Following the global financial crisis (GFC) governments all around the world, including Australia’s, engaged in knee-jerk stimulus spending, aimed at ‘kick starting’ the economy. Advocates argue that such spending stimulates demand, which subsequently triggers increased circulation of money and credit. I’d like to dispel some misconceptions about such policy.
The entire stimulus argument is based on demand side (or Keynesian) economic principles. However, demand side stimulus is only one approach to stimulating an economy. The other is supply side stimulus, involving tax cuts and removing regulation barriers, which inhibit production. Supply side stimulus has the advantage that, like demand side stimulus, it stimulates circulation of money, but has the added benefit that it stimulates people to earn more, invest more and save more. In this sense, supply side stimulus is superior to demand side stimulus.
The argument that Keynesian economics, i.e. the government borrowing large sums of money and spending it, is beneficial is based on false assumptions. When the government borrows money, it doesn’t come out of thin air. Rather, it is borrowed from someone. That someone is generally the private sector. Thus, to establish whether Keynesian stimulus is beneficial one must ask the question “does the government or the private sector allocate capital more efficiently?”. If the government allocates capital more efficiently then it makes macro-economic sense for the government to borrow money. However, if the private sector allocates it more efficiently then it is counter-productive to do so. If the former is always the case then it would make sense to abolish the private sector altogether and transition to a centrally planned economy. Clearly this isn’t the case. While in some instances government spending is more valuable than private sector spending (e.g. vital infrastructure that the entire economy critically depends upon), this isn’t always valid. Thus, before engaging in Keynesian stimulus one must analyse the details of how the government plans to spend the money, and evaluate whether this spending represents more efficient allocation of capital than what the private sector would otherwise do. The answer to this question varies, depending on the government’s and the private sector’s spending intentions. The problem I have with the stimulus packages of various world government is that they haven’t performed a full macro-economic cost-benefit analysis to determine whether their allocation of capital is optimal. Rather, they present simplistic arguments for the benefits of stimulus spending, and then spend the money willy-nilly without much consideration as to whether its allocation is superior to the commensurate private sector spending.
To compound the problem, governments retrospectively justify their stimulus spending by arguing that the economy has improved since the policy was implemented. This is a highly unscientific claim, as the governments have no idea how the economic dynamics would have evolved had they not engaged in stimulus spending. The reality is that economies naturally periodically go through boom-bust cycles. Therefore to wait for a bust cycle, implement a particular policy, then wait for the recovery and claim that it was a direct consequence of policy is folly.
I won’t argue that government spending is always bad, nor will I argue that governments borrowing money is always bad. What I do argue is that world governments have presented a simplistic and shallow case for their actions and have failed to perform any in-depth analysis of its overall benefits. Therefore I remain highly skeptical about the merits of their actions. Their actions have put major world economies into almost inescapable levels of debt, which in the long term will result in higher taxation and lower provisions of services and infrastructure. In the long term this could be catastrophic.