Posts Tagged ‘Government’

25th February
2009
written by admin

What is the responsibility of the government in times of recession? What is meant by “stimulating the economy”?

US GDP (in the long run) = number of working people * productivity of each working person.

Thus there are three levers the government can pull today to  increase GDP by 2025.

  1. Increase the number of people
  2. Increase our productivity
  3. Increase the number of people willing to work

The first would require increased immigration or a higher birth rate. The second is a function of education and the capital stock (which the government is in the habit of depleting) and the third (in the case of full employment) is a matter of personal choice.

Over the long run, there is very little the government can do to increase per capita GDP other than ensuring optimal productivity of the workforce and creating conditions which would ensure full (or close to full) employment without inflation. Sacrificing productivity is always the long term peril as labor is shifted to the public sector.

On the demand side of the equation, the government has the option of preventing people from saving and enforcing spending. Of course, in the longer run, the only option is preventing people from spending or saving and allowing the government to do the spending for them. Consumption is merely shifted from the private sector to the public sector with no net increase in demand on the generous assumption that government spending is as efficient as private spending.

Hayek gave a convincing critique of government action’s ability to stimulate “aggregate demand.” Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments’ artificial inflation of money and credit.

Sound money policy, conversely, allowed the disparate knowledge of millions of economic actors to be conveyed through the price system, rationally allocating capital and labor through relative prices. The problem with government attempts to manipulate the economy through fiscal policy — spending that takes resources away from those who are productive and redistributes it to politically favored interests — is that it is audacious. It assumes that government knows better how to spend and invest than individuals acting in their families’ best interest.

“The real question,” according to Hayek, “is not whether man is, or ought to be, guided by selfish motives but whether we can allow him to be guided in his actions by those immediate consequences which we can know and care for or whether he ought to be made to do what seems appropriate to somebody else who is supposed to possess a fuller comprehension of the significance of these actions to society as a whole.”

The usual retort to this argument is a variant on “in the long run we are all dead”. In the short run, then, the role of the government is to act as a counter-cyclical economic agent. Short runs turn easily into long runs, though, and short-lived is the president who decides the economy needs not “stimulating” but … what? We don’t even have a word for it.

David Brooks¬†expressed this thought succinctly, if somewhat belatedly, with his call for “epistemological¬†modesty”