Government spending spree has no real-world benefit

We, along with our children, will pay for our rapidly rising debts.

MELBOURNE Business School professor Joshua Gans on this page yesterday suggested, perhaps with tongue marginally in cheek, the debts that follow from government spending will not actually be a burden on our children.

Our children, he contends, will not pay at all because by the time they grow up, the debts will have been repaid.

But the fact of the matter is that we all pay. We pay today, and our children will pay tomorrow.

Today's wasted debt-creating public expenditure will need someone in the future actually producing and earning an income to repay the debts that are accumulating.

Nothing in an economy comes free. Why anyone should think deficits are an exception is anyone's guess. The only real question is not whether these debts will be repaid, but when and by whom.

And our children will be part of the payment process because by diverting resources into less productive assets, we weaken the economy and leave a depleted legacy of valuable capital upon which they can build.

But what Professor Gans is actually saying, I think, is that because the problems of the deficit become so acute so quickly, we are unable to just coast along forever, but must do something almost immediately.

Every Jimmy Carter has his Ronald Reagan, John Cain his Jeff Kennett and Paul Keating his Peter Costello. Every excess, you may be sure, has its day of reckoning and it typically comes sooner than you think.

A few days ago, I found the following in the latest issue of the Claremont Review of Books. This is a quote from George Gilder as part of a symposium on government and economic crisis. In it he wrote something that should be kept in mind as governments go about spending on their favourite projects. He, of course, was speaking of the United States. His point is just as valid here.

"Meanwhile, the profession upholds the phantasmagorical models of demand-side economics. Because these models find no confirmation in reality ― as Jean-Baptiste Say proved centuries ago, demand is always and only a side effect of real supply ― established economic theories are extremely difficult to learn and remember. You get Nobel prizes for minor and obvious insights in economic geography. Thus the exponents of the standard model are deeply threatened by any reality-based economics."

What Gilder is discussing is something called Say's Law, the very cornerstone of pre-Keynesian economics. A properly educated economist before Keynes published his General Theory in 1936 would have understood that only goods buy goods, with money as a mere intermediary. When all was finally said and done, each person could only buy with the value added they had created, which had then been converted into money.

I work and help in the production of some good or service. I am paid money for what I have produced. Others do the same and we each buy from each other using the money we have received for actually having created some value. Money makes the exchange more efficient, but beneath it all, the actual purchase is made with each person's own productions.

So the fictitious invention of demand through handing out deficit-financed tax cuts cannot stimulate demand unless it stimulates supply first, which it won't.

The great disaster of Keynesian economics was the introduction of the aggregate demand curve that had not existed prior to 1936 and was specifically rejected by economists before Keynes. That was what Say's Law meant.

And I am not talking about economists in 1803, when Say wrote his first book, but economists throughout the entire period from the mid-18th century right through to the publication of the General Theory.

Any policy dependent on shifting the aggregate demand curve will fail precisely because there is nothing in reality that corresponds to what the aggregate demand curve is supposed to represent.

Economists go about their business moving aggregate demand back and forth in their models, and are continuously confounded by the failure of anything to happen in the real world. The Japanese spent trillions of yen in the early 1990s with no result other than an actual worsening of economic conditions.

Now we are doing the same. We are spending up because our economic textbooks tell us that we can stimulate growth by adding to demand before we add to supply. Well, that is a theory, indeed. What we now need is someone to explain why it's supposed to work.

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