To Spend or not to Spend: that is the Question

Is the world economy to be saved by increasing spending or reducing debt? The alternatives are mutually exclusive. Even if you believe that spending now will result in sufficient future growth to render national debts manageable, that won't happen until the present crisis has been passed. Likewise with debt reduction strategies. We have to decide without knowing which path leads to salvation.

Paul Krugman thinks he knows the answer. Tightening our belts will have us all cooking rats on sticks over fires in barrels. The argument is as governments reduce spending and debt, government workers will stop buying cars, houses, and new refrigerators and firms that have government contracts will lay off workers. That isn't nonsense. Krugman might be right.

The contrary view is that reckless spending is precisely what got us into this mess. The mortgage crisis that triggered the recession was caused by too many people buying houses they couldn't afford, with encouragement from Congress. That was critical only because the major governments of the world were swimming in debt. Borrowing can stimulate economic growth only so long as lenders believe that they will eventually be paid back. The current crisis is really a result of the fact that the economic policies of Washington, Europe, and elsewhere, are unsustainable, and that everyone is finally being forced to recognize the fact.

It matters a lot whose right. There is no real evidence that government spending and regulation can rescue failing economies. Thomas Sowell shows that the history of the Great Depression, on which Krugman relies heavily, tells exactly the opposite story. It was government intervention in the economy that turned an ordinary recession into a fifteen year long Woody Guthrie song.

David Brooks has an excellent column present the case for deficit reduction.

Alberto Alesina of Harvard has surveyed the history of debt reduction. He's found that, in many cases, large and decisive deficit reduction policies were followed by increases in growth, not recessions. Countries that reduced debt viewed the future with more confidence. The political leaders who ordered the painful cuts were often returned to office. As Alesina put it in a recent paper, "in several episodes, spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions."

This was true in Europe and the U.S. in the 1990s, and in many other cases before. In a separate study, Italian economists Francesco Giavazzi and Marco Pagano looked at the way Ireland and Denmark sharply cut debt in the 1980s. Once again, lower deficits led to higher growth.

But a more powerful, if unintentional statement against government spending as a recession remedy comes from a Washington Post article by Keith B. Richburg.

In late 2008, with the financial crisis rippling through the global economy, China's leaders embarked on a two-year, $586 billion spending program to try to stave off a recession and keep the Chinese economy growing.

Unlike in the United States -- where President Obama's large stimulus plan became the subject of protracted congressional wrangling and was shaped to include tax cuts and aid to states -- Chinese leaders followed a simple mandate: Spend and build.

This should please Tom Friedman. The Chinese Mandarins don't have to worry about opposition parties or public sentiment. When they decide to spend, they spend. How did that work out for them?

The result, 18 months after the stimulus was introduced, is an astonishing frenzy of building -- highways, subways, airports, bridges, high-speed rail lines and even new cities constructed, literally, in the middle of nowhere.

Unlike Obama's stimulus, the Chinese weren't propping up the salaries of public employees unions, they were building real stuff. But too much real stuff, or stuff in the wrong place, doesn't pay real dividends in economic growth. Instead, it has to be paid for by absorbing the proceeds of real growth elsewhere.

Now a year and a half into the spending spree, and with the stimulus set to end in just six months, many economists and others here are asking pointed questions: Does China really need all this infrastructure? And what's going to happen when the bills come due?...

Economists estimate that out of the 4 trillion yuan (about $586 billion) stimulus package, the central government spent just over a quarter of the money, with the rest coming as bank loans to local governments. Also, many local governments took out additional loans on their own to finance public works projects. As a result, economists said, local governments are now sitting on a total potential debt bomb of 7 trillion to 11 trillion yuan.

"There's tens, or hundreds, of Dubais waiting in the pipeline," said Xu, referring to the debt-laden Persian Gulf emirate. "It was a panicked reaction to the global crisis. So they rushed out to spend money wherever they could. They borrowed from me -- and from every Chinese." He added another ancient proverb: "You eat your dinner at noon, you have to starve at night."

Richburg, I think, wants to believe that our stimulus was better because it was financed by Federal and not state borrowing. That is not comforting, considering how many of our state governments are going insolvent all by themselves. It also doesn't matter. Government borrowing is government borrowing, regardless of how it is distributed. Like our own stimulus, the Chinese spending spree wasted a lot of wealth to put off the day of reckoning.

The real question is how to restore public trust in the economy. Maybe running deficits of a trillion dollars a year isn't the way to do that.

Comments

[Stan Gibilisco]

We need to restore public trust in large institutions, both public and private.

People want to "eat their cake and have it too," but the universe doesn't work that way.

Does a connection exist between these two hypotheses?

[Donald Pay]

First, you have left out taxes. Spending that is paid for by taxes doesn't increase debt.

Second, it's not a matter of cutting spending. What is it you want, and don't want government to do? Do you want a bloated military running all over the Middle East, or do you want lean, green energy alternatives that obviate the need for the military to protect our "interests?"

Third, you are wrong about the Chinese leadership. They do have to worry about public opinion. The "Communist" Party is a single "big tent" party that has rival ideologies, different policy priorities and regional differences, which is probably why they spread the stimulus around to the provinces. In your piece, you have summarized the elite coastal financial view. That is not the view of the interior provinces, who have lagged in development during China's boom.

[William]

Donald,

("Spending that is paid for by taxes doesn't increase debt")

Are you seriously suggesting the country can "tax its way to prosperity"?

[BillW]

Donald,

Exactly how would investing in the myth of "lean, green energy" even if true reduce the need for the military to deal with the terrorists who have declared war on the United States?

[Donald Pay]

William: You have to have a correct balance between taxes and spending. What you spend on matters, as does what and how you tax. The conservative idea that all you have to do is cut taxes has bought us an incredible amount of debt.

BillW: See, when you say "myth," it just proves you don't have a basic understanding of what is going on. The terrorists are funded by oil money.

[William]

Donald,

I've never claimed that "all you have to do is cut taxes", you insist on building straw men to knock down, thinking you're having a debate. Tax policy is much more than simply raising or lowering taxes. What you tax and what you fund are much more important, although I'm sure our priorities are much different in those areas.

You appear to think that "green energy" is either ready "for prime time" or that government spending will "make it so" in the immediate future & I don't.

[luciyahelan]

I've never claimed that "all you have to do is cut taxes", you insist on building straw men to knock down, thinking you're having a debate. Tax policy is much more than simply raising or lowering taxes. What you tax and what you fund are much more important, although I'm sure our priorities are much different in those areas.I appreciate the concern which is been rose. The things need to be sorted out because it is about the individual but it can be with everyone. I like this particular article It gives me an additional input on the information around the world Thanks a lot and keep going with posting such information.
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[Nihar]

Obama was born in Hawaii. Doesn't really metatr if his Kenyan father was around for the birth or not. By current law he is a US citizen. People who question this make themselves look foolish or worse.Likewise, it is wrong to blame Obama for the meltdown of the US economy and for our soaring national debt. George W Bush and his party drove the US economy over a cliff before Obama was ever elected. Ronald Reagan very nearly bankrupted the country during the 1980s. Republicans are to blame for this mess. They love to spend trillions of dollars on unnecessary wars and a bloated imperial military. They all believe in Republican Big Government, but unlike Democrats, they want to put it all on the government's credit card. Republicans spend like crazy but then cut taxes to corporations and the wealthy. They cut off government revenue and thus create these huge budget deficits. And they refuse any talk about restoring taxes to a responsible level that would end the deficits so they are not serious about cutting deficits or paying off the national debt. They want to use the debt as an excuse to end Social Security, Medicare and Medicaid. Medicaid needs to be reformed and greatly trimmed back. But Social Security and Medicare are vital programs that are supported by payroll taxes. There is no reason to end them. So if the choice is to have a black president and keep Social Security and Medicare, or to have a white Republican president and end these programs, I will vote for Obama just like I did in 2008. I don't want to have to go off and die under a bridge when I get old.

[Svgi]

Idealistically, congress is supspoe to tax us and put all the tax money into a high interest bearing account. Then, they are supspoe to skim off the interest and give us back 100% of what we pay into the system annually, however, this system has never worked that way. So, instead, they set an amount of money (x) to represent how much you have to pay in taxes per dollars you earn. So, now you only get money back if you over pay. And again, they are only supspoe to spend exactly what they take in, and nothing more..However, congress gets a little greedy, and goes a little nuts with the check book, and writes checks they cannot honor-so we have to borrow money from other sources (i.e. Social Security, China, ect.,.) thus causing the national debt. Printing more of our own money to pay for this debt would not only devalue our dollar but cause inflation (which is the same as devalue).One thing to know and understand, no matter how high the national debt is, as long as there is income-we're okay, unless all the countries we owe money to comes to collect (which they won't because we're link into their economy) then we have little of nothing to worry about, with the execption of inflation.

[Donna]

tax refunds (a tax reutrn is the form that you fill out) are an overpayment of taxes that were paid by your employer for you. only pay what you owe-no more, unless you actually trust politicians-lol. the government is full of liars, cheats and thieves.donate extra money on your own, if you wish, to whatever charitable organization you want, and then take the tax deduction for being such a nice person. we really should get all of our pay and then have to make a check out every month for our taxes. then people would realize what they are actually paying.

[Chris]

Why would you want to pay more in taxes then the gomnverent asks for? You owe it to your gomnverent to pay taxes, but you owe it to yourself NOT to pay more then your fair share (and determining your fair share is what tax law is all about).