Ask the Expert: Tad DeHaven on Digging Ditches and the Stimulus

Sam Shaw, a freshman in high school at the Roxbury Latin School in West Roxbury, MA, asks:

"A liberal friend of mine defended the stimulus package by asserting the following:

A. Private sector spending has dropped.

B. Government spending is the way to pick up the spending and demand shortfall.

His conclusion: The government needs to throw a lot of money at the problem, even if it just means hiring workers to dig and fill in holes.

While I understand that intentionally getting nothing for something is an ineffective way to forestall economic failure, he got me on the assertion that government spending is the way to pick up the demand shortfall. Is assertion B disputable, and if so, how? How else can the economy return to positive growth given slow spending in the private sector? What are potential long-term implications of passing the stimulus bill?"

Tad DeHaven, Budget Analyst at the Cato Institute answers:

The focus of policymakers in Washington should be on fostering long-term economic growth instead of futilely trying to jump-start the economy with costly short-term government spending sprees. The idea that government spending can "make up for" a slow-down in private economic activity has already been discredited by the historical record - including the Great Depression and Japan's recent "lost decade."

The federal government, as well as state and local governments, has already spent taxpayer money at a record pace this decade. According to U.S. Bureau of Economic Analysis numbers, combined federal, state, and local expenditures in 2000 were an already unhealthy 30% of GDP. Eight years and two recessions later, government spending now amounts to 36% of the nation's economy and is trending higher. During that time we have witnessed the first $2 trillion federal budget and the first $3 trillion dollar budget. In fact, it isn't inconceivable that the federal government will start running annual deficits that are larger than the entire federal budget President George W. Bush inherited.

With all the money federal, state, and local governments have been spending shouldn't we be experiencing a boom? On the contrary, a combination of detrimental governmental policies has helped foster the current economic downturn. Thus, the idea that even more government spending will lift the economy out of its doldrums is akin to believing that an alcoholic can be cured with more drinks.

As was the case with previous economic contractions, people are losing jobs and unemployment is rising. Proponents of increased government spending often justify it on the basis that it will "create jobs." Indeed, the current "stimulus" package making its way toward President Obama's desk is being touted as a necessary fiscal sacrifice in order to get people back to work. But "stimulus" proponents either willingly ignore, or seemingly forget, that when the government taxes or borrows to "create jobs," it invariably sucks the job-creating lifeblood out of the economy because of the increased tax burden or the crowding out of private investment from the issuance of more debt.

The 19th century French economist, Frederic Bastiat, famously differentiated between that which is seen and that which is not seen. If the government spends money paying people to dig holes or even something fundamentally constructive such as building roads, the jobs "created" by these activities will be that which is seen. What will not be so readily seen are the jobs lost, or not created, because of the hit to the productive segment of the economy. Therefore, the fundamental question is whether central planners in Washington or private businesses and entrepreneurs are more capable of directing economic growth and facilitating job creation. One need only look at the stagnant economies of Europe, or the lessons of the defunct Soviet Union, to see which is to be preferred.

In order to reignite economic growth and job creation, the federal government should pursue policies directly opposite to what the misnamed "stimulus" would achieve: lower marginal tax rates, lower government spending, alleviation from regulatory burdens, and less restrictions on foreign trade. Should the federal government continue on its path of record deficit spending, the likely result will be further economic pain, more job losses, and a prohibitive tax burden on future generations of Americans.

Note: Bastiat's article "What is Seen and What is Not Seen" is available here.