Evidence of How to Grow an Economy

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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  • Anon

    I think you are way off on this one. The private sector is unwilling to spend at this point for multiple reasons (some of which you have pointed out on your blog). If the government cuts spending at this point any signs of recovery we are seeing will likely get stopped in their track.

    In the long run I agree that it would be better to have people employed by the private sector but we have to deal with our current reality.

    When you say “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”, which fact are you refering to?

    • http://www.pointsandfigures.com pointsnfigures

      Keynes notion on macroeconomic theory has been disproven. His multipliers are off. The velocity of money is off. To Keynes, he was indifferent if the dollar paid to the worker came from the govt or the private sector. Also, his budget analysis said you could raise taxes and raise revenue.

      Virtually every Keynesian notion on macroeconomics is wrong. It should be relegated to the dustbin of history. Seriously, are you drawing IS-LM curves and making decisions off them? They don’t work, and the economic modeling based on Keynes doesn’t work.

      Classical approach is realistic, more elegant-and then the argument is focused on how much govt regulation we have over totally free unregulated markets. Focus then becomes on negative and positive externalities and how we define them. Those are real arguments.

      It comes back to Coase Theorem.

  • Anon

    I think you are way off on this one. The private sector is unwilling to spend at this point for multiple reasons (some of which you have pointed out on your blog). If the government cuts spending at this point any signs of recovery we are seeing will likely get stopped in their track.

    In the long run I agree that it would be better to have people employed by the private sector but we have to deal with our current reality.

    When you say “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”, which fact are you refering to?

    • http://www.pointsandfigures.com pointsnfigures

      Keynes notion on macroeconomic theory has been disproven. His multipliers are off. The velocity of money is off. To Keynes, he was indifferent if the dollar paid to the worker came from the govt or the private sector. Also, his budget analysis said you could raise taxes and raise revenue.

      Virtually every Keynesian notion on macroeconomics is wrong. It should be relegated to the dustbin of history. Seriously, are you drawing IS-LM curves and making decisions off them? They don’t work, and the economic modeling based on Keynes doesn’t work.

      Classical approach is realistic, more elegant-and then the argument is focused on how much govt regulation we have over totally free unregulated markets. Focus then becomes on negative and positive externalities and how we define them. Those are real arguments.

      It comes back to Coase Theorem.

  • Anon

    You quoted Wesbury “Government must tax and borrow from the private sector to fund itself”. This is false. The U.S. government is not revenue constrained.

    If government spending decreases and the private sector is unable or unwilling to make up for that GDP falls. The maths are simple: If a country has, for example a 100% debt-to-GDP ratio, a GDP reduction of 5% immediately increases this debt to GDP ratio to 105.3%, even if the government doesn’t add a single dollar of new debt.

    There is no doubt that goverment is a poor resource allocator but in times like these we have little choice.

    • http://www.pointsandfigures.com pointsnfigures

      Au contraire. Hauser’s law shows that the government revenue averages 19%. So, in fact it is constrained. Corporations can recharter, people can leave. Evidence, look at state’s now. Countries are tougher, but it’s possible.

      The government is the poorest resource allocator.

      • Anon

        Please explain to me how the U.S government is revenue constrained. I clearly specified the U.S, federal government, not states.

        • http://www.pointsandfigures.com pointsnfigures

          US govt revenue is constrained. People will only pay so much in taxes no matter what the rate. At some point, they either shift to a black market underground economy, hide their income, barter etc. Hauser’s law says no matter the tax rate, the govt takes in about 19%.

          If this is true, why not eliminate all write offs, have a flat tax at some rate of 19% or less and send it in?

          • Anon

            Disagree on the government being revenue constrained. We do not need to collect taxes in order to spend. Collecting taxes is just a method of shifting private assets to the public sector. Let me ask you this, when there is a decrease in tax reciepts does there need to be an equal reduction in spending?

        • http://www.pointsandfigures.com pointsnfigures

          US govt revenue is constrained. People will only pay so much in taxes no matter what the rate. At some point, they either shift to a black market underground economy, hide their income, barter etc. Hauser’s law says no matter the tax rate, the govt takes in about 19%.

          If this is true, why not eliminate all write offs, have a flat tax at some rate of 19% or less and send it in?

  • Anon

    You quoted Wesbury “Government must tax and borrow from the private sector to fund itself”. This is false. The U.S. government is not revenue constrained.

    If government spending decreases and the private sector is unable or unwilling to make up for that GDP falls. The maths are simple: If a country has, for example a 100% debt-to-GDP ratio, a GDP reduction of 5% immediately increases this debt to GDP ratio to 105.3%, even if the government doesn’t add a single dollar of new debt.

    There is no doubt that goverment is a poor resource allocator but in times like these we have little choice.

    • http://www.pointsandfigures.com pointsnfigures

      Au contraire. Hauser’s law shows that the government revenue averages 19%. So, in fact it is constrained. Corporations can recharter, people can leave. Evidence, look at state’s now. Countries are tougher, but it’s possible.

      The government is the poorest resource allocator.

      • Anon

        Please explain to me how the U.S government is revenue constrained. I clearly specified the U.S, federal government, not states.

        • http://www.pointsandfigures.com pointsnfigures

          US govt revenue is constrained. People will only pay so much in taxes no matter what the rate. At some point, they either shift to a black market underground economy, hide their income, barter etc. Hauser’s law says no matter the tax rate, the govt takes in about 19%.

          If this is true, why not eliminate all write offs, have a flat tax at some rate of 19% or less and send it in?

          • Anon

            Disagree on the government being revenue constrained. We do not need to collect taxes in order to spend. Collecting taxes is just a method of shifting private assets to the public sector. Let me ask you this, when there is a decrease in tax reciepts does there need to be an equal reduction in spending?

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