Jost Zetzsche Tool Kit

Thursday, November 20, 2008

The revival of a costly myth

My friend Chandrasekar forwarded this mail to me. It is an interesting article about government spending. The way governments work all over the world, any new scheme has to be gone through with a very fine toothcomb. It is sad but true that any socalled temporary measures on the part of the government tend to linger on quite long after the end of its need. One example that comes to my mind is the Rent Control Act in Bombay, Chennai and other metropoles. Started as a stop-gap arrangement immediately after the end of the Second World War, it is still hanging on creating havoc in the houseowner-tenant relationship, new house constructions, availability of rented accommodation to newcomers to the city and what not.

Yet we do not seem to learn. It is really tiresome the way people have a short memory, so laments Christopher Lingle in "the revival of a costly myth". Over to Christopher Lingle. Dondu N. Raghavan will come afterwards.

Deficit spending to boost a weak economy is an argument that has little justification in fact and reality.

Despite having a stake driven through its heart after being identified as the primary cause of the stagflation of the 1970s, a failed economic policy has risen from the dead. Yet, the consensus at the recent G-20 meeting is that governments can create jobs and end recessions simply by spending more money.

The myth that higher public spending is good economic policy is so resilient that its supporters are unperturbed by all the evidence that contradicts it. Consider that Japan's policymakers began throwing massive amounts of money at the economy in the late 1980s to reignite it. This constant flow of deficits brought only a growing mountain of public sector debt with the economy regaining its long-term growth trajectory. Nor did it deter Japan from ushering in yet another recession.

More recently, the Economic Stimulus Act of 2008 gave so-called tax rebates worth $100 billion to US households in May, June and July. But the rise in spending was very small since most went into savings, including paying down debt.

Numerous studies show that one-time tax rebates cannot bring higher economic activity. This is because temporary increases in disposable income do not create incentives to increase consumption over time. The only certain thing is that stimulus packages based on increased public sector deficit will add to national debt.

Belief in the efficacy of deficit spending rests on a naïve notion that consumption is an important driver of economic growth. It is as though consumer goods and services are merely gifts of nature.

In reality, the path for sustainable economic growth requires more savings so that there can be more capital goods. As it is, capital goods are the basis of higher output and increased wages by boosting productivity. The provision of capital goods requires that consumption be deferred.

It seems that saving is not only a natural instinct, but it is also promoted by many fables, biblical and otherwise, that show the merits of thrift. In recent years, central bankers removed incentives to save by driving interest rates to unsustainable and artificially low levels while inducing more consumption.

This leads to a "paradox of spending" whereby consumers, deterred from saving by low deposit rates, are lured into low-interest borrowing to boost current living standards. This distortion in credit markets induces individuals to make decisions that lead to greater misery in the future for them and for others. Indeed, increased spending may cause incomes to fall by a greater amount since the attempt to buy more today backfires as there are fewer jobs and less to consume later.

By spending beyond means to create jobs, governments undermine or eliminate future employment

Therefore, policies that aim to raise consumption now lead to less capital being available for future production, so there will be less future consumption.

An enduring fable has it that governments can "create" jobs either through public spending to employ people in the public sector or to increase overall demand. During his campaign, Barack Obama promised to use $150 billion to promote windmills, solar panels and "energy efficiency" that would supposedly create five million "green" jobs.

In the first instance, government spending to "create" jobs costs more than jobs created in the private sector, since public sector recruitment involves massive bureaucracies. And since adding workers to the public payroll creates a new burden on taxpayers who have less to spend or invest, this means there can be no net gain to the economy.

In all events, government funding to "create" green jobs may be the worst of both worlds. Much of the support for green projects exists as they are thought to create more jobs because they involve more labour-intensive production. For example, supporters of initiatives for alternative fuels insist they would boost employment than would the building of conventional power stations. But conventional power stations operate with enormous economies of scale that bring lower unit costs so that more jobs can be created throughout the economy.

Job creation based on real economic merit does not require government involvement. But providing subsidies to support inefficient technology raises the labour-to-capital ratio so that the demand for labour will be lower and real wages will fall.

It is bad enough that deficit spending on job creation is simply ineffective. What is worse is that government spending schemes that expand public sector debt impose several burdens on future generations. Most obvious is the additional tax burden they must pay for debts incurred in the present.

By  spending  beyond  their  means to conjure up jobs, governments undermine or eliminate employment that would have been created in the private sector in the future. If increasing the share of GDP claimed by government leads to lower long-term economic growth, "creating" jobs today will mean fewer jobs in the future. The best way to avoid a future of booms and busts is to consign economic theories that support public sector deficits to the dustbin of history.

[Christopher Lingle is a research scholar at the Centre for Civil Society in New Delhi and a visiting professor of economics at Universidad Francisco Marroquin in Guatemala. Comments are welcome at]

Back to Dondu Raghavan. It is really amazing the naive manner of people faithfully repeating the old mistakes. Creating job is different from creating posts in government departments. As per the Parkinson's law, the more the posts, the more the infructuous efforts and nothing else.

The depression of 1932 is said to have been overcome by Franklin Roosevelt's New Deal. Actually what turned the economy around at that time was the onset of the Second World War creating acute demands for the war effort. Even in Germany the unemployment was reduced mainly due to Hitler's militarization of Germany, which triggered the Second World War.

Can this be repeated? I am afraid that the third world war if it comes may bring about things in such a way that the fourth world war can be fought with just bows and arrows, that too after some hundred years.

Dondu N. Raghavan


வன்பாக்கம் விஜயராகவன் said...

\measures on the part of the government tend to linger on quite long after the end of its need\

Very true. Reservations were supposed to be temporary measures in the beginning with a lifetime of 10 years. Now that is the be all and end all of government policies. Anti-brahminism was supposed to be a temporary feeling against top brahmin bosses in the Congress in the 1920s. Now, it has a life of it's own.

\The depression of 1932 is said to have been overcome by Franklin Roosevelt's New Deal. Actually what turned the economy around at that time was the onset of the Second World War creating acute demands for the war effort. Even in Germany the unemployment was reduced mainly due to Hitler's militarization of Germany, which triggered the Second World War.\

The US entered the war only in 1941. By that time the it's economy has been turned around - in any case the worst of economic and financial misery was over. One can say with some confidence that New Deal measures i.e. spending government money to create jobs in huge infrastructure programs did increase the spending power of ordinary people which in turn stimulated the demand for goods which set the wheels of indusry moving again. By 1937, the New Deal measures had begun to have their intended effects and the US was pacifist then. In other words, a classic case of pump priming. This does not mean it will work at all times in all places.

Germany had even more massive problems in 1923, when the inflation was 1,000,0000,000 percent. That was controlled by fiscal shock therapy and probably that inflation was part engineered to default on the War Reparations which Germany owed due to First World war. Even though Nazis and Hitler were lousy economic managers, due to public speding after Hitler came to power, like the building of autobahns, German economy did pick up by mid-30s. After that the rebuiding of German war efforts created even more jobs, even as thousands were liquidated in concentration camps.

Keynesianism, against which your article is written, has it's results, even though it is not a panacea.


dondu(#11168674346665545885) said...

What you say has got merit. Why don't you my Tamil post at

Dondu N. Raghavan

dondu(#11168674346665545885) said...

The US did enter the war only in 1941 but then it was having roaring business from 1939 to 1941.

The neutral United States took measures to assist China and the Western Allies. In November 1939, the American Neutrality Act was amended to allow Cash and carry purchases by the Allies. In 1940, following the German capture of Paris, the size of United States Navy was significantly increased and after the Japanese incursion into Indochina, the United States embargoed iron, steel and mechanical parts against Japan. In September, the United States further agreed to a trade of American destroyers for British bases. Still, a large majority of the American public continued to oppose any direct military intervention into the conflict well into 1941.
At the end of September the Tripartite Pact between Japan, Italy and Germany formalized the Axis Powers. The pact stipulated, with the exception of the Soviet Union, any country not in the war which attacked any Axis Power would be forced to go to war against all three. The Soviet Union expressed interest in joining the Tripartite Pact, sending a modified draft to Germany in November and offering a very German-favourable economic deal; while Germany remained silent on the former, they accepted the latter. Regardless of the pact, the United States continued to support the United Kingdom and China by introducing the Lend-Lease policy and creating a security zone spanning roughly half of the Atlantic Ocean where the United States Navy protected British convoys. As a result, Germany and the United States found themselves engaged in sustained, if undeclared, naval warfare in the North Atlantic by October 1941, even though the United States remained officially neutral.

Please see:

Dondu N. Raghavan

Werner Patels said...

Thank you for posting this. It's about time someone told the truth about deficit spending and such.

I hope all is well, my friend.

dondu(#11168674346665545885) said...

Thanks Werner. Sometime back I tried to put your blog in my blog roll as I have done for the other blogs, to which I had earlier given link. But I was unsuccessful at that time and I got an error message saying that your blog does not have RSS feed or something to that effect.

I have been meaning to write to you about this but this got postponed time and again. Today I am pleasantly surprised by your feedback. I tried just once more to put your blog too in my blog roll and this time I succeeded! It is much better than the static link. Whenever you post a new topic, it gets reflected (albeit with a certain time lag of a couple of hours) in my blog roll, with the first two or three sentences. In that way I am able to keep myself updated with your postings.

Now that this blog roll is there there is no need to give the static link.

Dondu N. Raghavan