Freeman

ARTICLE

Government Spending Cuts Are Bad for the Economy?

Take a closer look.

AUGUST 15, 2012 by TYLER WATTS

“Looks like I picked the wrong week to quit amphetamines,” laments the gruff air traffic controller played by Lloyd Bridges in the ribald disaster-spoof Airplane! Facing the tense situation of helping a nerve-wracked pilot safely land a large passenger jet, “Steve McCroskey” could get a performance boost by popping some pep pills, right?

In like manner, many commentators have suggested recently that the U.S. economy could use an upper in the form of more government spending—specifically, more public-sector jobs. Governments at all levels, they might say, picked the wrong time to engage in mass layoffs. The sentiment is expressed in recent articles in the New York Times  and Wall Street Journal. The Times reporters claim that the recent loss of 706,000 public-sector jobs—mostly at state and local governments—is “hurting [economic] recovery.” The article claims the unemployment rate would be a full point lower if government employment were at its 2009 levels and that public-sector “layoffs will siphon $15 billion in spending power [from the economy].”

The Journal reporters make similar claims about federal government employment. Their sources warn that (alleged) coming federal spending cuts “would tip the U.S. into recession early next year.” They note that federal spending is declining at 0.4 percent annually, with the federal government having shed 52,000 jobs in past year. These cuts have a ripple effect on employment and income, they argue, due to less federal “stimulus” money for state and local governments to maintain spending and employment, less money flowing to government contractors, leading to less employment in these local industries, and so on.

Somewhere the ghost of John Maynard Keynes is smiling his consent; if only the U.S. economy could continue to tap the stimulant of government jobs, the recovery would be much stronger!

But it just ain’t so. Pundits who lament the declines in government employment fall for one of the classic blunders in economics: looking only at the short-run effects of a policy on some people, but ignoring the long-term effects on everybody else. (Henry Hazlitt’s classic, Economics in One Lesson, exposes this blunder.) To understand the confusion, we must dissect what exactly people mean by the term “economic recovery.” A proper understanding of economics reveals that government cuts—not increases—are what’s needed for renewed economic vitality.

What Does “Economic Recovery” Really Mean?

Most economic commentators focus on simple numerical indicators such as GDP growth and the unemployment rate. In the heady pre-recession years U.S. real GDP growth hovered around 3 percent and the unemployment rate bottomed at about 4.5 percent. The latest GDP growth figure stands at 1.5 percent, and unemployment is 8.3 percent—poor indeed in comparison with those rosy benchmarks. Government cutbacks are bad news for those who only think in these terms. Government purchases—like hiring more workers—add directly to GDP, and if extra government hiring drew at all from the ranks of the unemployed, it would also reduce the measured unemployment rate.

But so what? If the goal were really just to get GDP up and unemployment down, it would be a simple task: Government would merely hire all unemployed people at whatever price it takes to induce them to “work”; the higher the pay the better, because–remember–increased government purchases add directly to GDP!

Those with a shred of common sense have probably anticipated two obvious objections to this procedure: What exactly will these government workers do? And where is the government getting the money to pay them?

This is where the macro indicators start to lose their meaning. What really matters for economic health is not simply the percentage of people drawing a paycheck, nor the alleged dollar value of total “production.” What matters is this: Are people doing the best they possibly can with their limited time, talents, and resources to serve the limitless wants of their fellow human beings? If not, how do things need to change?

Market-Based vs. Political Employment

Perhaps we’ve been spoiled by hundreds of years of a generally prosperous and growing market economy into assuming that all workers necessarily add to economic output by exactly the value of their paychecks. There is a strong tendency toward this result in a strictly market-based competitive economy. Companies whose revenues don’t cover costs can’t afford to keep their land, capital, and labor employed very long. Workers who produce more value than their paychecks are likely to see their pay bid up or start their own enterprises.

But such is not the case with government workers. Sure, some of them provide valuable services like filling potholes and judging court cases. But politics plays by a different set of rules than competitive markets. Political spending doesn’t have to pass a market test, wherein the price paid by willing consumers must cover the costs of the land, capital, and labor required to produce the goods. Politicians pay for their spending—and their workers—through taxes or, should further taxation prove unpopular, through borrowing and potentially even printing money. Politicians therefore face much less feedback and much less restraint regarding the employment of unproductive workers. This leads to a common theme in government at all levels: hiring too many workers relative to “consumer” (taxpayer) demands, or more commonly, overpaying their workforces relative to competitive labor market conditions. The latter situation is common for local and state-level governments, which lack an unlimited ability to use deficit finance, but can make large promises of future pension benefits to tomorrow’s retirees.

For real recovery to take hold, the fact remains that workers need to be doing something productive and not get overpaid for it. Compared to competitive markets, politically based employment offers feeble mechanisms to ensure government workers are really adding value by their toil. Indeed, one lure of government employment has long been the prospect of guaranteed lifetime income without the stress of market pressures like competition and the need to post profits.

Genuine Recovery: Painful Changes, Spontaneous Growth

The harsh reality of the recession has been a stark demonstration for many enterprises that they are no longer creating value. There are various reasons for this, mostly based on false signals to entrepreneurs and workers generated by myriad government interventions. Yet markets are amazingly resilient, especially in the large, entrepreneurial U.S. economy—despite all the intervention. Unraveling the mistakes of the housing-boom era takes time, but the correction grinds on despite many government attempts to forestall painful changes. One of these changes, the need for which is fairly evident, is a reduction in bloated public-sector workforces. Yes, this entails some lame GDP and employment numbers, especially in comparison to the peak years of the boom. These numbers are largely artifacts of the cycle; the heart rate is liable to decline during drug withdrawal, but this does not indicate that another bender is in order. Extra government expense at this time would be a bane, not a boon, to our economic health. In sum, “recovery through government spending” is akin to “good health through drug abuse.” In either case, a spike in selected short-run indicators will turn into a health disaster if the policy continues for very long.

ABOUT

TYLER WATTS

Tyler Watts is an assistant professor of economics at Ball State University and the winner of the 2012 Beth A. Hoffman Memorial Prize for Economic Writing.

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