Some economists hold that one cannot trust the market economy, which is seen as inherently unstable. If left free, the market economy could lead to self-destruction. Hence, there is the need for the government and the central bank to manage the economy. Successful management, in this way of thinking, is done by influencing overall spending.
According to this framework, it is spending that generates income. Spending by one individual becomes the income of another individual. Hence, the more that is spent, the greater the income. Spending, then, drives the economy. If—during a recession or for whatever other reasons—consumers fail to spend, then it is supposed to be the role of the government to step in and boost overall spending in order to grow the economy.
Funding and Economic Growth
What is missing is how spending is funded. Consumption cannot precede production. Robinson Crusoe could not just “spend” and realize greater wealth. Were people to simply consume and spend without producing and/or saving, it would just consume preexisting production and/or savings. This would not lead to stable economic growth. What enables true economic growth is production, saving, and capital investment. Imagine an economy that had to be rebuilt after mass destruction of capital and consumer goods. The solution would not just be to spend, but to produce and save, then to channel savings into capital goods. On this, Richard von Strigl wrote:
Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides laborers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs.
The introduction of money into the equation does not alter the essence of funding. Money is and economic good and acts as a medium of exchange. It is only employed to facilitate the exchange of goods; money cannot replace the consumer goods. The demand for goods is not constrained by increases in money supply, but by the production of goods. According to Rothbard,
Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.
The more goods produced, the more goods one can demand. This was the original point of Say’s law. People do not ultimately exchange for money itself, but because money can be exchanged for other goods and services. People are limited in their demand for goods by the produced goods they can offer in exchange.
Government is Not a Wealth Generator
The government, as such, does not produce any wealth. It must expropriate wealth already produced before it can rearrange it. How, then, can an increase in government outlays grow the economy? Various individuals, who are employed by the government, expect compensation for their work. The only way it can pay these individuals is by taxing others who are generating wealth through production and exchange. By doing this, the government weakens the wealth-generating process and undermines economic growth. According to Mises,
…there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.
As long as the “subsistence fund,” savings, and capital investment, remain large enough to support government-sponsored activities, while also enabling an increased wealth-generating production, the fiscal and monetary stimulus appear to work. In reality, artificial growth and malinvestment grows on top of genuine economic growth, temporarily hiding its effects and leading to the fallacy that spending grows the economy.
If, however, savings and capital investment declines while government spending continues or increases, then the overall economic activity is likely to decline also. The more the government spends, and the more the central bank pumps, the more savings and capital accumulation are depleted, thereby undermining the prospects for economic growth. The government is not a wealth-generator and the central bank’s monetary policy involves the exchange of nothing for something. These activities undermine economic growth, they do not create or encourage it.
True wealth-generators—because of the increase in government outlays and monetary pumping—have to suffer the consequences of government spending diverting resources from the market and crowding them out, reduced purchasing power of money, being taxed to support non-wealth-generators and their activities, economic instability, reduction of genuine saving and capital investment, etc.. This, in turn, hinders the production of goods and services and acts to retard, not promote, overall economic growth.
Economic Cleansing
Conventional thinking presents economic adjustment—labeled as an “economic recession”—as something terrible that must be avoided at all costs. In fact, economic adjustment is a situation when scarce resources are reallocated in accordance with consumers’ priorities. Allowing the market to do the allocation always leads to better results. Even the founder of the Soviet Union, Vladimir Lenin, understood this when he introduced the market mechanism for a brief period in March 1921 to restore the supply of goods and prevent economic catastrophe. Yet most experts these days cling to the view that the market cannot be trusted in difficult times.
A better way to fix economic problems is to allow entrepreneurs the freedom to allocate resources in accordance with individuals’ priorities. In this sense, the best “stimulus plan” is to allow the market mechanism to operate freely. Allowing the market to do the job results in some activities disappearing altogether while some other activities will increase. Expansionary fiscal and monetary policies do not rescue the economy, but instead rescue artificial activities that are generating products of lower priority to consumers. Expansionary fiscal and monetary policies sustain waste and promote inefficiency by diverting resources away from the private economy.
Interventionism vs. “Nothing”
The best economic policy is for the central bank (if it exists at all) and the government to do nothing as soon as possible. By doing nothing, the central bank and the government will enable wealth-generators to accumulate savings and for producers and consumers to readjust after the distortions of prices and production. The policy of doing nothing forces various activities that add nothing to the private economy to change, retrench, or disappear. After some time, this sets a platform for the expansion of various wealth-generating activities through production, exchange, saving, and capital investment.
Conclusion
Contrary to many commentators, neither the Fed nor the government’s expansionary monetary and fiscal policies can increase economic growth. On the contrary, expansionary policies only weaken, divert, and distort production, exchange, saving, and investment. Therefore, spending itself—especially government spending—does not grow the economy.
