Wednesday, January 12, 2011

The Government Cannot Grow the Economy

Caroline Baum has written an excellent essay explaining why the government cannot "grow the economy." She is rightly put off by the very nature of the metaphor and further explains why, even if we accept the phrase "grow the economy" it is a fantasy to think that the state can accomplish such a feat.  "In the real world, of course, the more you “grow the economy,” the less you have to show for it." She even quotes the wise and pithy Henry Hazlit,

How marvelous is the Keynesian world! The more you spend the more you save. The more you eat your cake, the more cake you have.”
I lectured on the very topic of economic expansion two days ago in a course I was invited to co-teach with Guido Hulsmann at the University of Angers. I gave the first lecture explaining the mechanisms of economic progress. In order to obtain more and better goods that allow us to satisfy more of our ends, obviously we need to increase our production. Because of the law of returns, gains from increasing our labor face certain constraints. Therefore, we need to take advantage of the use of capital goods which requires more roundabout production processes. Because capital goods need to be produced before they can be used, we must restrict our consumption (engage in saving) in order to sustain ourselves during the time we are making the capital goods that we can then use to produce more consumer goods. Consequently, saving and investment is necessary for economic progress.

Additionally, more roundabout production processes open more opportunities for the division of labor, which further increases our productivity. Because in the market division of labor, however, people are producing for other people, this raises the problem of coordinating all of the economic activity undertaken by the many different specialized producers at the various stages of production. Therefore, wise entrepreneurship is necessary to see that previously accumulated capital is not wasted.

The state can do none of the above. In fact it is worse than useless, the government is positively destructive. Baum's only less-than-bright spot in her essay is when she makes a concession that "Attempts to grow the economy by government spending can only provide support in the short run." In fact, government spending cannot even do that. Any support given is not temporary, it is merely apparent--an illusion. Increasing government spending can make nominal GDP look better, because government spending, after all, is a chief component of GDP. In fact, if GDP is increasing only due to government spending, the economy is actually regressing because capital is being consumed producing things people in society value less than their cost of production.

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