Evidence of How to Grow an Economy

Posted by Jeff Carter
on January 18th, 2011

There are two schools of thought that have been laid bare on how to grow an economy. The two diametrically opposed schools permeate every economic debate. Austan Goolsbee came out and basically said death and destruction awaits the American economy if the debt ceiling isn’t raised. I want to take three different economist views and statements and synthesize them into a coherent policy for growth.

First off, I want to take you back to January of 2009. I was at a University of Chicago Roundtable discussion on the financial crisis. One of the panelists was John Cochrane. He didn’t have a lot of good things to say about the interventions and government policy, both Treasury and Fed. In his summary, he said this, “Governments can choose to grow or inflate their way out of a deficit. They always inflate.” As we have seen, the Federal Reserve has made a conscious choice to try and inflate their way out of trouble. Prescient words by Cochrane, but not a huge stretch since he had solid evidence over the years about how each and every government handled their economic problems. He articulates it a lot better and clearer than most.

Another very good economist is Brian Wesbury. He works for FT Portfolios. On Jan 10, 2011, he released an article on government spending versus private spending. If you think about calculus, and operations this makes perfect sense. Distilled, here is his premise. At any given point in time, there is a finite supply of capital flowing through the economy. Competition for that capital is a zero sum game. It’s a competition between the government and private companies. All investors must make a decision on where to invest their money. Each of them weigh the opportunity costs of the decision and make a rational choice. When government chooses to increase its spending and therefore, increase its borrowing-the static supply of capital along with the zero sum game combine to crowd out the capability of investment by the private sector. At the margin, this decision influences economic growth. Wesbury says,

“Contrary to popular belief, government spending is not stimulus – it’s anti-stimulus. Look back at the US in the 1970s, or Europe (and Canada) over the past 30 years. Whenever government spending rises as a share of GDP, unemployment rises too. Government must tax and borrow from the private sector to fund itself. The larger the government, the smaller the private sector, and the fewer jobs there are.”

This hard cold fact fundamentally disproves the macroeconomic theories of Keynes. If you were taught Keynesian economics in school, forget everything you learned because it only works on a blackboard.

Today, we received some more data from a very good economist from Stanford. John Taylor writes an excellent blog, and wrote a great short book on the financial crisis. In his blog Friday, Taylor showed how private investment is the best way to decrease the unemployment rate. His data confirm the statements made by Brian Wesbury. In sum, cut government spending and lower tax rates to stimulate private investment, economic growth will follow.

“This is not what the data show. Consider this chart which shows the pattern of government purchases as a share of GDP and the unemployment rate over the past two decades. (The data are quarterly seasonally adjusted from 1990Q1 to 2010Q3.) There is no indication that lower government purchases increase unemployment; in fact we see the opposite, and a time-series regression analysis to detect timing shows that the correlation is not due to any reverse causation from high unemployment to more government purchases.”

Regardless all the doom and gloom you may read, America is still the most dynamic economy in the world. Get the bureaucrats and politicians out of the way and we can grow our way out of this mess. This means, end subsidies, get rid of regulations, drastically cut spending, cut capital gains taxes, and cut personal income tax rates since so many small businesses pay at that rate. Create a climate for economic activity. The last two years has been a primer on how to kill an economy.

Democrats and Keynesian economists will disagree. But at the end of the day ask yourself this question; Is it better to give an unemployed person a government check, or a job where they can earn a check? I vote for private jobs.

ADDENDUM

So, in the near term debate of the debt ceiling here is what they should do. Increase the debt ceiling, but only after a corresponding massive cut in government spending, and a decrease in taxes. Accounting numbers will tell them that the debt is increasing-since they will use static budget analysis to interpret the numbers. In reality, economic activity will increase and decrease the amount of expected debt projected by the use of accounting numbers. Win/win.

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