This is an article written in 2009 replying to an article that criticised something I had written prior to that. My own article reprinted below was titled, Picking losers and was in reply to this written by James Guest. My original article that set this exchange in motion was published at Quadrant and titled, The Dangers of Keynesian Economics, dangers which are endless and only getting worse. There is nothing in the least dated in the article reprinted here even if the names are now different and the circumstances have now changed. For all that, governments are still stealing from the poor and middle class to give to our so-called public servants along with the rich.

The difference between myself and James Guest seems to come down to whether one actually believes markets work or, instead, thinks that we cannot count on them for growth and prosperity and that the government must come to the economy’s rescue to keep things ticking over. 

There has been, let us agree, a major dislocation in markets across the world. Jobs are being lost in 2009 at a rate we have not seen for sixteen or seventeen years. It’s not good, you wish it were better, but it’s the way things are. 

Moreover, these occurrences are not unknown but take place with a kind of regularity that makes their visitation unwelcome but not completely unexpected. Economies are subject to the cycle, and in the downturn firms that cannot make a quid disappear. 

So what do we do now? Do we have our domestic entrepreneurs decide where the best use of our resources would be, or do we leave it to Kevin Rudd and Co? Do we let people who have a market-focused desire not to lose their money make such decisions, or do we pass the baton onto a bunch of politicians and public servants who, if a productive economy is still our aim, are almost by definition incapable of deciding how our resources should be put to use. 

Let me therefore say exactly what Richard Posner is quoted as saying so there is no need to infer anything about my thoughts. The stimulus is very expensive and may well do major long-term damage to the economy. 

We are already looking at a budget that we are told is going to squeeze billions out of every hollow log the government can identify. The Government has committed large amounts of money on various projects of its own that it now must fund by raising taxes and imposts at every turn while winding back various benefits that had been provided in the past. 

How can any of this be a good thing? We are socialising more and more of our economy, putting decisions into the hands of those who have no genuine competence to make productive decisions. It will rescue some now at the expense of many more later on. 

James Guest quotes my writing that “it is clearly difficult to get the message across that spending money on anything at all is not the road to growth.”  It just seems to me that in his reply, he confirms just exactly that. 

He signs on to the expenditure on insulation without I am sure having done a moment’s worth of analysis himself. He writes: 

If the program were using resources which would otherwise be used in a more productive way that would be a ground for criticising it but that is not likely to be the case because the contracts to insulate houses and the budget spending tap for them can be turned on and off very quickly.  

OK, then. Come to the end of the project. There will then be many houses with insulation and there will be the debt the government incurred in having all this work done. You can say the same about the school auditoriums that are being built on the same principles. But what there won’t be is a single dollar of additional cash flow in the hands of government which it can use to pay off that debt. 

This is in complete contrast from a well chosen, properly costed private sector project of the same sort. In the private sector, such activities are designed to be self funding from the eventual cash flows that accrue when the project is up and running and earning its keep. 

On government project of this kind, however, there really never is a time when the debts are paid off. Only when some form of austerity is forced on public revenues because of the need to pay off the interest on the debt do the debts eventually disappear. 

And all the while the resources that are being used in these loss-making government projects are not being used in profit-making activities elsewhere. There are therefore the large but invisible losses to the economy of all the activities that were not done because the government has decided to direct our limited and scarce capital and labour into projects of its choosing. What we are losing are the projects that would have been supported on the market by people who would actually have been willing to pay for the goods or services when they were finally put up for sale. 

From the way James Guest writes, you would think we were in the midst of the Great Depression. You would think that we are wrestling with mass unemployment rather than a minor downturn in activity that, were it left to work itself out, could at least in Australia, be over and done with by the start of next year. 

We do not have a quarter of the labour force unemployed, as we did in 1932. That a forecast unemployment rate of between 7-8% should be a trigger for a spending frenzy shows a lack of proportion, and little regard for the long-term consequences that piling up such debt may cause. 

The problem once again seems to come back to macroeconomic theory as it is now taught. All spending is good no matter what it’s on. You put the various outlays under the labels consumption, investment or government – the C+I+G of modern theory – and forget about what you are spending the money on. It is really all the same, so the particulars apparently don’t matter. 

Public sector construction projects, without an increase in value relative to their costs, is a loss-making enterprise, just as it would be in the private sector. Running deficits for a net loss in value is like a giant Ponzi scheme. 

Macro theory tells you that there are multiplier effects. Even if the original outlay loses money, it is said, all of the secondary expenditures on various goods and services do their part to keep the economy growing. 

But if the initial expenditure loses money, then all of the secondary expenditures that hang off it are contributions to an overall loss-making project. Imagine if every one of the related expenditures had been part of a single enterprise. The fact that this spending is broken down into individual payments to various enterprises only disguises the fact that whatever is being produced is not leading to the creation of enough value to repay all of the costs. 

The economy is not creating enough additional value to validate the increase in the total level of spending. Something, somewhere will have to give. 

There is then the US.  The American stimulus package puts in place an immense increase in expenditure and a massive increase in debt. Yet James Guest believes that Obama’s $800 billion package is so paltry that it is “hardly going to touch the sides”. 

Is there really no sense of just how much sludge in the crankcase this expenditure will create? What will it take for it to be understood that economic growth occurs not in the spending but in the goods and services produced? 

It is true that a large part of the wealth we thought we had has disappeared. It was paper wealth, bundled up in asset values that when actually tested on the market, turned out to be a mirage. That says to me that our economic structure had become distorted and that some rearrangement of our economic structure is now required. 

Into this readjustment process we are now going to interpose government direction of expenditure on assets that will never pay for their own keep and we are doing so without an ounce of evidence anywhere to show that they will. 

We are creating the conditions for a very slow recovery in real incomes and another downturn to follow whatever upturn we now manufacture. Because of our spending today, the basis for a truly sustained period of growth and prosperity may continually elude us. 

Each and every job in the private sector must create value for those who employ. In the public sector, around the first 30% of expenditure might be productive in that sense, but the rest is taxpayer funded admin and transfers. I don’t say it is necessarily without value or purpose, only that it is dependent on taxpayer funding to allow these activities to occur. 

But what can be said about the extraordinary expenditures governments are now taking on to spend the economy into recovery? These are deficit financed without a thought in the world on how to pay them off. 

It is the timeworn role of governments to pick losers. It is what governments can be expected to do for which they have had much practice. I cannot think why they should be encouraged further along this road than they have already gone.

How is this for being completely out to lunch: The bicycle is the slow death of the planet?

General Director of Euro Exim Bank Ltd. got economists thinking when he said:

“A cyclist is a disaster for the country’s economy: he does not buy cars and does not borrow money to buy. He does not pay for insurance policies. He does not buy fuel, does not pay for the necessary maintenance and repairs. He does not use paid parking. He does not cause serious accidents. He does not require multi-lane highways. He does not get fat.

Healthy people are neither needed nor useful for the economy. They don’t buy medicine. They do not go to hospitals or doctors. Nothing is added to the country’s GDP (gross domestic product).

On the contrary, every new McDonald’s restaurant creates at least 30 jobs: 10 cardiologists, 10 dentists, 10 dietary experts and nutritionists, and obviously, people who work at the restaurant itself.”

Their only unit of account is job numbers, not wealth creation. It never occurs to any of them that the resources not used one way will end up being used somewhere else, and often in a more productive – that is, growth-inducing – way.

Both from Drudge at one and the same time.

Do deficits matter anymore? Biden’s first budget signals they don’t…

And then this at the very same time.

Biden pledges to tackle supply shortages as prices rise…

Let me note that it takes a year or so for price increases to catch fire since consumer demand stays mostly the same while investment, and massive increases in public spending in general, are diverted into useless unproductive channels. Eventually, however, the flow of money expenditure begins to grow more rapidly than the flow of actual goods and services to buy.

Seen the price of houses lately?

The first half was my post on Value added and public spending. Growth only occurs where the value of what is produced is greater than the value of the resources that have been used up during production. There was a time when everyone understood that, even economists. Alas no longer. But there is a second element that matters, and that is the price mechanism. Unless you have a functioning price mechanism, where market prices reflect relative scarcity, you cannot tell what anything actually costs.

Which brings me to this: I, Mechanical Pencil: Why a socialist economy can never work. There you will see why the price mechanism matters and how crucial it is that the prices in the market are actually set by people who are trying to earn a living from what they sell. This is what I say about the price mechanism:

This is so important that almost nothing is as crucial as this for ensuring our prosperity continues. Without a functioning price mechanism, in which businesses set their own prices for themselves without government involvement, an economy absolutely will not work. Unless businesses are permitted to set their own prices based on their own production costs and customer demand, you are guaranteed to live in poverty.

The buffoons who “manage” the Victorian economy are creating disaster. It is why the most important element in the Victorian budget dealt with mental health: ‘Very targeted’: Acting Premier defends mental health levy.

Business owners have warned the levy set out in Thursday’s budget is a tax on employment and will hit those in the retail, hospitality and tourism sectors hard.

“These are very targeted, appropriate, well-thought-out revenue initiatives that impact less than 5 per cent of employers,” Mr Merlino said.

“Many of those are multinational companies. It is very targeted, and in terms of the benefit to businesses, right across the state of Victoria is massive….

The acting Premier rejected the notion that Victorian businesses – which were badly hit by the state’s second wave of the coronavirus pandemic caused by government failures in hotel quarantine and contact tracing – were being penalised for the state’s mistakes.

He also said a $4 billion budget blowout over the past two years on Victoria’s Big Build project had no impact on funding mental health services as the two were in different funding streams – the former in capital spending, and the latter on service delivery.

Looneys everywhere.

The video is on Value Added – which I did many years ago as part of my economics course. Much too long to watch, but it’s there if you are interested. Alas, value added is virtually no longer even mentioned inside an economics course, and even when it is it is never dwelt upon.

This mishmash is how value added is defined at Google. This is about as close to what you might get in an economics course today, and then only if they are discussing the National Accounts. It’s never mentioned as part of macro generally.

1. the amount by which the value of an article is increased at each stage of its production, exclusive of initial costs. “the proportions of both total output and value added fell”

2. the addition of features to a basic line or model for which the buyer is prepared to pay extra. “value-added digital technology”

Value added was once properly understood as the difference between the cost of the resources used up in some production process and the revenue stream generated by selling the products that have been produced. It was about creating economic growth and higher living standards. Government spending is almost never value adding, and I include the word “almost” since occasionally, very occasionally, governments actually create more value then they use up. There is no such government anywhere in the world today.

I am reminded of all of this by the release of the Victorian budget and the shamelessly shallow response in the media. Treasurer goes all in on the Robin Hood approach to funding.

If you ever needed proof of how confident the Andrews government is of winning the next election, look no further than Thursday’s budget.

Handing down his seventh budget, Treasurer Tim Pallas resembled Robin Hood as he hit developers, big business and affluent home buyers with higher taxes to fund billions of dollars in spending on mental health, hospitals and schools.

Boosting taxes is rarely popular at the ballot box. But next year, the state government’s tax revenue will increase 13.2 per cent, with an average annual increase of 6.9 per cent over four years.

Justifying the tax grab, Mr Pallas said he was simply asking Victorians who had done well out of the pandemic – successful businesses and those lucky enough to hold on to their jobs – to help those who had suffered the most. It’s a strong argument.

This was once known as eating one’s seed corn. This is entirely using up your capital base with no replacement in sight. This has gone even beyond Keynesian moonshine, where they used to pretend that the problem they were solving was caused by too much saving. I guarantee you Australians are not saving too much, nor is anyone else. Now it is just spending for spending sake.

And let me thank Rodney for finding this video and alerting me to its existence on Youtube.