Mises Wire

The Myth of National Defense Spending

Among the most persistent of myths in the sphere of economics is of the supposed benefits of government spending in the economy. Apologists will include government spending in gross domestic product measures, as if government production is truly “productive.” A common argument in favor of government spending is national defense spending.

US senator Tommy Tuberville (R-AL) declared on Twitter that he would be voting against a defense package that would send further money to Ukraine and Israel. American Enterprise Institute senior fellow Marc Thiessen quote tweeted the senator, saying,

Ukraine aid money is going to Alabama to produce the following systems: High Mobility Artillery Rocket Systems (HIMARS), Javelins, M1A1 Abrams tanks, M2A4 Bradley infantry fighting vehicles, Hydra-70 rockets, M777 howitzer parts (Paladin M109A7), M88A2 Heavy Equipment Recovery Combat Utility Lift Evacuation System (HERCULES) vehicles, and Stryker armored personnel carriers.

This is creating jobs for your constituents and hot assembly lines in factories in Alabama that will benefit U.S. national security.

Why are you voting against Alabama defense jobs?

One can argue the ethics of defense spending, but that is a different form of analysis. It is important to unpack whether this statement is accurate. Is more defense spending beneficial for constituents and consumers?

First, let’s accurately portray the argument in favor of more defense spending. The argument is likely as follows: Legislation that sends more money to the Department of Defense will go out in the form of government contracts to private manufacturers. These manufacturers will create more jobs, create more goods for defense, and generally “boost the economy.” These jobs give wages to laborers who demand goods from other industries, and so on.

Thiessen’s argument goes further. When legislation is passed, it might be earmarked for contractors within a certain locality. The legislators bring benefits to their constituents in the form of new jobs. Thus, there is an incentive for legislators to support such legislation as it will bring jobs to their districts.

This is often called pork-barrel legislation. Legislators pack a bill going through Congress with government spending appropriations that go toward their constituents and special interests. This method is used to garner votes for a piece of legislation by making it “beneficial” for all who support it. Amendments are offered to get more votes, and the benefits get further distributed to constituents who will vote in the next election. It is commonly used as a tactic to help special interest legislation that would otherwise be unpopular.

The first proper critique of this method comes, of course, down to financing of the legislation and contracts. Not an ethical critique but an economic one. Government spending must be financed in some way. The three means are taxation, inflation, and borrowing. Or taxation, hidden taxation, and deferred taxation. It is always a tax on the citizenry.

The easiest to identify are normal taxation and borrowing. Taxation is easy enough to understand. Borrowing involves the issuing of treasury bonds in exchange for private dollars, with the expectation of future repayment of those bonds with interest in the future. It is a promise of future taxation.

Inflation comes through central banks intervening in the latter process. The central bank purchases treasury bonds from what we call in the United States primary dealers and creates new money in the form of either orders of physical currency through the Bureau of Engraving and Printing or adding to their accounts at the Fed. New currency to finance fiscal spending will bid up prices in the private sector, especially through the loan market. All these methods are regressive.

With simple taxation, the effect on markets is clear enough: Taxes are either income or attached to some good or service. When attached to a good or service, say a tax on cigarettes, there is a deadweight loss as less exchange occurs.

Figure 1: Deadweight Loss from a Tax

Source: Wikipedia.

Taxes on income will result in a reduction of income. Income will be diverted only to the most urgent of needs, what we might call the highest ordered needs. There is less ability to consume and demand goods that might stimulate production. There is less ability to save, which will harm future production possibilities and perhaps the loans markets.

Inflation will similarly affect spending. Inflation raises the price of goods and services. It will push consumers to spend in the moment, out of fear of prices rising further. This reduces demand for goods that satisfy lower ordered needs. Austrians go further to describe how business cycles come to be through this process. All the methods of financing will distort the actions of consumers and the producers that cater to them.

Continuing from financing, the actions of the contractors themselves will affect the market. Fundamental to this understanding is an understanding of market prices. Market prices result from demonstrated preferences by consumers. Consumers buy or do not buy goods at certain prices, and producers make decisions anticipating a certain price for a good or service. The actions of producers and consumers in accordance with their preferences and demands are crucial to the proper coordination of land, labor, and capital.

Government contractors enter the market with funds that are not given to them by shareholders. They purchase capital, rent or purchase land, and rent labor for wages. A government action is not that of individuals. It is funded through money taken by force. These contractors are not providing goods to individuals with demands but a government agency making broad requests. These contractors are not a natural market phenomenon that produces goods for true consumers.

Resources like land, labor, and capital are not demanded for their own sake. They are valued because they are used to produce lower ordered goods, the lowest being consumer goods. The burger buns a McDonald’s franchise purchases are not valued because McDonald’s wants to consume them but because they produce a good that they hope to sell. The same is true of the laborers it employs. Their labor is demanded to produce the goods they want to sell to consumers. The same is true of the land rented or bought for the business. These resources are higher ordered goods.

Entrepreneurs make decisions of which land, labor, capital, and processes to employ based on their anticipations of market prices for the lower ordered good they are producing. The government contractor does not operate in this way. The government contractor already has revenue secured from contracts. They are not responsive to a market price, and thus their demand for higher ordered goods (the resources used to create a lower ordered good) is also not responsive.

Resources that would ordinarily go to produce goods for consumers are instead demanded by the contractors that cater to the government. They compete for capital and affect market prices for higher ordered goods. Increased demands for these goods will raise their prices and government contractors will divert resources from industries that create consumer goods. Consumers are made worse off, and resources are sent to the contractors.

Thus, we reach the “public goods problem.” Typical public good analysis describes a public good as a good that is “nonexcludable” and “nonrivalrous.” This means a public good is either available to all citizens, does not dwindle in supply with use, or both. The problem arises that many of the so-called goods described might very well not meet these conditions. It might be better to describe a public good as a government monopoly over a good or service.

The problems with public goods are the free rider problem and the lack of proper prices. For this article, we will focus on the latter. The lack of prices on the market implies either a lack of demand or a total monopoly on the goods by the government. The demand for these goods is not the result of individuals demanding fighter jets, new naval ships, and missiles. Perhaps if allowed to, they would be, but for now they are the result of proclamations by the government.

The demand for these goods from manufacturers is not reflective of real demand by consumers. These are not goods that will be consumed by the average American. These goods are not “productive” (i.e., the result of the natural market). Rather than have goods that help the consumer, we receive the orders of politicians and the Department of Defense that are contingent on some expected conflict in the future.

Contrary to what Mr. Thiessen argues, further government spending will not necessarily help Americans. The methods of financing the spending will distort the market by harming consumers and producers. Whichever method of taxation is used—ordinary, deferred, or hidden—the market will be warped from its natural activities. Resources, including laborers and capital, that would flow to true consumer goods are instead diverted to the demands of government. Rather than allow the market to provide material goods and services that are demanded by consumers, the government siphons resources from productive America. Government ditch digging doesn’t help the well-being of its citizens.

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