Does Government Spending Bring Prosperity?
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Professor Greaves is a free-lance economist and lecturer. His recent books include Understanding the Dollar Crisis and Mises Made Easier (Glossary for Human Action).
Many leaders in high places now promise us that our government will never again permit poverty and depression to devastate our land. They propose more government spending as a cure for every economic evil. And millions of people believe that such a program will work.
The underlying philosophy behind political spending is not new. Similar ideas have appeared throughout all history. They came to full flower shortly after the economic collapse of 1929, when unbalanced budgets were generally accepted as necessary economic measures for relieving those in distress. You could not let innocent people starve, could you?
People pointed to idle factories, unemployed workers and their unsatisfied wants. All we need to do, they said, is to get the government to start priming the pump. A little government spending would provide the would-be workers with the wherewithal to buy the things they desperately need. This would encourage businessmen to put the unemployed to work in the idle factories. This solution sounded so simple, and its political appeal was apparent. So we tried it.
People just plumb forgot all that economists had ever taught. Many desperate persons reached for whatever share they could get of the apparent prosperity that followed. Until war changed the picture, the price they paid was chronic unemployment by the millions. Are we now asking for a repeat performance?
Most people seem to forget that the government can pay out only what it borrows or collects in taxes. They also forget one of the most elementary facts of a free economy —men who will not accept going wage rates must remain unemployed. Likewise, they fail to understand the real causes of depressions. A logical examination of pertinent data would show them that it was Federal Reserve money manipulation that brought on the depression we all deplore. We Americans truly need to know some very simple economic facts.
No free man works, buys or sells unless he fully believes that such action will bring him greater satisfaction than he could enjoy if he did not take that action. This means that in a free economy no man ever takes a job at any wage unless he believes he is better off working at that wage than he would be if he did not take it. Likewise, no employer ever employs a man at any wage unless the employer feels that he will better his situation by employing that man at that wage. So, in a free economy, employees and employers believe that they have the best available terms. When they feel otherwise, they shift jobs or employees.
In the same vein, no woman ever buys a dress unless she believes that dress will bring her more satisfaction than any other use she could make of the same amount of money. On the other side of the transaction, no storekeeper ever sells a dress unless he places a higher value on the money he receives than he does on the dress he sells. As a result of the sale, both buyer and seller are happier.
Thus, in a free economy, every freely made transaction benefits all participants. Consequently, any interference with freely made transactions must result in a decrease in the satisfaction and happiness of all persons concerned. An economy that is free from restricting regulations thus permits its people to enjoy the greatest happiness they are capable of producing.
The Proper Sphere of Government
However, in order to enjoy the full pleasures of prosperity, it is necessary for peaceful people to be protected from all robbers, thieves and fraudulent schemers who seek something for nothing at the expense of their fellow-men. For this protective purpose, men have instituted governments. Governments, like all valuable assets, have a price. This price is collected in some form of taxes. Reasonable taxes are a legitimate expense for all protected persons, property and production. Taxes are like insurance premiums. In fact, a good government might be called a form of life, fraud and robbery insurance. It is as necessary for modern society as accident insurance is for every car driver of moderate means. Without it, the risk of living, owning property and driving might well involve financial risks that only a few could afford. Good governments permit people to pursue their pleasures and production while protected from the rascals who would infringe on their rights by force or fraud. Taxes paid for this protection are an investment which permits men to pursue their personal satisfaction and prosperity as each one sees fit.
When governments spend money for other than protective purposes, they must first get that additional money. They can only get such funds by one or more of three different methods. They can amass such funds by collecting more ordinary taxes, borrowing from private savers, or simply printing the extra money they want to spend. Most modern governments use all three methods. Can such government spending increase the transactions and satisfactions of individuals and, thus, the happiness and prosperity of the people as a whole?
Hidden Costs
A most common economic error is the failure to see or realize the complete price of what one buys. People are too apt to reach for something they want now, without weighing the costs they cannot visualize at the moment. Many fail to realize that more beer and merriment today may well mean no bread or meat tomorrow.
So it is with government spending. We see the results of government spending all around us. Government services are sold at bargain rates below cost. The bureaucrats are good steady customers, and the subsidy receivers spend money more freely than those who earn it. But many do not see the complete price. They do not see the schools, homes, hospitals and factories that could have been erected if the same funds had been left in private hands. They do not see that present bureaucrats could be private citizens producing goods not now available, and that such an increase in marketable goods would tend to reduce all prices and thus increase the satisfactions and living standards of every buyer. They do not see the taxes that creep into the prices of every loaf of bread and pair of shoes, placing the prices of such necessities beyond the reach of the most needy.
When the government raises the money it spends by borrowing savings or taxing its citizens, it merely transfers spending power from private owners and to political spenders in power. This creates no new wealth. It reduces the amount private citizens can spend while increasing the amount government can spend. With less money in their pockets and bank accounts, private individuals and corporations must reduce the amounts they spend or invest. Assuming prices and wages remain the same, they must buy fewer goods and employ fewer workers on private payrolls producing what people want most.
Money spent by governments cannot create any more jobs or produce any more wealth than it can when spent by private persons. In fact, it creates less, because both the tax collectors and tax spenders must be paid a commission. Their labors add nothing to the wealth of society. The shift of the money from private citizens to political spenders must result in fewer productive jobs, and thus a smaller amount of goods and higher prices than if the money had been left in private hands.
Pattern of Production Changed
Political spending also changes the whole pattern of the nation’s productive forces. If the government spends its money by giving out subsidies to one privileged group, the productive facilities of the country are then partially directed toward satisfying the desires of that group instead of the desires of those who originally earned the money. Many workers and investors must shift from producing goods and services for customers who earn their money, to producing goods and services for those who first receive the dollars distributed during the government’s spending spree.
Then, too, much government spending is not based on the economic principle of getting the most for the least. This permits political spenders to grant privileges to their friends. Such political plums provide more satisfaction and prosperity for nonproducers at the expense of producers. The net result must always be a reduction in the production of wealth. Any such reduction in the quantity of goods and services available in the market tends to raise all prices and thus reduce the satisfactions and living standards of every buyer in that market. So spending to help one group, laudable as it may seem, does not, and cannot, create general prosperity.
Diversion to War
If the government spending is for war or defense, then some of the nation’s investors and workers must go to work producing munitions and military supplies. All the savings and workers so engaged are withdrawn from industries satisfying the private needs and wants of individual consumers. The end result, of course, is a reduction in the satisfaction of the needs and desires of all those who prefer consumer goods over war goods. The nation may have full employment, but individuals must certainly get along with fewer consumer goods. Such lower personal satisfactions have never been considered greater prosperity.
The only reason men and factories are ever unemployed is that they will not produce what consumers want most at prices consumers can and will pay. Both men and factories can always be employed, if they will accept market wages and prices. When they consider these too low and rely on government to pay higher than market wages and prices with funds obtained from private citizens, the immediate result must always be unemployment or lower wages for those formerly engaged in satisfying the desires of those whose money the government now spends. Unless supported in idleness, these workers will soon gravitate to those industries or pursuits that benefit most from the increased government spending. Their competition will bring wages down to market levels, and then no workers will any longer benefit from the increased government spending.
Any switch of money from private owners to political spenders can only result in a redirection of the nation’s productive forces and temporary gains for those who first receive the government orders or subsidies. In the end, a readjustment of the nation’s productive forces will become necessary. During the interim, total human satisfactions will be reduced and the general welfare will suffer.
Danger of Depression?
The question now asked is whether a substantial reduction in present government spending would create a depression. Under the present restrictive labor and monetary laws, the painful readjustment might well be long and severe. Under a free economy, with free market wages and interest rates, the necessary readjustment could be quickly made and soon everyone would be enjoying a much higher living standard.
If the government reduces both taxes and spending, it will leave more money in private hands. This money then can, and will, employ more people at higher real wages to make more of what people want most. The nation’s productive forces would be redirected toward satisfying the wants of productive persons, rather than satisfying those who were the recipients of government expenditures. In a free market economy, every worker and investor tends to seek those outlets which will produce what consumers want most, as indicated by the wages and prices consumers will pay. So workers and investors now engaged in satisfying political spending would soon find more profitable outlets satisfying the increased spending of private producers. Everyone would soon have more. That is not a depression. That is prosperity.
Results of Inflation
In cases where the government prints the money, either directly or indirectly, by first printing bonds and then issuing new money with only its own bonds as security, the result is inflation. Inflation is a tax on everyone who owns or is owed a dollar. Its effects are more hidden than those of other taxes. Another important difference is that inflation transfers economic wealth from one group of people to another group, as well as from private citizens to their government. The inflation tax is a boon to all who owe dollars and a burden on all who are owed dollars. It changes the values of every contract that specifies a future payment in dollars. It reduces the value of the money involved. This is a temporary boon to the payer but, in effect, a tax on the recipient.
Under such inflationary conditions, wise businessmen become hesitant about signing long-term contracts, so necessary for our present-day complicated production system. Government inflationary spending thus places an additional damper on prosperity, over and above all drawbacks and redirection of productive forces brought about by government spending of funds amassed by taxes or bond sales.
Those who first receive the newly printed money are able to buy a part of the nation’s production without having made any contribution. They must profit at the expense of all those who have contributed to the total production offered on the market place. Since the rewards of productive contributors are less, some will retire or reduce their future contributions to the market. Production will be further reduced by the fact that some of the printed money recipients are supported in nonproductive pursuits. Total production must, therefore, be lower. This means there will be less for everyone who spends dollars in the market place.
Taxes which raise prices or curtail private spending cannot increase total human satisfaction. Increased taxes reduce the voluntary transactions of a free people and thus reduce their total satisfactions. Contrariwise, any reduction in government spending and taxing will increase the individual transactions of a free people and thus their individual satisfactions and prosperity.
Comment by R. M. Dalton on 20 January 2009:
Being a person who subscribes to free market economics I fully agree that government involvement in the economy tends to have detrimental effects on prosperity. Having learned that FDR\’s New Deal prolonged the depression, what I can\’t figure out is why war spending during WWII got us out of the depression. If you believe in free markets it is counter intuitive that government war spending increases economic prosperity. Most free market economic historians seem to gloss over this \"minor\" contradiction. Maybe someone will help me out.
Comment by A. MacLean on 20 January 2009:
Good question. The reality may be that it wasn’t the actual war spending that rid us of the depression, but rather the enormous pent-up demand for goods and services that erupted immediately following the war. Manufacturing facilities were in full use and required a shift of products, but the demand for those products certainly existed. As a result the period from late 40’s through 50’s and into the 60’s may have included the economic peak for our ‘free market.’ Once the Vietnam conflict started to sap both resources and our man-power everything changed. Just my opinion, but I think this follows the above article.
Comment by Alvaro on 20 January 2009:
I was puzzled by the same question. The answer I found was this: WWII didn\’t end the depression. It ended unemployment because 12 million people were drafted to wage war, and lots got jobs in factories making weapons and supplies. But all those people endured even more privations during war, with rationing or living in the battlefields.
When Truman took over, one of the things he did was getting rid of the New Dealers and scrapping a lot of policies. This and the spending of saved money that workers and GIs made during the war ended the depression.
Please note that this spending was genuine in the sense that people restrained from consumption during the war, as opposed to getting in debt to buy stuff.
I found the answer to this and other questions at http://www.mises.org
There is also a wealth of economic and historic info at http://www.lewrockwell.com
You can use Google to search on these sites. Just type this the following in the Google search box:
end of depression site:mises.org
Best regards,
Álvaro
Comment by Private-Freedom on 20 January 2009:
R. M. Dalton,
The reason you can’t come to grips with explaining how WW2 got us out of the Great Depression is that this explanation is really a myth. It is not true. People think it is true because of the economic data. But they never read between the lines.
The standard of living for the average American during the war was actually *lower* than it was during the deepest part of the depression. The government forbade the construction of many goods, for example ovens, cars, and other appliances. In addition, the government instituted price controls, which resulted in massive shortages for even the most basic necessities.
The reason why people think that the war stopped the depression is the fact that millions of unemployed workers from the depression were sent overseas to fight in the war. Many others were hired by massive government spending programs to create weapons of war.
If one understands that simply having jobs does not mean that people are better off, and that massive consumption does not mean there is massive production, then you will see how the claim that the war ended the depression is clearly a myth. People are not better off by simply working. They are better off working to produce goods and services that people actually want. No average worker gains any utility whatsoever from missiles or battleships, nor is an unemployed worker better off if they are sent away to die in a war.
What got the country out of the great depression was the events that occurred in the year 1946. In that year, the first full year of peace, the government lowered its spending by roughly 2/3. This lowering of spending thus gave productive businesses that much more money with which to hire productive labor and to invest in capital goods. In that year, the real economy grew by something on the order of 30%. As far as I know, this is a single year record for any economy in the history of economic study.
In addition, the price controls were lifted, the ban on the production of certain goods was lifted, and there was a massive influx of fresh new labor. Furthermore, the US infrastructure was not at all devastated by the war. This meant that many of the factories and business firms that remained idle during the war were again filled with workers.
*That* is how the country actually got out of the Great Depression.
Comment by Private-Freedom on 20 January 2009:
A. MacLean,
There is no such thing as “pent up demand”. There is actually an unlimited desire on the part of mankind to own more wealth. The only thing that prevents people from doing so is that they lack the capital, or in other words, the price for goods is just too high.
As the productivity of labor rises, costs of production fall, supply rises, and prices fall. This fall in prices is what allows people with limited incomes to buy more. Theoretically, if you take any average income for any average worker, say $40,000/year, and present him or her with an economy that has such a high productivity of labor that the prices for all goods is in the cents, for example a house is $5.00, a car is $1.00, clothes are $0.01, etc, then that worker is not going to simply buy what he used to buy in physical terms. He is going to buy all that his money can buy.
This principle refutes the “pent up demand” doctrine, because that doctrine assumes that people have a maximum *physical* demand for goods, and no more, no matter what the price. Clearly this is false.
Comment by A. MacLean on 20 January 2009:
Perhaps I used the wrong term; by “pent-up” I was referring to the fact that from 1941-1945 the country was primarily producing for war, not private consumption. My main point was that it was the period immediately after the war, not the war, that brought us out of the recession. For what ever the reason (WWII), government intervention does not allow the free market to operate. I agree with you even if I used terminology you disagree with.
Comment by David Gardner on 21 January 2009:
The United States entered WWII in 1939. We began selling food and weapons to England and Russia. We didn\’t militarily enter the war until December 1941. The result was economic growth in 1939 – 1941. That stopped in 1942. Even more interesting is 1946, when Keynesian economists predicted there would be a recession because Federal spending dropped by over 25%. In 1945 – 1946 the war was over and 10\’s of thousands of soldiers \"lost\" their jobs. But the opposite occurred. Civilian output increased by about 30 percent.
http://www.thefreemanonline.org/columns/our-economic-past-the-great-escape-from-the-great-depression/
Comment by R. M. Dalton on 21 January 2009:
Private-Freedom and A. MacLean
Thank you both for your insightful responses. Some points.
First, Private-Freedom states that there is no such thing as pent up demand and then goes on to describe something that sounds very much like pent up demand. It may be a minor point but I think important. It seems that demand greater than supply could be defined as pent up demand. If you contend that there can be no such thing as pent up demand because there is no such thing as pent up supply I might buy it.
Second, it is very interesting and exciting to think that after 12 years of depression caused by government meddling in the economy and 4 years of war, the economy recovered in one year – 1946. Do a lot of economic numbers support this and is this a widely held view? If so would somebody please go tell Obama before it\’s too late?
Third, it is also interesting to contemplate that you can have full employment and still have generally hard times. Could it be that this could only happen in war times?
My personal experience coincides almost perfectly with this thesis. Born in 1931 into poor circumstances, as a child I remember not having much in the 30\’s because we didn\’t have any money – Dad had only part of a job, and then not having much during the war, even though both parents had full time jobs, because of shortages. Then in 1946 my parents suddenly were able to buy our own home and things got much better very fast.
Comment by R. M. Dalton on 21 January 2009:
After further thought on full employment and hard times, I guess they managed to do it in the eastern block of communist countries for 70 years and in Cuba for 60 years.
Comment by Paul Richards on 21 January 2009:
Yea, the joke in Russia during that period was, “You pretended to work, and they pretended to pay you”
Comment by Mthompson on 7 February 2009:
My thoughts on your question: 1. The war was nearly 10 years after the depression first began. Don’t underestimate the healing powers of time. 2. The war caused people to save money (b/c nothing to spend it on), so they came out of the war with relatively strong balance sheets. 3. The war killed many people (making labor scarce) and destroyed the industrial capacity of Europe (making America THE place to buy goods). 4. Pent-up demand for goods after war ended.
Comment by Marc Seltzer on 15 February 2009:
We are building an explanation for how the war could be credited for ending the Great Depression. What I haven’t heard mentioned was that industrial productivity increased greatly during the war years. We set out competitively — to win the war — to make the most, best, biggest, fastest war machines and we organized our production like never before. The government was buying and employing at full capacity. Hurray, but not sustainable. When the war ended, we had abilities that had not existed before to create efficiently. We had a trained labor force, organization, demand for aid in the war territories, and at home. Even today if you magically dropped the cost of labor by half, or the cost of raw materials by half, a lot of employers would say, “recession? what recession,” and would begin hiring and producing at deeply discounted prices.
Comment by Rom on 16 February 2009:
Capitalist societies tend to allow the rich to gain dominance and to control the livelihoods of the rest of the people making them dependent on wage labour, which is the major problem with free markets.
The trouble with economists who extol the virtues of free markets is that they appear to be on the side of the rich, justifying the low wages and the unemployemnt and the concentration of ownership of wealth by the few.
Comment by networth on 17 February 2009:
It’s remarkable to think that this article was first published in 1956. It just goes to show the concept of free will and free enterprise really is timeless.
Comment by Rob Berriman on 4 March 2009:
It’s remarkable to think that there are people out there like Rom who think that the ‘rich’ are a some sort of separate species who only think to enslave the poor humans. They are people like us. In a truly free society we are all rich. Some more than others, but only according to what they ‘contribute’ to the well being of all. In a free society wealth is fluent. Some rise, some fall. There are no stagnant classes of ‘rich’ and ‘poor’. The idea that there would be the rich on one hand and the poor on the other is a myth. Wealth would run the gamut, from the poorest to the richest. Only in a controlled economy could there be stagnant, fixed classes, with no hope of ‘moving up’ in the world.
Comment by rewinn on 16 March 2009:
The analysis in the article is precisely that of Hoover in 1929, and it fails for the same reason: it’s nicely reasoned b.s.
Demand is present desire plus ability to pay. Where there is demand, the free market will provide a supply. When private demand falls, public demand must rise to keep the economy going.
Hoover ran our economy until 1933, four years of increasing bleakness. In contrast, FDR had nothing but an improving economy every year, with the sole exception of the year when he decided private demand had risen enough to cut back public demand. That was an error, economic activity fell, and he had to restore public demand.
WW2 slowed economic recover because, although it increased public demand, it diverted that demand into activities that were nonproductive (…although necessary for survival.)
The ideology of Mises, like that of Marx, can never be disproven because whenever they are put into place, their failures are explained as failures of implementation. But that’s o.k.; even Greenspan now acknowledges that there’s something wrong with his theory. The high priests of Mises (like those of Marx) will go to their graves convinced of the rightness of their beliefs and the wrongness of the world for not conforming.
Comment by Louis on 28 April 2009:
Sorry rewinn, sense is sense. Apparently not all sense is common. It is simply logical that the Austrian School works. Comparing Mises to Marx?! Are you serious? That’s like comparing the ideas of personal responsibility with the notion that no one should be held accountable for their own actions. Marxism may work in magical situations were people have no motivation to live a better life but the Austrian school works in all situations because people DO have motivations to live better lives.
I guess it really shouldn’t be refered to as Austrian economics; it’s just economics.
You don’t ask why gravity keeps you from floating off into space anymore, right? You’ve been taught some science. It’s just physics. Law of physics… law of economics…
Comment by Louis on 28 April 2009:
Read Henry Hazlitt\’s Economics in One Lesson. Honestly, read it. Not saying it will be a game changer for you but it might shed some more light.
Comment by Jacques on 9 May 2009:
Government can raise the money it spends by borrowing. If the lenders are residents of the same country I understand that this is just a transfer of ressources, no wealth is created.
But how do you analyze it when the lenders are non residents? It seems that in this case it is actually an inflow of new ressources, the problem being that at a later stage the government has to repay the loan which is then an outflow of ressources.
Can we then say that government spendings funded by borrowing from non residents actually creates wealth which at a later stage will have to be destroyed?
Comment by walter on 12 May 2009:
This was a very good reasonable discussion about economics until a couple of clowns showed up and firmly demonstrated their ignorance about economics.
Rom, do you not know much at all about economics and how its related to personal freedom? You state \"Capitalist societies tend to allow the rich to gain dominance and to control the livelihoods of the rest of the people making them dependent on wage labour, which is the major problem with free markets.\"
Who are these \"rich\" you write about? You make them sound like they are some new species but they are just business people who happen to take a financial risk to make a better life for themselves. Do you not want a better life for yourself as well? Furthermore, the ones who become rich via free markets (not gov\’t favors or special interest legislation) do so by providing a useful service or product to people which is then freely purchased. Furthermore, these write about the non rich as people \"dependent on wage labour\". Are not these the workers that make the company function who in a free society are \"free to choose\" to work for the employer or not – assuming the employer wants to hire them. The \"rich\" are not holding a gun to anyone\’s head or have enslaved them in any manner. Also keep in mind that in a free market the wage laborour can start his own business to compete with the evil \"rich\" and put them out of business anytime he likes all it takes is a lot of hard work.
Moreover, I second Louis\’s advice of reading Henry Hazlitt’s \"Economics in One Lesson\"
Comment by Robert Anson Heinlein on 12 May 2009:
I completely agree. To put it painfully simply, stop relying on your government for your own laziness. Work hard. If you have half a brain, you could even end up doing well.
Comment by Science HUB on 5 June 2009:
Why not. you can see its clearly visible in world economy recent days. Its definitely gonna bring Prosperity.
Comment by John on 5 June 2009:
if you are refering to government spending as helpful. please refer to the following link. It is 40 minutes long. so have time when you do:
http://video.google.com/videoplay?docid=-466210540567002553&ei=vyQpSrCMEYnKqgKDnbW0Cg&q=money%2C+banking%2C+and+the+federal+reserve
it will explain the problems with your “solution”
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Comment by Miles Hayward-Ryan - NZ on 26 January 2010:
Rich v poor
Rom’s comments deservedly got demolished.
My take on it is that no realistic business person wants poor customers. The wealthier the customer is, then the easier it is to sell and the more profit made.
Business should get behind an ‘end poverty crusade’ starting with the Professor Greaves article about government spending as the basic learning tool.
That is freedoms true answer to socialism and needs to be sold as such.
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