I think the following two paragraphs contain the most concise and understandable contrast of two competing visions on how the economy works (emphasis mine):
For Keynesians, job creation is simple. Entrepreneurs have knowledge of how and what to produce. All that is required is more demand, in order to induce them to undertake more hiring.
n contrast, in our [Adam] Smith-Ricardo story, the knowledge of how and what to produce has to be discovered. Entrepreneurs have to figure out ways to utilize resources that satisfy wants in an efficient way. The market mechanism first must undertake trial and error to create production processes that exploit comparative advantage. Until these new patterns of sustainable specialization and trade are discovered, there are no job slots.
I bolded the key phrases. Do you believe that progress comes from stimulating evermore demand or from trial and error experimentation?
I believe the latter. Progress, wealth, improvements in the standard of living, GDP per capita growth — whatever you call it — comes from experimentation and trial and error and a process that allows the valued to survive and multiply and the least valued to die off (i.e. evolution). This trial-and-error market process is driven by the ultimate democracy of individuals voting with their own value store on the the things they value and vote against those things they don’t value.
The problem for me with the former explanation, creating more demand, is where this new demand comes from.
The theory says that more government spending will put more money into some folks pockets, which they then spend. So, then the businesses that benefit from that extra spending will spend more too. And so on. This is a chained spending effect. By the time the that extra dollar of government spending has worked its way through the economy, it’s spawned more than a dollar of economic activity.
This seems reasonable on the surface. But pry deeper. Where did that extra dollar of government spending come in from in the first place? It either came from current or future spending.
If it came from current spending, then all we’ve done is take a dollar from someone to get the spending chain started. That someone may have started their own chain by spending it themselves.
Defenders of this theory will say, yes, but that someone wasn’t going to spend it any time soon so it’s best for everyone that the government took it and spent it.
I believe the miss in this line of thinking is that someone was waiting to discover something of value to spend it on, while spending it now does not help him find that value.
What’s really happened is that demand was pulled forward from the future and we’ve spent it on something that doesn’t add value.
Companies see this when they run ineffective limited time promotion. The sale will produce a sales spike during the offer period and a lull afterwards. The sale encouraged people who were going to buy the product anyway to buy it sooner, and buy less later.
But, in the case of the government pulling forward demand, it makes things worse.
That someone with the original dollar was waiting to spend that dollar on something he valued — maybe a new pill that will reduce his sick days and make him more productive.
Instead, the government takes it and spends it on another can of green beans. So, instead of having four cans of green beans in the pantry (that he’s never going to eat), he has five now — something that doesn’t bring as much value as that new pill. But, hey, the green bean growers and canners are better off. Except, we find that since there’s a glut of canned green beans now, green bean makers will sell fewer cans in the coming months.
So, creating demand through government spending is a myth. There is no creation. Just moving demand from one place to another or from the future to now — and in either case, we replace careful spending with careless.
- The value of a college education (ourdinnertable.wordpress.com)
- Grandpa’s Lament (ourdinnertable.wordpress.com)