvious. We should be investing in raising our revenue by engaging some short term spending (preferably including long term investments in that short term spending).

Now if only the budget cutters in Congress could see that.

Why Johnny Can't Cut Spending

Well, said, Jonathan Chait. Well said, indeed!

(The Johnny in the title "Why Johnny Can't Cut Spending" refers to Speaker Beohner, not Mr. Chait.)

From "Why Republicans Can’t Propose Spending Cuts",

"Reporters are presenting this as a kind of negotiating problem, based on each side’s desire for the other to stick its neck out first. But it actually reflects a much more fundamental problem than that. Republicans think government spending is huge, but they can’t really identify ways they want to solve that problem, because government spending is not really huge. That is to say, on top of an ideological gulf between the two parties, we have an epistemological gulf. The Republican understanding of government spending is based on hazy, abstract notions that don’t match reality and can’t be translated into a workable program."

This is exactly the problem! We have one major party that has some idea -- if an imperfect grasp -- of what's going on struggling to reach agreement with the other major party ... the one that not only has no idea what's going on but fundamentally opposes the whole idea of what's really going on at an ideological level. We're dealing with a faith-based community of Republicans who insist that we really need to cut spending. But it's just because they believe in cutting spending for its own sake. There is no logical grounds for dramatically cutting spending supported by cold, hard fact. There is only a doctrine claiming that cutting spending is always the right thing in all circumstances. That's incorrect. And it's a harmful error ... a potentially disastrous error.

The "Burden of Debt" versus the Burden of a Weak Economy

Dean Baker from "Brad Delong Beats Me To Responding to Nick Rowe":

"... The burden of the debt only exists if there is reason to believe that debt is somehow displacing investment in private capital, which is certainly not true at present. 

I would probably argue the case even more strongly. In a depressed economy like we have today, there is reason to believe that the deficit, by boosting demand, is actually increasing investment, thereby making future generations wealthier. There is also the issue of human capital, that by keeping workers employed and keeping families intact, it is improving the productive capacities of the labor force in the future. 

Perhaps most importantly,it is essential that people understand that the measure of the burden of the debt in future generations is not the size of the debt, but the extent to which we believe the debt has reduced output in the future compared to a counter-factual where we did not run the debt. If the debt did not reduce the economies' future productive capabilities (or even raised them) then there is no burden of the debt. In any case, how well we are treating our children is measured first and foremost by the health and the economy and the society we pass on to them, not the amount of government debt."

(Emphasis added by me)

This is part of why it makes sense to put deficit spending into fixing the output gap. While the economy is rolling, it's rolling slower than it ought to be. If we use deficit spending to push our economy up to its potential, we pass on a more healthy economy to our children.

(For other related comments, see Mark Thoma's "Bogus Arguments about the Burden of the Debt")

And the reverse also holds. In a depressed economy, austerity should shrink what we're handing to our children. Apparently the IMF is starting to learn that lesson about Europe, though as Krugman points out, the GOP seems not to have caught on to the lesson.

Grunwald Clarifies Exactly Where Ryan Stands

Highlights from Grunwald on Ryan in "Paul Ryan and the Stimulus: A Match Designed to Make My Head Explode":

"Funny, Ryan somehow forgot to mention that he was one of those proponents. He had voted for the Bush stimulus, along with the Bush tax cuts, the Bush wars, the Bush security spending binge, the Bush prescription drug benefit, the Bush highway bill that included the Bridge to Nowhere, and the Bush bank bailout. Fiscal conservatism!"

and

"Republicans never explained how $715 billion worth of tax cuts and spending could be good public policy while $787 billion worth of tax cuts and spending was freedom-crushing socialism. In the minority, they didn’t have to. And Paul Ryan? As usual, he fell off both sides of the horse. He voted for the ideological tax-cut bill that would have increased the deficit, and the political spending bill that would have increased the deficit. And then he railed about Obama and the Democrats increasing the deficit."

Grunwald, of course, gave more detail around the above, but those're the real biting crux of it. For all of his reputation, Paul Ryan really turns out to be about nothing more than GOP partisan politics. His records shows that he's got the typical Republican history of ranting about Democrats and deficit spending out of one side of his mouth while voting for Republican budget-busting policies with the other.

Education Spending, the Prequel (pre-2005)

Gravity and Education Spending spoke to the federal education funding situation from 2005 and thereafter. Here's one that addresses the years before that by borrowing a chart from ed.gov. Note how little that gray federal segment is compared to the rest of the bars. And they wonder why fluctuations in federal education spending don't correlate with student performance. Maybe it could be the fact that federal education spending has generally been a small portion of the total.

from http://www2.ed.gov/about/overview/fed/10facts/edlite-chart.html#2

Gravity and Education Spending

There's a CATO Institute graph going around that paints a very distorted picture as if we had some sort of continuously skyrocketing federal spending on education. In truth, that's not the case at all. We saw a very large -- but very brief -- spike on account of the Great Recession. The CATO graph neglects to include the estimates for 2011 and 2012 spending that show it going back down.

Data from http://www.gpoaccess.gov/usbudget/fy11/pdf/hist.pdf

Sometimes what went up comes back down. And that's without even adjusting for inflation.

The 2010 through 2012 figures are estimates. But CATO included the 2010 estimate, so why not the rest of the picture so that we could see it comes back down?

What happens if we adjust for inflation and population?

Not only does the brief boost go away, but it looks like its going to go below 2005 levels.

Update: for a little pre-2005 context, see Education Spending, the Prequel (pre-2005).

Debunking the Notion that Inequality Wouldn't Impact the Economy

It's been claimed -- incorrectly -- that overall activity would neither be increased nor diminished by how evenly or unevenly money is distributed within our national economy. According to that line, we'd get the same amount of commerce regardless of whether we have a larger share of the pie held by the wealthy or by the lower and middle classes. "Money is money," or so they say.

Except that in reality, lower average propensity to consume (APC) results from significantly increased real income.¹ Who has how much matters because people tend to spend different portions of their income at different levels of wealth. Wealth and income distributions make a significant difference to effective demand. We're not concerned with what people would like to have if they had enough money; we're concerned with what people will spend with the money they're getting. If Warren is a wealthy person and John is a poor person and over time Warren attains a higher share of the available money, total spending -- effective demand -- generated by those two consumers will drop.

If there's $1,000,000 of total income between the two at time T1 and Warren gets $950,000 while John gets $50,000 and Warren spends 33.33%² of income to John's 100% of income, then total spending by these two individuals at time T1 will be:

T1: $316,635 + $50,000 = $366,635.00

When income ratios shift and there's an inflation-adjusted $1,000,000 of total income at time T2 and Warren gets $975,000 while John gets $25,000, Warren's spending ratio (APC) will likely have fallen slightly from the previous propensity, but we'll stick with 33.33% for simplicity and understatement. Meanwhile, John can't spend as much as before because John's available funds have dropped. Even if Warren still spends at the same rate -- which is unlikely -- then total spending would be:

T2: $325,967.50 + $25,000 = $349,967.50

That would be a drop from time T1 to time T2 of $16,667.50 in inflation-adjusted spending. I've picked an arbitrary APC for Warren, but herein we're just showing the rough effect. The dollar values are merely for illustration of the concept. Even if the exact average amount might vary slightly from the $16,667.50 of our illustration, the point remains that there would be a shortfall. With more of the money shifted to those with a lower APC, you get lower consumption which is to say lower effective demand.

Even if total income increases, with enough shift from those who will spend higher percentages of their income to those who will spend lower percentages of their income, total spending can fall. More total wealth does not necessarily translate to more total spending. More total wealth will only increase total spending when distribution among varying APCs (and thus the overall APC) remains sufficiently stable. Having wealthy people is useful; but we need enough money in the hands of average consumers to support that wealth. Concentrate too much of the available wealth into too few hands and you get less ability to consume which means less effective demand.

Confronted with that reality, the "money is money" crowd rely on APC's flip-side, average propensity to save (APS). They're two sides of the same coin. As APC drops, APS rises. Our hypothetical Warren has a lower propensity to consume but a higher propensity to save. Some try to claim that the reduction in APC would be balanced out in terms of economic activity by the corresponding increase in APS. Unfortunately, that would only hold true in a closed economy with no outlets for investment other than productive investments (such as business start-ups and expansions). We're not a closed economy, so even when increasing APS does translate the savings into productive investment, those investments need not necessarily be domestic. For the United States, given that foreign returns are out-pacing domestic returns from such investments, much of the savings naturally translates into foreign investment which does absolutely nothing to balance out the reduction of consumption in our domestic economy.

Even if we were a closed economy, we have a variety of investment options beyond just productive business investments alone. For instance, Warren might buy gold ETF shares from Glenn who might then use the proceeds to speculate on the British Pound or perhaps to buy Treasuries.³ A dollar of savings lacks any certainty whatsoever that it would spur even a penny of business investment. Particularly when many businesses are avoiding expansion because they already have more than enough capacity to meet projected demand for their goods and services for the next several years, we find ourselves in a situation where there is both a shortage of effective demand from consumption and a shortage of available productive investment options due to insufficient need to expand caused by that same shortage of effective demand.

This all matters because we need a certain level of effective demand in order to sustain full employment. Without sufficient consumption, businesses need fewer workers. With less demand for labor, wages fall. Dropping wages and employment both further depress the nation's ability to consume, leading to yet more unemployment and dropping wages. With too much of our wealth concentrated at the top, we can't support as much wealth. That's bad for rich and poor alike. As Franklin D. Roosevelt said, "we all go up, or else we all go down, as one people." We as Americans believe in promoting wealth and affluence. But to do so effectively, we must have enough of a strong base underneath the top to support a growing top. To have steadily growing affluence, we must mitigate the divergence of our most wealthy from our lower and middle classes.

 Notes:

1. When the shift is initially happening, we refer to the marginal propensity to consume (MPC), essentially the rate of change in APC. Herein, we're not concerned with the rate of change but rather just the implications of such a change from one state of APC at one point in time to another state of APC at a second point in time.

2. The 33.33% and 100% value are arbitrary representations of the fact that higher income consumers spend less of their total income than lower income consumers. The actual observed multiplier for various income levels may vary. What's important here is not the specific percentages but rather the impact of the difference in percentages.

3. Treasuries arguably could indirectly contribute to productive domestic investment when the government spends within the economy. Likewise, the gold seller could use the proceeds to invest domestically. However, neither of these have the direct impact on domestic economic activity seen from domestic consumption or direct domestic business investment. They're not a clear proxy for domestic activity. They're a case where savings may or may not translate to investment.

Debunking the Notion that Inequality Wouldn't Impact the Economy

Update: A newer revision of this piece is available than the one below. While this version is still OK, the newer version is recommended as both more complete and I think a better read. The newer version is available at  http://thoughtstate.blogspot.com/2012/02/debunking-inequality-economy.html and http://www.addictinginfo.org/2012/02/10/debunking-the-notion-that-inequality-wouldnt-impact-the-economy/.

It's been claimed that, "Money is money: demand is made by those who have it to spend. If it is unequally spread, the amount of consumption remains the same if saving remains the same."

Except that in reality, lower average propensity to consume (APC) results from significantly increased real income. Who has how much matters because people spend different portions of their income at different levels of wealth. Wealth and income distributions make a significant difference to effective demand. We're not concerned with what people would like to have if they had enough money; we're concerned with what people will spend with the money they're getting. If X is a wealthy person and Y is a poor person and over time X attains a higher share of the available money, total spending -- effective demand -- will drop.

If there's $1,000,000 of total income at time T1 and X gets $950,000 while Y gets $50,000 and X spends 33.33% of income to Y's 100% of income, then total spending at time T1 will be $316,635 + $50,000 = $366,635.00.

If there's an inflation-adjusted $1,000,000 of total income at time T2 and X gets $975,000 while Y gets $25,000, X's spending will likely have fallen from the previous propensity but we'll go with 33.33% for understatement. Meanwhile, Y can't spend as much as before because Y's available funds have dropped. Even if X still spends at the same rate -- which is unlikely -- then total spending would be $325,967.50 + $25,000 = $349,967.50. Admittedly, I've picked an arbitrary APC for X, but the point is to show the effect. Even if the exact average amount might vary slightly from a drop of $16,667.50 in spending between T1 and T2, the point remains that there would be a shortfall. With more of the money shifted to those with a lower APC, you get lower consumption which is to say lower effective demand.

Even if total income increases, with enough shift from those who will spend higher percentages of their income to those who will spend lower percentages of their income, total spending can fall. More total wealth does not necessarily translate to more total spending. More total wealth will only increase total spending when distribution among varying APCs remains sufficiently stable. Having wealthy people is useful; but we need enough money in the hands of average consumers to support that wealth. Concentrate too much of the available wealth into too few hands and you get less ability to consume which means less effective demand.


Note on totals versus individuals: the figures above are not intended as a complete representation of our entire economy. They're just looking at two selected hypothetical consumers within that economy and the total between those two. In order to represent the total economy, we'd need to involve such factors as the ratio of upper incomes to lower incomes with many Y-type consumers existing for each X-type consumer. However, representing the entire economy is thoroughly unnecessary for illustrating the main point. We're not looking to calculate out the exact total dollar amount shifted out of the domestic economy by shifting income shares from lower-income individuals to higher-income individuals. The point is simply to explain the fact that there is some amount being shifted out of the domestic economy.


Note on the impact of increasing APS: It's been argued that this reduction in APC would be balanced out in terms of economic activity by the corresponding increase in APS. Unfortunately, that would only hold true in a closed economy with no outlets for investment other than productive investments (such as business start-ups and expansions). We are not a closed economy, so even when increasing APS does translate the savings into productive investment, those investments need not necessarily be domestic. For the United States, given that foreign returns are out-pacing domestic returns from such investments, much of the savings naturally translates into foreign investment which does absolutely nothing to balance out the reduction of consumption in our domestic economy. Further, even if we were a closed economy, we have a variety of investment options beyond just productive investments alone. There is absolutely no certainty whatsoever that a dollar of savings will necessarily even spur a penny of business expansion. Particularly when many businesses are avoiding expansion because they already have more than enough capacity to meet projected demand for their goods and services for  the next several years, we find ourselves in a situation where there is both a shortage of effective demand from consumption and a shortage of available productive investment options due to insufficient need to expand caused by that same shortage of effective demand.

The Second Paradox of Thrift

We generally consider savings good for individuals as a matter of common sense. One would naturally think it would be good for the nation as well. As it was put to me at one point, "But if a household gets ahead by saving, not spending, why don't a million households?" The question requires different answers depending on whether you're concerned with those million households as an aggregate of individual spenders or as a unified spender through a national government.

The traditional answer considering the aggregate of individual spending hails as the paradox of thrift. The typical increase in savings by the average consumer comes via reducing spending rather than from an increased income. Given level income, as one consumer spends less in order to save more, that consumer increases his personal net worth. However, the decrease in spending lowers that individual's contribution to demand. If decreased spending by half the potential spenders is offset by increased spending from the other half, then there's a break even for the overall economy. But if every spender in an economy spends 1% less in an effort to save more, then overall demand for goods and services would be diminished by roughly 1%. When supply and demand happen to be matched, that reduced demand doesn't require as many employees as before to fill the orders. The resulting layoffs mean fewer people can save thus ironically causing reduced aggregate savings from a too aggressive (or panicked) shift towards individual savings.

On the other hand, if we're talking about those million households in the unified sense of a national government, we need to look at a different aspect of the question. At that point, we can shift our focus to that first part about "gets ahead". Almost no household truly ever gets ahead by saving rather than spending in real life. Saving is how households that are already ahead maintain that being ahead. Households get ahead in the first place by spending on tools to increase income (such as job training, education for higher-wage jobs, tools for trades, goods to improve and sell, etc.). Saving foolishly can be far worse than spending wisely.

In that sense that recognizes that certain debts can increase future income by more than the debt, what's good for households can be good for nations. For a nation that's already doing great, saving could do a wonderful job of steadying the already rolling wealth. For a nation that's not doing well, investments in improving the national potential will tend to do much better. In that sense, it's just like an individual. Your high-income CEO would be wise to put enough money into safe investments that he no longer has to have his job to pay the bills and just does it for personal satisfaction. Your broke high-school graduate would be better advised to get an engineering degree on loans than to try to save up from working at a gas station or other low-wage job. A nation in steady growth (or a boom) mirrors the situation of the well-paid CEO or engineer. A nation in low growth (or recession) mirrors the situation of the low-paid laborer who can't quite afford the basic cost of living and will never be able to save up enough to make a difference without taking on debt to achieve a higher income.

Simply put: If you have a high income (strong growth), it is wise to save. If you have a low income (weak or negative growth), it is more wise to spend on increasing your income. The second paradox of thrift: for an individual or nation, you have to already be doing well before thrift makes as much sense as spending wisely.

Bastiat's Fallacy In The Parable Of The Broken Window

Frédéric Bastiat

The Broken Window may be the most popular story among today's Libertarians and disciples of Mises. Discuss government spending, and they will almost assuredly bring up Bastiat's parable of the Broken Window as if its mere mention should ward off all thought of govt spending. Unfortunately for Broken Window devotees, Bastiat's bases his conclusion on a false assumption.

For anyone not already familiar with the story, Bastiat presented us with a citizen whose son had broken his window. Bystanders consoled the citizen with the thought that at least some good would come of the broken window in that it would mean business for the glaziers. Bastiat, however, argued that had the citizen not needed to pay six francs to the glaziers to fix the window, then those six franks would have been spent on new shoes or a new book. As such, according to Bastiat's telling, the additional work for the glazier came only at the cost of work for the cobbler, the bookbinder, or some other profession. Bastiat offered up his story as an argument against the trade restrictions of protectionism, although today it is more commonly used as an argument against figures showing an increase in economic activity in the wake of a disaster. It's also rolled out against any govt project on the basis of the opportunity cost of what might have happened otherwise.

Bastiat's fallacy: The six francs would not necessarily have been spent. The shoes might not have been bought. Nor the book. His six francs might well have sat buried in his mattress, his house fell down, and someone built over it. Bastiat and all those who call out "the parable of the Broken Window" depend upon an assumption that does not hold, namely that the citizen must certainly have spent that six francs. Clearly that is not the case. The citizen may or may not have spent the six francs. If they were not spent at that time, the six francs may have been lost or forever stored in a static asset (such as cash or gold physically kept in a safety deposit box). Even if it were spent, there is no guarantee that it would be spent in the region of the window and employ a local cobbler or bookbinder.

The safe or safety deposit box are among many options for static assets representing inactive money for our economy. For a domestic economy, any store of assets outside of that economy (e.g., in a foreign nation) will generally spur no activity whatsoever in the domestic economy while those funds remain outside. If the citizen must withdraw funds from a foreign investment to fix the window and those funds would have otherwise stayed in the foreign investment indefinitely, then activity has been added to the domestic economy. Likewise, funds that the citizen would otherwise have invested in foreign assets can not be said to cause the domestic bookbinder to lose a sale because of those funds going into fixing a window. An event that diverts funds back into the domestic economy has increased the domestic economy from funds that would not otherwise have been put to use in the domestic economy.

In Bastiat's example, this obviously means the son breaking the window did not necessarily hurt the cobbler or bookbinder. That would only be the case if the citizen was sufficiently impoverished by the replacement of the window as to be unable to afford the shoes or the book. That may have been the case for Bastiat's citizen, but will not necessarily be the case whenever a citizen's window is broken by his son. Some citizens will have spare gold in the vault or spare funds in foreign investments that they will bring into the economy in order to replace the window and still get the new shoes or book.

Beyond Bastiat's example, at least some of the funds used to rebuild after a disaster will normally have been sitting in static assets. For the region being rebuilt, it doesn't matter what those static assets were so long as they were not otherwise going to be spent in that region. That's how regions get an economic boost from disaster recovery, such as fixing windows. Of course, recognizing this effect does not mean celebrating the disaster. No reasonable person is happy to see damage just because of the effects of the rebuilding. Among other reasons for non-celebration, the additional activity for repairs will not always be sufficient to more than make up for jobs lost or suspended because of damages. Still, deploring the damage doesn't mean we can't recognize the economic effects of the rebuilding itself.

For govt projects in general, the fallacy shows us that govt spending will generally defy its Broken Window critics and add to the economy so long as the spending draws a sufficient portion from outside the active, domestic economy. Unless too much of the funding comes from taxing those on a tight budget, building a new or expanded road and hiring a construction worker should not be expected to impoverish the taxpayer even before we consider the long term benefit of the road to the taxpayer. Only taxes on those who have the least will necessarily withdraw money from the economy. Upper-bracket taxes can simply mean somewhat less being stored in static assets such as foreign investments that would not benefit the domestic economy anyway. And issuing T-Bills at today's extraordinarily low rates to pay for expanding and improving infrastructure will not tend to divert funds from business investment either. My choice of how much to invest in risky start-ups with high potential return will be determined by my risk tolerance rather than how many bonds the Treasury issues. It's a safe bet that's the case for most other investors too. That risk tolerance isn't likely to increase until we have a credible boost for the economy -- not just some half-hearted nod to the idea. Let's fix some windows. And make those "windows" big infrastructure improvements and lot's of 'em.

No, World War 2 Didn't End The Depression

There's a common myth out there that goes, "the Great Depression was finally ended by World War 2". It has some slight variations, such as "the Great Depression lasted 15 years" or even "the market didn't recover until govt spending stopped".

All of these are complete misunderstandings of history if not outright lies.

While there may not be as accepted a definition for depression as for recession, there's a good bit of consensus along the lines of these two criteria for an economic depression:

1. real GDP decline beyond 10%
2. period of decline lasting more than three years

Year	2005 Real GDP
1929	977,000
1930	892,800
1931	834,900
1932	725,800
1933	716,400
1934	794,400

Real GDP declined every year from 1929 through 1933. By 1934, the economy had been pushed back into growth again. There you have it: the end of the Great Depression. It was 1929-1933, far short of 15 years. One can not be in a depression and have real GDP growth because a depression is defined by GDP decline. One can note other factors peculiar to depression, such as deflation. But a depression only exists while there is a declining economy as measured by real GDP. One can debate what ended the Great Depression, whether it was a combination of monetary and fiscal policy, deficit spending alone, monetary policy alone, or some other set of factors. But there is no reasonable debate that the Great Depression ended years before World War 2 when the economy returned to growth.

Some effects of the Great Depression -- though mostly diminished -- did linger somewhat until World War 2. That much is true. Although unemployment had been drastically reduced before the war, it was still high until the war. Yet while it took quite a while to achieve full recovery, it did not take all that long to achieve renewed growth. Unemployment peaked in 1933. By 1936, the New Deal had kicked the economy into rolling again and -- though unemployment was still high -- the main economic indicators were back in gear. In early 1937, industrial production reached a level above that of 1929. But then pressure picked up to balance the budget, and FDR and Congress cut back spending. Although unemployment had been dramatically reduced from its peak, it was still too high for the economy to be self-sustaining. With the fiscal and monetary tightening of 1937, production dropped and unemployment went back up. Seeing the mistake, they stoked spending back up in 1938 and the recovery resumed.

Unemployment remained problematic throughout the 1930s and into the start of the 1940s. But even that measure declined every year that the New Deal was fully in force. The recession of 1937-1938 showed the effect of govt cutbacks pushed by Republicans overzealous to balance the budget at the wrong time. The cuts interrupted the full weight of the New Deal to push the economy forward. The unemployment rate continued to drop right up until the start of the war. We were already growing towards full recovery before the war. Admittedly, the massive increase of spending for the war -- far beyond that of the New Deal -- did push unemployment to very low levels far more rapidly than we would have achieved without the focus of a war effort. But the war boom runs quite the opposite of a case against spending. The extreme, focused spending for the war effort rocketed our economy higher. It was a finale to the New Deal, like a burst of fireworks at the end of a good 4th of July show. It couldn't be further from the truth to say that "the market didn't recover until govt spending stopped". When govt cut spending while the economy was still weak, the economy suffered. Except for the disastrous cut-backs that brought us the recession of 1937-1938, government didn't stop spending until the markets had recovered.

Cuts Damage: Even for the Body Politic

"For every $1 the government doesn't spend, economic activity shrinks by as much as $2."

from Insights on Stimulus, Thanks to the Mafia

This insight comes from an Italian study showing that when they freeze spending for government project in areas where Mafia corruption was found, the reduction in government spending leads to an even larger decrease in economic activity in the region than the amount of the initial cut. Not only do private sources not step in to make up for whatever the government doesn't spend, but without the government project there is even less private spending than there would be otherwise.

There are, of course, limits to how much the ratios seen in that study will match the ratios one would see elsewhere, such as in the U.K. austerity programs or the massive budget cuts that the GOP is attempting to foist upon the American people. However, the general mechanism will apply. When you're looking at useful infrastructure improvements [roads, rail, bridges, etc.] and/or programs upon which businesses rely for stability -- such as having their healthy, able-to-work labor supply not bogged down with personally looking after their grandparents -- [Social Security, Medicare, etc.], these things will generally hurt economic activity if government significantly cuts spending.

What is Small Government?

What does small government mean? Those calling for massive cuts say we've got big government and they just want us to get back to small government. They say that whoever disagrees with them wants "big government."

Like pretty much all of my fellow Americans, I want govt to stick to its appropriate role. I want a government that does only what we need it to do. But what if that's what we've got now?

Comparing against other modern, industrialized nations would be one way to put it into perspective. In 2009 we had larger than normal expenditures from stimulus and lower than normal GDP from the Great Recession. That year, we had a GDP of roughly $14,258 billion and total Federal spending of $3,518 billion. That's 24.7%. In the same year, the U.K. central government spent around 32.6% of their GDP. Looking back to the more normal levels of a year that doesn't include stimulus spending, in 2007 our Federal spending was 19.38% of our GDP. That same year, the U.K. central government spent 28.44% of their GDP. That's how the general trend goes. Between 1995 and 2010, the our national govt spending undershot their national govt spending by 8.7% on average.

National govt spending as a share of GDP in the US and UK

The U.K. is far from alone among the other industrialized nations in dwarfing our national govt spending.

Expense (% of GDP) in 2004 from data.worldbank.org

By and large -- though some other countries often run budgets proportionally similar to ours -- we have a relatively small government compared to the other industrialized nations.

Perhaps one could argue that maybe the general trend in the other industrialized nations is to maintain giant governments that dwarf our so-called big government. If that's the case, we should easily be able to find vast, expensive programs that we don't really have any use for in our society ... that few of us would want government to do. Where are those programs?

Shall we cut infrastructure spending and let our already crumbling roads and bridges decay further, making it harder for our businesses to transport products? Shall we dismantle Social Security and allow elderly citizens to starve in the streets? Should we stop investing in the medical research that has helped make our biomedical industry such a large contributor to our GDP? Shall we stop funding education and fail to foster skills needed to compete in the modern global economy? Shall we stop monitoring our food supply so that producers can get away with cutting corners and contamination runs unchecked? Shall we cut billions by stopping payments for police, fire-protection, and border security?

These things are all quite necessary from the government. A modern society doesn't function as well without any of that. When you look at charts showing a much smaller government hundreds of years back in our history, keep in mind that we had an entirely different economy back then. We didn't have the transportation system that we have today. We didn't have a social safety net to make it so an elderly miner could retire rather than just working till he died nor workplace regulations to make it less likely for him to die of black lung. We didn't have such a thriving biomedical industry both making our health better and enriching our nation. We didn't have a workforce capable of designing high-tech products to sell to the rest of the world. We didn't have most of the great things about our modern economy that require government programs to work smoothly and in many cases to function at all. One can't expect the economy of the 21st century to operate with the government spending levels of the 18th or 19th centuries. When we had significantly smaller government, we also drove horse-drawn carts, used outhouses, suffered polio, and couldn't reasonably expect to have a chance of ever retiring. Should we really be basing our idea of appropriate government spending on a time to which we wouldn't want to go back in any other way?

Plan For Growth

"It takes as much energy to wish as it does to plan." - Eleanor Roosevelt

We have uncomfortably high unemployment. We want that to come down. We also have an uncomfortably high deficit. That needs to drop too. What we need is a plan. One that can do both. One that can work.

Our new House majority has loudly pushed focusing on the deficit with budget cuts. The trouble, as I've previously shown and discussed in relation to specific budget cutting figures, is that any significant budget cuts are very, very likely to steer us into far higher unemployment. That would further reduce tax revenues and make the deficits worse. So that just won't work. We can't get rid of the deficit by chopping growth and making the deficit worse.

What can we do?

Well, what happens if we maintain the status quo? What happens if we proceed with spending at the exact dollar amount it is now, keep tax rates exactly where they are, and manage to keep the pace of growth at the roughly 3% estimated for 2011? (Note that spending is scheduled to shrink in 2012 with the expiration of stimulus programs and the winding down of expensive wars. So this assumes we actually spend more than is currently expected for some of these years.)

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue stays at the current 14.81% of GDP

Interesting. We'd have a surplus by 2029 at that rate and could start reducing our debt. That's without budget cuts. That's even assuming more spending for at least one of those years than is currently projected. We'd all love to see that budget gap closed sooner, but that's going in the right direction.

OK, how can we speed that up? What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012 but keep all else as before, with spending staying at the 2010 dollar level and a 3% GDP growth rate?

Deficit/surplus assuming budget holds steady, 3% GDP growth, and revenue goes back to 18.2% of GDP in 2012

A bit better. That'd have the surplus and its potential paying down of the debt begin in 2022. But let's try for more. What happens if we go back to the 30-year average of revenue as a percentage of GDP starting in 2012, keep spending at the 2010 dollar level, and find some way to increase our growth rate over 3%? For the sake of charting, let's imagine we get it up to 4% in 2012, peak at 5% in 2013, and then manage 4% thereafter.

Deficit/surplus assuming budget holds steady, but revenue goes back to 18.2% of GDP and avg. 4% GDP growth from 2012

That's more like it, don't you think? If we could achieve an average 4% GDP growth over that time, we could be seeing revenue eclipse spending in 2019, assuming we keep spending at the dollar amount from 2010 and return revenue back to the 30-year average of 18.2%. That's just 8 years from now. I don't know about your kids, but that's even before my older daughter will start college.

That's fairly vague, I'll admit. I've left a lot of room for what exactly those efforts to increase the rate of GDP growth might be. Where to get the money? I'm not a defense expert, but even some conservatives are suggesting we have some fat to trim in the defense spending. Imagine if we took those proposed cuts on spending beyond what the Pentagon actually needs to do its job and transferred that money into real job creation programs.

Off the top of my head, I can come up with several ways we could be doing more to create jobs through our Federal govt:

1. a reborn national Civilian Conservation Corp chartered for 5 with potential to renew
2. repairs to all of our crumbling bridges (and maybe revamping some roads too)
3. high tech research towards "green" energy and products

The first two of these would easily pay off right away. We've got a lot of unemployed construction workers, and it shouldn't take a terrible lot of retraining to put a lot of them to work in a CCC or on improving our transportation infrastructure. The research part might take a bit longer to get going, but the pay-out would go even further. Well beyond when we might have brought our unemployment down using a CCC and beefed up infrastructure projects, we could be benefiting from jobs and sales in exporting of green tech, just like we've benefited from Defense Department and NASA research in our computer industry. That's investing prudently in a future for our children.

It's time.