The government surprised many economists last week when it announced that the nation’s economy (as measured by the country’s Gross Domestic Product) had shrunk in the last three months of 2012 by one-tenth of one percent. The news was met with a collective shrug, instead of any sense of real panic. No one thought it was anything other than an aberration, and everyone agreed that a later adjustment might even show a mild gain, instead of the almost infinitesimal loss.
But behind the news was a real story, or maybe several stories, the sum of which should hardly lead to an outbreak of sanguinity.
The first story was the principle reason identified for the economy’s downward turn: a 22 percent drop in military spending. This fact suggests a couple of points. First of all, what generates military spending? The answer is the federal government, and that little piece of “tell-me-something-I-don’t-know” information serves as a reminder that government spending is not always as undesirable as Tea Party dogma would have you believe.
In fact, government spending helps an ailing economy by spurring job growth (not coincidentally, the unemployment rate also ticked up last month, to 7.9 percent) and by increasing the rate at which money flows through the country’s economic system.
This fact, and it is a fact, notwithstanding what neo-conservative economists might espouse, fully supports the view that in times of economic malaise (i.e., when the private side of the economy is lagging or just plain depressed), government spending, not government austerity, is the appropriate antidote.
When economies are sluggish, they suffer from a deceleration in the flow of the medium of exchange (dollars in the U.S.) by which commerce occurs. Thus in a recession, simply stated, a dollar will complete the cycle from employer to worker to consumer and back to employer more slowly than it will in an economy with low unemployment and high productivity. Anything that increases the speed by which that dollar completes its cycle will improve the condition of the economy.
Thus government spending is desirable, if not absolutely necessary, in a recession. Yes, markets ultimately do adjust, but they adjust much more quickly when they are jump-started, which is what a good stimulus program of increased government spending is designed to do.
Government austerity in an economic recession is exactly the wrong prescription for exactly the same reason. Reducing the amount of money in circulation reduces the speed by which any single dollar completes its cycle. So employers see less income from the sale of the widgets their workers produce, leading to decisions to reduce the number of employees who make and sell those widgets. With less income earned by those employees and less employees earning that income, fewer widgets are purchased, and with still fewer widgets purchased, the employers may find the existence of their business threatened.
It’s a vicious cycle, to be sure, one that can get very nasty very quickly without the infusion of economic activity that government spending can create. And, yes, the evils that can also come with certain government spending are part of the package. Thus, the military-industrial complex, so loathed by the political left, and the welfare/entitlement programs, so hated by the political right, are both in the mix.
But ideology and moral viewpoints aside, no one should claim that government austerity in the throes of an economic recession is desirable. It isn’t, as the recent government report of the slight drop in the GDP reflects.
If you are with me so far, then you should be asking why it has suddenly become fashionable to favor sequestration (as many on the political right and some on the political left are now claiming). Sequestration, the mandatory “across-the-boards” reduction in government spending that Congress voted to impose on the economy back in 2011 (when the nation’s debt suddenly seemed to be the monumental crisis that absolutely had to be addressed), is due to take effect on March 1. It will, if allowed to last for any appreciable time, plunge the country back into a major recession.
Congress is currently grappling with what to do to avoid its own self-imposed “remedy” to the “crisis” of the nation’s debt. If the issue could be stripped of politics, a solution in the form of a compromise would be relatively easy to broker. That solution would include targeted cuts in military spending (to include a large reduction in America’s military presence overseas) and an adjustment to Medicare and, perhaps, to Social Security that would keep those programs intact, but would delay the realization of benefits for those otherwise eligible.
But whatever solution ultimately emerges will miss the real remedy that a straight application of sound economic theory would otherwise dictate. That remedy would be to increase, not decrease, government spending so as to keep the recovery going, instead of stalling it or reversing it entirely.
So, let me conclude by talking about the nation’s debt. In the long-term, it is probably too large, especially if it were to continue to grow at the pace it has in the last four years. But in the short term, i.e., over the next five to ten years, it shouldn’t even be considered an issue. We need government spending to generate the kind of growth that will ultimately make government spending unnecessary.
Sound anomalous? Not if you appreciate how the economic cycles work. In a recession, fewer workers are employed and they are paid less; thus government revenues (tax collections) fall and the federal debt increases. In a fully functioning economy, more workers are employed and they are paid more; thus government revenues increase and the federal debt decreases. Check out the 1990s for proof of the foregoing. At the end of the decade, with full employment having been in place for several years, the country was realizing a surplus of tax revenues that was projected to completely wipe out the federal debt in 15 years.
A series of massive tax cuts, two major wars and the collapse of the housing and financial markets completely negated that prediction.
Ed,
I never figured you for a trickle down advocate.