By 1870, however, some 50 years after Austen’s death, things had improved enormously. Real wages were significantly higher and rising. Most people could now afford more than a single set of clothes, life expectancy was increasing, and London was a far healthier place in which to live. What happened to so dramatically improve the average Englishman’s lot in just two generations? Nasar explains:

The economic historian Harold Perkin argues that “Consumer demand was the ultimate economic key to the Industrial Revolution,” providing a more powerful impetus than the invention of the steam engine or the loom. London’s needs, passion for novelty, and growing spending power supplied entrepreneurs with compelling incentives to adopt new technologies and create new industries.

There you have it. For millennia people were starving to death and the solution was right there in front of them: Consume more. Similarly, those who died of thirst in the world’s deserts could have been saved if they had only drunk more water.

The Thrall of Ideas

This is not to deride Nasar, but to suggest that Keynes was on to something when he quipped that “even the most practical man of affairs [or the most intelligent historian] is usually in the thrall of the ideas of some long-dead economist.” Nasar’s passage, following as it does a recital of the terrible poverty that was the common lot for nearly all of human history, perfectly illustrates the emptiness and absurdity of popular Keynesianism. The work that Nasar quotes – The Origins of Modern English Society 1780-1880 – was published in 1969 at the height of Keynes’s popularity: during the presidency of Richard “We are all Keynesians now” Nixon and before the stagflation of the 1970s.

Nasar’s last sentence, however, contains an important truth in the phrase “growing spending power.” The term spending power implies effective demand, which means not just need or desire but the wherewithal to fulfill that need or desire. Wherewithal, in turn, implies previous production and saving (deferred consumption).

What a man produces is what he can bid for the produce of others. The value of what he creates – that is, its value to others – represents his effective demand in the marketplace. If he produces nothing, if what he produces has no value (mud pies), if what he produces loses its value (stone knives in the Bronze Age), or if he produces more than can be consumed (houses after a housing bubble has burst), he has no effective demand though his needs be unchanged.

Say’s Law

This restates Say’s Law, which Keynes in his General Theory popularly, though misleadingly, formulated as: Supply creates its own demand – misleading because a supply of goods with no value yields no effective demand and because supply that does have value to others does not create effective demand, it is effective demand.

What Keynesians do not understand is that if a man is hired to dig holes and then fill them back up, he is fully employed but he produces nothing of value; effective demand is not increased by his efforts. Nor does giving him money or goods in exchange for his useless labor create effective demand; it only shifts it from the people who produced what was given him.

Only production creates effective demand and only after what was produced is sold can other goods can be purchased and consumed. What changed England was not increased consumption but increased production, production that made increased consumption possible. And, yes, that increased production was due in large part to the entrepreneurial employment of the steam engine and the loom, inventions that Nasar so cavalierly dismisses.

An example of the errors excessive aggregation can lead to is found in Keynes. In places he argued that one problem facing the economy of the 1930s was that opportunities for productive investment were becoming fewer and fewer and so savings would permanently exceed investment.  For Keynesians, excess savings represented  a decline in consumption, which in turn reduced aggregate demand and therefore potentially led to depression. This theme was echoed in other writers at the time.  So what many had seen as the key to economic growth — accumulation of capital — was in Keynes’s view a fool’s errand since there was no place for the capital to be invested profitably.

Thus for Keynesians there is no link between savings and investment; the lack of demand associated with excess saving meant that investment opportunities were drying up. This is one reason Keynes favored the socialization of investment: He believed government could direct those savings in ways that would create new investment spending.

Not a Singular Good

Putting aside whether he was correct about the power of government to allocate resources, the deeper problem is that capital is not a singular good.  We don’t just add some lump of “capital” to other lumps of “capital” and get investment. In reality capital is comprised of a whole panoply of heterogeneous goods, each of which has its own demand and supply. More important, the economy as a whole is comprised of a structure of capital, which requires that these individual pieces of capital (including human capital) fit together like pieces of a jigsaw puzzle. Capital goods complement each other in an integrated structure. When entrepreneurs think up a production process, they envision a grouping of capital goods, including human capital, that they see as fitting together to form a coherent plan.  If the firm profits, it continues with the plan.  If it makes losses, pieces that don’t fit are discarded and new pieces that fit are added on (assuming there are no bailouts!).

Rather than viewing investment opportunities as something finite to which we apply successive dollops of capital, seeing capital as an integrated structure enables us to understand why investment and growth beget more investment and growth. As resources are deployed to come up with new products, those new products, if successful, create opportunities for new investments that add value to them. The most obvious example is the personal computer and the Internet, which dramatically multiplied opportunities for new investments in hardware, software, and human capital.

Removable Fingertips

Investment in technology begets new investment in complementary products. Who needed a cell phone shell until there was a cell phone? A friend recently bought gloves with removable fingertips, allowing use of a smartphone without taking the gloves off.  This is the story of economic growth, a story best understood when we get out of the habit of thinking about capital and investment as undifferentiated aggregates.

So rather than seeing an economy as a balloon slowly deflated as new investment opportunities dwindle, the better analogy is a balloon the surface of which is expanded by innovation, putting it more in contact with new opportunities.

There’s no worry that we’ll ever run out of investment opportunities or ways to use capital. Human ingenuity will continue to come up with new products, and that same ingenuity will capitalize on the new complementary investment opportunities those products create. Growth begets growth and expands the sphere of opportunity without practical limit.

The debate focused on Keynes’s view — and Hayek’s critique of it — that once an economy is mired in deep recession, the only solution is for the government to borrow and spend in order to increase aggregate demand and stimulate investment and job-creation. Thus for Skidelsky, cutting government spending is precisely the wrong thing to do. Selgin, however, insisted that government spending impedes recovery by depriving the private sector of capital for investment. He said that government spending, whether on digging and filling up ditches or bailing out insolvent banks, is a tragic mistake with many ramifications. Selgin also drew attention to the artificial boom created by central bank money creation, without which there would be no bust. “The economy is like a drunk throwing up the morning after the night before,” Selgin said.

You can download the 44-minute audio file here. Read accounts of the debate here and here.

Though I am admittedly biased, I believe Selgin and Whyte carried the day. The large audience came in decidedly pro-Hayek — and left that way as well.

In that column I argued that the key to a healthy economy is production not consumption, and that the attention paid to increasing consumption during downturns is misguided.  I was accused of holding a naïve version of Say’s Law because I appeared to claim that “supply creates its own demand.”  However, I have written several pieces (examples here and here [pdf]) arguing that this is a misreading of Say’s Law.  His actual text shows the law is better rendered as “production is the source of demand”:  We cannot exercise consumption demands without having first produced value (or getting resources from those who have).

This argument hardly aligns me with the “interests of rich people and powerful business executives,” as Yglesias claims.  It applies to all producers of wealth, from minimum-wage workers to midlevel managers to the rich and powerful.  In a depoliticized, freed market, individuals cannot consume without having first produced (or having received voluntarily transferred resources from others). Yglesias is the one seeing sides where there are none.  Producers aren’t a distinct group — everyone in the market is both a producer and a consumer.

The ultimate source of wealth in society is producers who create value.  The hourly worker creates value by providing a marginal product whose value is greater than the real wage she is paid (though competition tends to compete this differential to a minimum).  The firm as a whole creates value by producing an output that consumers value more than the sum of cost of the inputs used by the producer, including the value of the time the production process takes.

Constant Innovation

All this value creation can be seen as forms of innovation.  As Deirdre McCloskey argues in her new book, Bourgeois Dignity, capitalism is best understood as a system of constant innovation.  Firms that figure out a better way to get consumers what they want, either by producing it with less-valuable inputs and/or changing making the final product more valuable to consumers, are innovators who create value and wealth.  Ongoing acts of successful innovation (as judged by genuine market profit) create wealth for both the innovator and the consumer.

The wealth for the innovator is the profit she earns.  The wealth created for the consumer comes as either lower prices through lower-cost production or improved and hence more-valuable goods.   In addition, workers who produce more-valuable goods and services see increases in their wages and hence their wealth. The value-creation that comes from the ongoing innovation of the market is what creates the wealth that makes consumption possible.

Notice that even though the producer clearly is thinking about the consumer when she innovates, wealth-creation does not require an already-existing increased power to consume.  An act of innovation alone produces wealth by cutting costs or adding value to a product.  Thus to suggest that my argument is undermined by the fact that the goal of production is consumer satisfaction is to miss the point.  Yes, producers produce because there are consumers who consume, but it is production not consumption that creates wealth.

Why Is Labor Idle?

This is no less true in a recession or during high unemployment.  The problem is not getting consumption power directly in the hands of idle labor.  The problem is whatever is making labor idle. Why is this wealth-creating potential lying around unused by owners of capital.  Again, consumers need not have additional wealth for firms to profit from innovation.  Why, then, do firms think they cannot do so?

There are several possible answers to this question, and just about all of them, in my view, are related to the misguided government policies of the last several years that have created an environment in which the private sector is pessimistic about the prospect of creating wealth.  Getting people back to work and returning the economy to wealth-creation will happen because production revives and not because we “stimulated” consumption.

Innovation by producers, not consumption, is what creates wealth in a market economy.  Producers know that simple truth, and I think most citizens know it deep down as well.  But sometimes the simplest truths are the hardest for the self-proclaimed elite to understand.

(Yes, the poem came out two years before publication of Keynes’s General Theory, but one can see that Keynes’s way of thinking already was already in vogue.)

The lad tells the bishop:

“I want to be a Consumer,”
The bright-haired lad replied
As he gazed up into the Bishop’s face
In innocence open-eyed.
“I’ve never had aims of a selfish sort,
For that, as I know, is wrong.
I want to be a consumer, Sir,
And help the world along.

“I want to be a Consumer
And work both night and day,
For that is the thing that’s needed most,
I’ve heard economists say,
I won’t just be a Producer,
Like Bobby and James and John;

I want to be a Consumer, Sir,
And help this nation on.”

The poem is meant to be farce, but it also is a theme of Paul Krugman’s columns. If one can sum up all the present Keynesian claptrap into one sentence, it would be this: Americans need to consume more.

Should one doubt the close association of the poem with what the Keynesians are declaring, read on:

“I want to be a Consumer
And live in a useful way;
For that is the thing that’s needed most,
I’ve heard economists say.
There are too many people working
And too many things are made.
I want to be a Consumer, Sir,
And help to further trade.

“I want to be a Consumer,
And do my duty well;
For that is the thing that’s needed most,
I’ve heard Economists tell.
I’ve made up my mind,” the lad was heard
As he lit a cigar, to say;
“I want to be a Consumer, sir,
And I want to begin today.”

Last year, Hillary Clinton visited China and urged the Chinese central bank to continue to purchase U.S. government debt because “We are all in this together.” Clinton stated (in other words, of course): China is the producer, and the United States is the consumer, and this keeps the perpetual motion machine of a world economy going.

(Once upon a time, international trade involved the exchange of real goods, but today’s sophisticated economy has done away with that necessity. Paper for products will do.)

Clinton, in essence, was claiming that the responsibility of U.S. citizens is to consume Chinese products, and the Chinese should gratefully accept U.S. dollars. What do Americans receive? Why they receive computers and cell phones, clothing, and a million other items.

What do Chinese get for all of this? Why, they get jobs. (For lack of space, I won’t go into the current brouhaha about the value of China’s currency, which I will address in a future column.)

Never mind that Clinton advocated something akin to real exploitation, in which one group of people works for minimal compensation and another class of people receives goods without having to work for them.

If anyone really wants to understand the mentality behind the “stimulus” plans of former President Bush and President Obama, it is this: The United States must become first and foremost a nation of consumers, and the way to do it is for the government to provide dollars, Americans to quickly spend them, and people overseas to accept the dollars and keep working.

A fundamental tenet of economics is that the end of production is consumption. Unfortunately, Keynesian economists seizing the public microphone claim the purpose of consumption is to clear the shelves so producers will have something to do in the future.

So the lad apparently was right. The purpose of consumption is consumption, and the purpose of production is, well, production. Just ask the Keynesians.

Krugman and many other economists believe that the government is much too stingy and that what it needs to do is not cut back on spending and borrowing but rather throw the spending levers full forward. I present their views (as fairly as possible) and then look at them from another perspective.

The Keynesians – including Krugman – hold that the key to recovery is spending, increasing “aggregate demand” to move our economy out of an alleged “liquidity trap.” (A “liquidity trap” is a special situation, according to Keynesians, in which interest rates are near zero and people are holding money and not spending it. The way to bust out, say Keynesians, is for governments to borrow and spend in order to give the economy “traction.”)

Furthermore, with Ben Bernanke at the Federal Reserve System claiming that the Fed needs to find creative ways to ratchet up the rate of inflation to at least match “target” rate of 2 percent, we have the supposed experts claiming that inflation is the magic carpet to prosperity and full employment.

The thinking behind such policy prescriptions is this: Inflation will lead individuals and businesses to spend now, which supposedly will clear the inventories and convince producers to make more goods to put on the shelves. Further inflation will encourage people to continue spending, and the process will go on indefinitely. According to Krugman and others, this will give the economy traction, and from there the spend-produce-spend machine will grind along.

No Perpetual Motion

Excuse me if I differ with this assessment. First and most important, a surge of new money, while encouraging people to spend now, will not result in the economic perpetual motion that inflation advocates predict. What is more likely is that producers will gladly sell their current inventories, but they also would recognize the rush of spending as temporary at best.

The problem is that the new money injected into the system will not encourage longer-term capital investment, and why should it? Unlike the producers in economists’ mathematical models, which assume that firms automatically invest in new capital when spending increases, people in the real world are living, breathing, and thinking entities who actually observe economic conditions.

Second, with the hostile rhetoric against businesses coming from the Usual Suspects in Washington and in the media, the climate amenable to long-term investment simply is near nonexistent. Economist Robert Higgs writes that the current political environment is fraught with “regime uncertainty”: Entrepreneurs and capitalists are unwilling to commit resources long-term if the government is likely to confiscate them or create an economic climate so hostile that profitability is impossible.

As Henry Hazlitt wrote, with inflation the “good effects” come first and the bad effects follow. In the beginning people have more money in their pockets, and they purchase things at prices that existed before the surge of new money. It looks as though prosperity has returned.

However, as more and more money is pumped into the economy, not only do prices go up but so do inflationary expectations. Long-term capital investment is jettisoned for assets that will increase in value relative to money during inflation, and in the end the economy is mired in both higher prices and higher unemployment.

Hazlitt likened inflation to the “Dead Sea Fruit,” which “turns to ashes” in one’s mouth. Unfortunately, the most “brilliant” minds are demanding we harvest and eat this fruit, and when it turns to ashes they will blame businesses and free markets. They always do.

Specifically, Krugman defends the claim that World War II got us out of the Great Depression, because “this is a situation in which virtue becomes vice and prudence is folly; what we need above all is for someone to spend more, even if the spending isn’t particularly wise.”  Even spending on something destructive like war, he argues, is what is needed to solve the problem, especially when the “political consensus for [domestic] spending on a sufficient scale” is not available.  In Krugman’s version of Orwell’s Newspeak, destruction creates wealth, and war, though not ideal, is morally acceptable because it produces economic growth.

Thankfully, we can get behind his Newspeak to see the fallacy of his economics. To believe that spending — any kind of spending — is the cure for what ails us is to ignore the subjective nature of wealth and the microeconomic basis of economic growth in favor of an absolute reification of economic aggregates such as GDP and unemployment.  Spending trillions of dollars fighting a war can certainly bring idle capital and labor into employment, driving up GDP and lowering unemployment.  But this does not mean we are any wealthier than we were before.

Mutually Beneficial Exchange

Wealth increases when people are able to engage in exchanges they believe will be mutually beneficial. The production of new goods that consumers wish to purchase is the beginning of this process.  When instead we borrow from future generations to spend on goods and services connected not to the desires of consumers, but rather to the desire of the politically powerful to rain death and destruction on other parts of the world, we are not allowing individuals the freedom to do the things they think will make themselves better off.  And we are certainly not extending that freedom to those killed in the name of our economy-enhancing war.  At a very basic level, the idea that any kind of spending is desirable overlooks the fact that spending on war (and, I would argue, public works as well) actively prevents people from enhancing their wealth through production and exchange linked to consumer demand.

Employing people to dig holes and fill them up again, or to build bombs that will blow up Iraqis, will certainly reduce unemployment and increase GDP, but it won’t increase wealth.  The problem of economics is the problem of coordinating producers and consumers.  This coordination happens when we produce what consumers want using the least valuable resources possible.  That is why it is wealth-enhancing to dig a canal using earth-movers with a few drivers rather than millions of people using spoons, even though the latter will generate more jobs.

Sending soldiers off to war is a waste of human and material resources, and is almost by definition wealth-destroying, no matter what it does to GDP or unemployment rates.  The only way one can view economics amorally, as Krugman wishes to, is if one is only concerned with total GDP and not its composition.  However, it is the composition of GDP, in the sense of how well what we’ve produced matches consumer wants, that ultimately matters for human well-being.  It’s easy to create jobs and generate spending, but those do not constitute economic growth, and they are not necessarily indicators of human betterment.

So yes, Professor Krugman, it does matter how we try to get ourselves out of depressions.  The world is not upside down and vices aren’t virtues.  War isn’t peace and destruction isn’t wealth-creation. The real solution to digging out of a recession is to remove the barriers to the free exchange and production that actually comprises wealth-creation.  Borrowing trillions more from our grandchildren to spend on building the equivalent of pyramids or on blowing up innocents abroad only digs the hole deeper.  And when one is reduced, as Krugman is, to saying we “needed Hitler and Hirohito” to get us out of that hole in the 1930s, one has abandoned morality to worship at the altar of economic aggregates.

No critic of free-market economics can ever again accuse us of being irrational and immoral when it is Paul Krugman who says destruction creates wealth, and war is an acceptable second-best path to economic growth.   Don’t let Krugman’s Newspeak fool you:  War and destruction are exactly what they appear to be.  To argue as Krugman does is to abandon both economics and morality.  Big Brother would be proud.

The Austrian insight is relevant to both capital and labor.  In standard Keynesian models (as well as most other macroeconomic models), capital is understood as an undifferentiated mass.  The Keynesian model also assumes that interest rates do not equilibrate the supply of savings and the demand for investment funds.  Thus when people save more, there’s no signal transmitted to investors that they should build more for the future.  As a result, the decline in consumption that accompanies the increase in savings causes firms to invest less as their inventories pile up without any offsetting increase in investment elsewhere due to the lower interest rate.

In the Austrian view investment cannot be treated at this high a level of aggregation.  The production process that leads to consumption goods comprises a number of stages, starting with the “early” stages of research and development and raw materials, and finishing with the “later” stages, such as wholesaling or inventory management, which are closer to the final consumer purchase.  Looking at the structure of production this way enables Austrians to note that when saving increases and causes interest rates to fall, resources will indeed be drawn away from the late-stage investments in inventory, but they will be drawn toward investment in early stages of production, as the interest lower rate makes longer-term production processes involving more stages relatively less costly.  Over time, savings promotes those longer-term processes, which are more productive and provide us the capital base for economic growth.

By disaggregating investment, the Austrian model also reminds us that different kinds of  capital goods have to “fit together” to be productive.  This is most clear when central banks try to inflate to generate growth.  In this case, the lower interest rates produced by excess money lead to increased investment in those same early stages.  However, unlike the first story, where that increased investment is financed by reduced investment in the later stages, inflation also increases consumption as the lower interest rate reduces savings.  The credit expansion creates no new resources but leads to more investment at both the very late and very early stages of production. This is the boom of the business cycle.

However, like a railroad being built, misaligned, from two directions, the plans of both sets of investors are unsustainable and the capital projects are left unfinished.  We have a recession.

Labor Too

All that is true of capital here is also true of labor.  Most Keynesian models also treat labor as an undifferentiated aggregate, speaking of “the” labor market and “the” wage rate.  Once we look at the microeconomic processes underlying the structure of production, we see that each of these stages has its own labor market.  Thus when resources move from one stage to another, the demand for labor will shift also, leading to changes in each wage rate.  Growing sectors will attract labor, and shrinking ones lose it.

During an inflation-generated boom, labor, like capital, is misallocated across stages.  And when the boom turns to bust, workers will lose their jobs as the projects they were working on are abandoned.  Unemployment results as we enter the recession.  However, that unemployment, like the misallocation of capital, will not be evenly distributed across the economy.  To see the real costs of inflation-generated business cycles, we need to get behind the aggregates to see the fundamental mechanisms of change.

Being too focused on Keynes’s aggregates can also mislead us as to the best ways to get out of the recession once we’re in it.  It may look as if all we need more is investment or more jobs. But once we understand that the “fundamental mechanisms of change” have to do with the boom’s microeconomic misallocation of capital and labor, we see that what is needed is a reallocation of resources not just more of them.  Capital needs to move out of unproductive lines and back toward productive ones, and the same is true of labor.

Stimulus spending, bailouts, and extension of unemployment benefits only prevent the fundamental mechanisms of change from doing their work in unwinding the errors of the last decade.  The cure for macroeconomic discoordination is freeing up the entrepreneurial market process to reallocate and coordinate resources.  But 80 years after Hayek first made the point, the fascination by economists and politicians with Keynes’s aggregates continues to conceal the fundamental mechanisms of change, and in so doing, also continues to block the processes through which a sustainable recovery can take place.

All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary. Human progress has no tendency to cast it in doubt, but rather the effect of confirming it and of always further widening knowledge of the scope of its validity. Its continued and growing recognition is therefore closely linked to human progress.

This is not trivial stuff, even though I suspect people are quick to say something like, “Well, yeah, I guess we have cause and effect.” The reason is, all too often people confuse cause and effect, claiming the effect really is the cause.

For example, a fever is not the cause of an illness; instead, it is the effect of an infection, which the body attempts to fight through heat. Thus treating a fever, though it will grant temporary relief, does not stop the illness.

Unfortunately, in the discussion of economics, and especially regarding the current depression, it is common for people – including trained academic and business economists – to confuse cause and effect. As one who reads a lot of commentary, I would say that the most frequently cited “cause” of the recession is “lack of spending” by individuals and businesses.

This explanation, I admit, sounds perfectly natural, and I believed it myself when I was a budding newspaper reporter more than 30 years ago. People stop spending and the economy goes into the tank, so government must take up the slack. That has been the mainstay of what economist Robert Higgs calls “vulgar Keynesianism,” and it dominates the columns of Paul Krugman and the editorial pages of the nation’s most elite newspapers.

However, there seems to be a problem. The federal government has spent at unprecedented rates these past few years and run gargantuan deficits, yet it is clear  the economy is stuck. Some, like Krugman, believe government spending was not high enough, which made the alleged recovery stall.

But what if the Keynesian cause-and-effect patterns are wrong? Do recessions occur because people are spending less, or are people spending less because the economy is in recession? This is not a frivolous point. If recessions occur, as Austrian economists believe, because the previous boom created a number of unsustainable malinvestments that must be liquidated before a recovery can begin, then government tricks to try to get people to spend more money simply won’t improve the economy.

I will go one step further: If the Austrian approach is correct, the “stimulus” so heralded by economists and others actually would have a negative effect on the economy precisely because such a “stimulus” would exacerbate the present malinvestments that caused the problems in the first place. Trying to prop up the economy by showering it with new money actually makes things worse.

All things, including economies, are subject to the law of cause and effect. However, to properly interpret this law we have to understand what is a cause and what is an effect. Unfortunately, too many academic economists cannot tell one from the other, and what naturally follows are bad policies that prevent a real recovery.

Tracy’s book discussed both the nature and economic effect of government. And how refreshingly lucid is his treatment! It makes most modern descriptions of government look childish.

Today most mainstream observers regard government as a source of investment in society. Across the political spectrum, overlooking differences in detail, one finds agreement that government spending, at least at some level, creates value.

Tracy did not see it that way. Like other liberal, free-market economists of early nineteenth-century France, Tracy saw the State essentially as a predator, a destroyer of value, and the source of class conflict. (Which is not to say he thought government should be abolished.)

“In every society the government is the greatest of consumers,” he wrote. This puts him at odds with most of what is believed about government now. Government spending, he insisted, does not create wealth.

Nor does it stimulate others to create wealth, a belief that is dominant today. Prosperity cannot be achieved through consumption, he held, and he didn’t buy the “multiplier.”

[T]hose who persuade themselves that consumptions can be a cause of direct riches, maintain that the levies made by government, on the fortunes of individuals, powerfully stimulate industry; that its expenses are very useful, by augmenting consumption; that they animate circulation; and that all this is very favourable to the public prosperity. To see clearly the vice of these sophisms, we must always follow the same track, and commence by well establishing the facts.

He then proceeded to refute Keynes – a mere 119 years before publication of The General Theory of Employment, Investment, and Money.

The expenditure [government] makes does not return into its hands with an increase of value. It does not support itself on the profits it makes. I conclude, then, that its consumption is very real and definitive; that nothing remains from the labour which it pays; and that the riches which it employs, and which were existing, are consumed and destroyed when it has availed itself of them…. [This and all other emphasis added.]

In other words, real investment in a free market, which is driven by entrepreneurs’ attempts to satisfy consumers who — crucially — are free to say no, produces value, as indicated by the resulting profit. Thus we know that the output is esteemed more highly than the untransformed inputs. Government spending is not of that nature.

But what about government spending on infrastructure, those “shovel-ready projects” so beloved by the champions of government stimulus spending? Tracy cleverly pulls the rug out from under the argument by seeming at first to approve of such spending. Unlike the waste of other government spending, he says,

It is quite otherwise with funds employed in public labours of a general utility, such as bridges, ports, roads, canals, and useful establishments and monuments. These expenses are always favourably regarded, when not excessive. They contribute in effect very powerfully to public prosperity.

And yet, “they cannot be regarded as directly productive, in the hands of government, since they do not return to it with profit and do not create for it a revenue which represents the interest of the funds they have absorbed….”

Besides, Tracy wrote, even government projects aiming at valued outcomes crowd out private efforts that would have been more efficient.

[W]e must conclude that individuals could have done the same things, on the same conditions, if they had been permitted to retain the disposal of the sums taken from them for this same use; and it is even probable that they would have employed them with more intelligence and economy.

Even spending on science would be better left to private entrepreneurs.

Finally, we may say the same things of what the government expends, on different encouragements of the sciences and arts. These sums are always small enough and their utility is most frequently very questionable. For it is very certain that in general the most powerful encouragement that can be given to industry of every kind, is to let it alone, and not to meddle with it. The human mind would advance very rapidly if only not restrained; and it would be led, by the force of things to do always what is most essential on every occurrence. To direct it artificially on one side rather than on another, is commonly to lead it astray instead of guiding it.

Now Tracy goes in for the kill.

From all this I conclude, that the whole of the public expenses ought to be ranged in the class of expenses justly called sterile and unproductive, and consequently that whatever is paid to the state, either under the title of a tax or even of a loan, is a result of productive labour previously executed, which ought to be considered as entirely consumed and annihilated the day it enters the national treasury. Once more I repeat it, this is not saying that this sacrifice is not necessary, and even indispensable…. But [every citizen] should know that it is a sacrifice he makes; that what he gives is immediately lost, to the public riches, as to his own; in a word, that it is an expense and not an investment.

The upshot? For Tracy it is that government should be kept small and inexpensive. Note the jab he gives to “the greatest politicians.”

Finally, no one should be so blind as to believe that expenses of any kind are a direct cause of the augmentation of fortune; and that every person should know well that for political societies, as well as for commercial ones, an expensive regimen is ruinous, and that the best is the most economical. On the whole, this is one of those truths which the good sense of the people had perceived for a long time before it was clear to the greatest politicians.

Next week: Tracy on government borrowing.