In spending its way to economic recovery, the government boldly casts principles aside
Many Americans have experienced the adverse consequences of the recent economic downturn: retirement savings wiped out, jobs lost, or at least a general feeling of financial uncertainty. Our leaders in Washington have reacted by enacting a flurry of new government spending initiatives including bailouts, “stimulus packages”, and a vast new federal budget. The ultimate success of these policies–and the security of our economic futures–rest on a single premise, a wager made on a massive scale: that government spending can “stimulate” the economy and spark the renewed creation of wealth.
This idea is not a new one. Over 150 years ago, economist Frederic Bastiat penned his “parable of the broken window,” in which he examines the economic implications of a boy breaking a shopkeeper’s window in a fictional town. The townspeople observe that the shopkeeper will need to pay the glassmaker to fix the window, that the glassmaker might in turn spend those earnings at the bakery, that the baker would then spend that profit somewhere else, and so on. Therefore, they conclude, the broken window turns out to be not a loss, but rather a stimulus that starts a ripple effect of new economic activity. Far from being a problem, the boy’s destructive act seems to be a way to give the fictional economy a boost.
But this stimulus theory is a fallacy. Bastiat points out that while the spending on new glass is easily observed, there is a corresponding absence of spending that goes unseen. Forced to spend his savings on a replacement window, the hapless shopkeeper is now unable to pay for other things, like a newspaper advertisement or more shelves. The expense of buying a window is thereby a silent, unseen loss of potential business expansion. Thus, while the glassmaker might benefit from the increased business in the short term, it has simply come at the expense of the shopkeeper (and the other businesses he might have frequented). Overall, the total wealth in the economy has been decreased by the cost of a window.
While Bastiat offers an important and true lesson in his broken window parable, he offers something even more valuable in the method by which he reaches it: he carefully studies all the relevant facts in a case, their causes, and all their inevitable effects–in a word, he approaches economics as a science, as a study of principles. Just as the chemist needs to carefully study and understand all of the principles governing the elements in a substance to successfully predict how they will behave when combined with others, the economist must study and understand all the aspects of a given policy to determine what its actual effects will be. Conversely, just as the chemist who fails to consider all the factors in a reaction will fail to achieve his desired outcome (and potentially suffer grave consequences), so too does the shortsighted and unprincipled economist.
Observe the actions of the Bush and Obama administrations, which have been characterized by frenzy and impulse. From the first Sunday-afternoon announcement of the government’s seizure of mortgage giants Fannie and Freddie, to the bailout of AIG (but not Lehman Brothers), to the multiple enormous “economic recovery” spending bills rushed through congress in weeks, it has become clear that our leadership is flying by the seat of its pants–i.e., without reference to any firm principles at all.
Both Presidents Bush and Obama have defended their unpredictable, shifting policies on the basis of urgency: Bush dismissed critics in September, saying, “There will be ample opportunity to discuss the origins of this problem. Now is the time to solve it.” Obama has stressed repeatedly the need to “act boldly and swiftly” to avert economic disaster, brushing aside warnings of the long term economic damage caused by massive deficit spending, more restrictive regulation, and higher taxes.
While a sense of urgency in the face of crisis can be a virtue, it can only be so if it is guided by rational principles. When US Airways Flight 1549 was crippled by a failed engine, the efficacy of the pilot in assessing the damage and analyzing the options against his knowledge of avionic principles was crucial to his life-saving landing in the Hudson River. However, had his measured, rational sense of urgency turned into blind panic, the outcome would almost certainly have been much worse.
The government’s handling of the economic downturn has fallen into the latter category. Rather than analyzing the underlying principles at work, Bush, Obama, and Congress have demonstrated an inclination to do something, anything that seems superficially plausible to try to reverse course. They call this “harnessing the spending power” of government, which means transferring liabilities and losses from the balance sheets of select companies and individuals to the balance sheets of all taxpayers. By simply erasing the financial mistakes of some and handing the cost to others, we are told, the government can end the recession and return us to prosperity.
Given the seriousness of the circumstance, this type of swift action may sound enticing, but will it truly work? There is a telling parallel here between government spending and the fictional broken window. One of the clues to the fallacy inherent in the broken window theory emerges when taking the idea to its consistent implementation: If wealth could somehow be increased by breaking windows, then it would stand to reason that the townspeople should break every window in sight. And why stop there? If a glassmaker’s increased business indicates economic gain, why not destroy the entire town, so that the whole population could be put to work rebuilding what they once had? Obviously, this scenario would represent an enormous and senseless destruction of wealth, despite the resulting “full employment.”
Likewise, we should ask of the current economic policies: If the government can benefit the economy by paying off the debts of a few, why not pay off the debts of all? Why not assume the mortgages and credit card bills of the entire country? If this is the road to prosperity, what are we waiting for?
The answer, of course, was long ago given by Bastiat: spending money, in and of itself, creates no wealth. The “economic activity” we see as a result of government spending is simply the transfer of wealth from the pockets of some to the pockets of others. The result is only a rearrangement of wealth, not its creation (and actually a loss, when the overhead of government bureaucracy is taken into account). While the “improved” financial health of some may seem desirable in the short term, it necessarily comes at a higher cost down the road. Just as the broken window ultimately leaves the fictional town one window poorer, the economic stimulus bills leave us all deeper in an already deep hole of debt that will have to be repaid someday, somehow.
By focusing on the immediate and visible, while evading the long term, as yet unseen effects of their actions, our leaders are committing exactly the error that Bastiat warns us about. They are treating economics not as a science of principles, but as a day-by-day experiment where the rules are subject to change and cost is no object. We have already seen the damaging effects of the resulting climate of uncertainty in our markets, and we will continue to experience the fallout as the true costs emerge.
If we want to retain the standard of living we currently enjoy and see it improve in the future, we must combat this pragmatic, short-term mentality. Economic success requires recognition, not evasion, of the fact that the principle of cause and effect applies just as inexorably in financial policy as it does in the scientist’s lab. Only when we reestablish acceptance of this idea can we hope to reverse course and return to the road of long term prosperity.
Photo by Nancy on Flickr