I can think of nothing more fundamentally foolish, more unequivocally self-destructive to our economic well-being today than attempting to balance the federal budget or place it in surplus. It is totally unnecessary and every dollar we cut from government spending is a dollar taken from someone’s income. That we should be so enthusiastically pursuing such a policy when there are almost 3 million unemployed workers is mind-boggling. How is further lowering the effective demand for goods and services supposed to help? It cannot, of course, and will only serve to make things worse–much, much worse.
This is the most important issue facing our economy today and the terrible irony is that it is completely avoidable. There is no logical reason to be obsessing over the debt and the deficit.
Explaining why cutting government spending (or raising taxes, which is the functional equivalent) is such an idiotic idea in the midst of the worst stagnation since the Great Depression is actually relatively straightforward. The real challenge is dislodging the conventional wisdom that is already so deeply-seated in people’s minds (including those of both Chris Bowen and Josh Frydenberg).
How the Private Sector Creates Unemployment
This is probably the single most overlooked issue when it comes to discussing the debt and deficit. One cannot truly understand the role of the federal budget without explicit recognition of the following structural problem: the private sector does not generate sufficient demand to make it profitable to hire everyone who is willing to work. Consumers do not want more, more, more. They reach a point, as do firms, when they are satisfied, where they don’t want another big-screen TV, house, car, evening out, et cetera. This tends to happen at the end of economic expansions (the Roaring Twenties, for example), which is why they then become recessions. Once the recession is underway, not only do incomes fall, but households and firms will opt to spend an even smaller percentage of these smaller incomes. Downturns, therefore, can be very difficult to escape by relying on the private sector alone.
Note that meanwhile, there has been no change whatsoever in our ability to produce goods and services! There was no technological reason, for example, for the suffering during the Great Depression. We had the ability to continue to produce output at the 1920s level; what was missing was sufficient demand to hire everyone willing to work. As a consequence, living standards collapsed. That’s where the system breaks down, as it did in October 1929 and December 2007.
How the Government Can Supplement Employment (and private sector profits)
Situations like the 1930s and today benefit no one. Unemployed workers would like jobs, employed workers would like not to have to support (formally or informally) the unemployed, and entrepreneurs would like to sell more output. There is an obvious solution: the federal government can supplement demand. Start off with a simple example: just imagine that they pay people $30,000/year to stand on a street corner and make nice comments about passers-by to raise national morale: “My, don’t you look handsome today!” “Go get ‘em, tiger!” “You’re important and people like you!” While this may make the others feel uncomfortable and cause them to avoid these particular street corners, it is nevertheless a net addition to aggregate demand. This is so because when these public greeters go home from work, they spend money from their incomes. This takes nothing from the mouths of existing workers because we already had the ability to produce more (again, compare the Roaring Twenties with the Great Depression). On top of that, the formerly unemployed now have jobs plus the ability to purchase goods and services and entrepreneurs earn more income because their sales rise–everyone is better off.
Now let’s make the example a little more realistic and actually give the government employees something useful to do (but not necessarily profitable, since that’s what the private sector already does). Instead of street corner greeters, they could be soldiers, airmen, sailors, marines, librarians, teachers, police officers, firemen, social workers, national park rangers, et cetera. This adds even more to the nation’s wealth because now even the formerly employed enjoy more goods and services (for example, protection from domestic and foreign aggression and a place to go camping). Remember, the core economic problem is the private sector’s inability to generate sufficient demand to employ everyone. This solves it by supplementing demand. It creates more employment, higher wages, and greater profits.
How the Government can Finance its Spending
Whence comes the money the government uses to pay the soldiers, airmen, sailors, marines, librarians, teachers, police officers, firemen, social workers, and national park rangers? It could tax the private sector, but that’s not terribly effective since it raises demand in one place by lowering it in another. So, they should deficit spend. To keep it simple, let’s say the manner in which this is accomplished is direct borrowing from the Reserve Bank of Australia. This means the Treasury sells its debt to another branch of the government, in exchange for which it receives the cash it needs to pay those workers. When the debt becomes due, they sell more. Because all Australian debt is owed in a currency we are legally permitted to produce, it is impossible to face debt default. We can choose to default, but we are never forced to.
This is not inflationary. This is true for a variety of reasons, the most critical of which being that it does not represent more money chasing fewer goods since the quantity of the latter rose–that was the whole point of the exercise. We wanted to lower unemployment and produce more output
That’s the essential story in as few words as I can tell it.
The bottom line is that the private sector does not generate sufficient demand to hire all those who are willing to work. The real irony is that we have plenty of capacity to produce output for them; they just can’t afford to buy it. But, if we supplement this with public sector deficit spending–something we can finance forever since the debt is owed in our own currency–then this absolutely unnecessary problem can be solved.
To do the opposite, to lower government spending (or raise taxes) in the midst of a period of high unemployment, is not only counterproductive, but it’s also cruel. The federal government does not borrow in order to be able to afford something it could not otherwise buy. Rather, the goal of deficit spending (at least when we are at less than full employment) is to stimulate demand. This is not analogous to how a household budget works.
There are, of course, complications (some real, some imagined), but these pale in significance to the benefits. First off, for those who are worried about the size of Australian government debt, not only is that a red herring, but it is actually more likely to get worse by cutting government spending. The biggest factor driving the deficit right now is the fact that during periods of high unemployment, tax revenues fall and government payments for unemployment and income assistance rise.
We don’t turn this around by creating more unemployed people!!!
Second, it does not cause government corruption. That’s a separate issue–the government can be plenty corrupt with surpluses! Furthermore, don’t forget when looking for abuses to cast an eye on the private sector, too (something about which Adam Smith, the father of capitalism, was terribly concerned). Markets are about as effective at controlling corruption among workers and firms as democracy is in preventing abuses in government. That is to say, they help, but they are not panaceas. We should remain ever vigilant.
Third, government spending is not crowding-out the private sector. The idea that entrepreneurs are just dying to employ more workers and raise production if only Queensland would lay off a couple more teachers is downright silly. In fact, I strongly suspect that those making such arguments don’t truly believe them.
I don’t think Chris Bowen and Josh Frydenberg are bad people, they are just ignorant. That would be their business except that their decisions affect millions. In their rush to be “fiscally responsible,” they are being economically irresponsible.
This has been a remix of John Harvey’s article at Forbes magazine for an Australian audience!