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Archive for the ‘Keynes’ Category

It’s sometimes difficult to make fun of Keynesian economics. But this isn’t because Keynesian theory is airtight.

It’s easy, after all, to mock a school of thought that is predicated on the notion that you can make yourself richer by taking money from your right pocket and putting it in your left pocket.

The problem is that it’s hard to utilize satire when proponents of Keynesian theory say things that are more absurd than anything critics could possibly make up.

Paul Krugman, for example, stated a couple of years ago that it would be good for growth if everyone thought the world was going to be attacked by aliens because that would trigger massive military outlays.

He also asserted recently that a war would be very beneficial to the economy.

Equally bizarre, he really said that the terrorist attacks on the World Trade Center would “do some economic good” because of the subsequent money spent on rebuilding.

And let’s not forget that John Maynard Keynes actually did write that it would be good policy to bury money in the ground so that people would get paid to dig it out.

As you can see, it’s difficult to mock such a strange theory since proponents of Keynesianism already have given us such good material.

But let’s try.

Here’s an amusing satirical image of Ludwig von Mises describing Keynesian economics.

Here’s Paul Krugman doing a Keynesian weather report.

This is the one that got the biggest laugh from me, though I’m chagrined at the misspelling.

Keynesian Fire

Last but not least, here’s an image of a neighborhood that has been the recipient of lots of stimulus. I bet the people are very happy.

Sort of reminds me of this satirical Obama campaign poster.

Let’s close with a few serious observations.

I recently added my two cents to the debate in an article debunking the White House’s attempt to justify the failed 2009 stimulus.

And there’s lots of additional material here, here, and here. My favorite cartoon on Keynesian economics also is worth sharing.

But you’ll probably learn just as much and be more entertained by this video from the Atlas Economic Research Foundation. It looks at the left’s fascination with disaster economics.

And here’s my video debunking Keynesian theory.

I’ll end with a gloomy comment. It’s easy to mock Keynesian economics, but it’s very hard to put a stake through its heart.

How can you kill an idea that tells politicians that their vice – buying votes with other people’s money – is actually a virtue?

P.S. Here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek. And even though it’s not the right time of year, here’s the satirical commercial for Keynesian Christmas carols.

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Early last year, with the sequester about to begin, President Obama stated that “these cuts are not smart, they are not fair, they will hurt our economy, they will add hundreds of thousands of Americans to the unemployment rolls.”

He made this statement because Keynesian theory says government spending can boost “aggregate demand” and goose an economy. So less government spending obviously must be bad for growth.

Then, in October, Obama claimed that the partial government shutdown “inflicted completely unnecessary damage on our economy” and also asserted that, “every analyst out there believes it slowed our growth.”

This statement also was based on the notion that government spending is a form of “stimulus” for economic performance. So anything that slows spending must be a downer for the economy and job creation.

The President had good reasons to worry, at least based on the aforementioned Keynesian perspective. The burden of government spending declined in 2013, both in nominal terms and as a share of economic output.

In other words, the sequester and the partial shutdown did exactly what the President warned about.

So did this mean the economy under-performed? Before we look at the data, I’m going to take a wild guess and predict just the opposite.

Simply stated, you don’t get more growth by expanding the size and scope of government. Here’s what I wrote last year about Keynesian fiscal policy.

Keynesian economics is the perpetual motion machine of the left. You build a model that assumes government spending is good for the economy and you assume that there are zero costs when the government diverts money from the private sector. With that type of model, you then automatically generate predictions that bigger government will “stimulate’ growth and create jobs. Heck, sometimes you even admit that you don’t look at real world numbers. Which perhaps explains why Keynesian economics has a long track record of failure. …The ongoing damage of counterproductive government outlays is much larger and more serious than the transitory costs of redeploying resources when spending is reduced. And overseas borrowing at best creates illusory growth that will be more than offset when the bills come due. Ultimately, the real-world evidence is probably the clincher for most people. As noted above, it’s hard to find a successful example of Keynesian spending.

Now let’s look at some real-world data.

The Wall Street Journal points out that the economy finally experienced some semi-decent growth in 2013, leading the editors to opine that less government leaves more resources in the productive sector of the economy.

Thursday’s news of 3.2% growth in the fourth quarter of 2013 was greeted with cheers and relief. The economy has now grown at 2.5% or faster for three quarters, and the pace in the last six months is the fastest since 2003-2004…The best news is that growth all came from private spending and investment, not the artificial high of unsustainable government spending. The official government contribution to growth was a negative 0.9% due to falling defense outlays and the federal budget sequester. The national-income accounts have a bias that treats government spending as a net contributor to growth even when it’s wasted. Remember how the Keynesians predicted that less spending would mean slower overall growth? Maybe the opposite is true: When government shrinks, the private economy has more money and room to expand.

I obviously agree with these sentiments, but let me augment the passage from the WSJ editorial with a few additional comments.

1. There is a bias in some of the government data. Or, to be more accurate, some data is presented in ways that lead some folks to make sloppy assumptions about government spending contributing to growth. That’s why I prefer looking at how national income is earned (GDI data) rather than how national income is allocated (GDP data).

2. When the burden of government spending shrinks, the economy expands because labor and capital will be used more efficiently. Simply stated, those resources are far more likely to be utilized productively when they’re allocated on the basis of market forces rather than political deal-making.

3. And let’s not forget to add an important caveat that we shouldn’t draw too many conclusions from a quarter or two of data, particularly when there are many factors that determine economic performance.

That being said, there certainly seems to be lots of evidence showing that bigger government is counterproductive and smaller government enhances growth.

We have good evidence, for instance, of nations growing faster when government outlays are constrained, including Canada in the 1990s and the United States during both the Reagan years and Clinton years.

And the Baltic nations imposed genuine spending cuts in recent years and are now doing much better than other European countries that relied on either Keynesian spending or the tax-hike version of austerity.

But if you think those anecdotes are inadequate, you can review some scholarly research on the negative impact of excessive government spending from international bureaucracies such as the Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly persuasive.

Moreover, you can find similar findings in the work of scholars from all over the world, including the United States, Finland, Australia, Sweden, Italy, Portugal, and the United Kingdom.

Let’s close with a couple of encore performances. First here’s my video on Keynesian economics.

And here’s my video on Obama’s failed stimulus.

Hmmm…maybe, just maybe, politicians should obey the Golden Rule.

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Keynesian economics is the perpetual motion machine of the left. You build a model that assumes government spending is good for the economy and you assume that there are zero costs when the government diverts money from the private sector.

With that type of model, you then automatically generate predictions that bigger government will “stimulate’ growth and create jobs. Heck, sometimes you even admit that you don’t look at real world numbers.

Which perhaps explains why Keynesian economics has a long track record of failure. It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Nixon, Ford, and Carter in the 1970s. It didn’t work for Japan in the 1990s. And it hasn’t worked this century for either Bush or Obama.

But politicians love Keynesian theory because it tells them that their vice is a virtue. They’re not buying votes with other people’s money, they’re “stimulating” the economy!

Given this background, you won’t be surprised to learn that Keynesians are now arguing that the recent partial government shutdown hurt growth.

Here’s some of what Standard and Poor’s wrote about that fight and why the shutdown supposedly reduced economic output, along with their warning of economic cataclysm if politicians had been forced to balance the budget in the absence of an increase in the debt ceiling.

…the shutdown has shaved at least 0.6% off of annualized fourth-quarter 2013 GDP growth, or taken $24 billion out of the economy. …the resulting sudden, unplanned contraction of current spending could see government spending cut by about 4% of annualized GDP. That would put the economy in a recession and wipeout much of the economic progress made by the recovery from the Great Recession. …The bottom line is the government shutdown has hurt the U.S. economy.

Part of me wonders whether the bottom line is that S&P was simply looking for an excuse for having made a flawed economic prediction earlier in the year. They basically admit they goofed (though, to be fair, all economists are lousy forecasters), as you can see from this excerpt, but we’re supposed to blame the lower GDP number on insufficient government spending.

In September, we expected 3% annualized growth in the fourth quarter… Since our forecast didn’t hold, we now have to lower our fourth-quarter growth estimate to closer to 2%.

Unsurprisingly, the Obama Administration has been highlighting S&P’s analysis.

A number of private sector analyses have estimated that the shutdown reduced the annualized growth rate of GDP in the fourth quarter by anywhere from 0.2 percentage point (as estimated by JP Morgan) to 0.6 percentage point (as estimated by Standard and Poor’s)… Most of the private sector analyses are based on models that predict the impact of the shutdown based on the reduction in government services over that period.

And the establishment press predictably carried water for the White House, echoing the S&P number. Here’s an example from Time magazine.

The financial services company said the shutdown, which ended with a deal late Wednesday night after 16 days, took $24 billion out of the U.S. economy, and reduced projected fourth-quarter GDP growth from 3 percent to 2.4 percent.

If nothing else, this is a good example of how a number gets concocted and becomes part of the public policy discussion.

Let’s take a step back,however, and analyze whether that $24 billion number has any merit.

The Keynesian interpretation is that the shutdown took money “out of the economy.” According to the theory, money apparently disappears if government doesn’t spend it.

In reality, though, less government spending means that more funds are available in credit markets for private spending. This video explains why Keynesian theory is misguided.

And if you want to dig further into the issue, you can click here for a video that explains why we might get better decisions if policy makers focused on how we earn income rather than how we allocate income.

Now that I’ve shared the basic arguments against Keynesian economics, let me give two caveats.

First, resources don’t get instantaneously reallocated when the burden of government spending is reduced. So I’ve always been willing to admit there could be a few speed bumps as some additional labor and capital get absorbed into the productive sector of the economy.

Second, a nation can artificially enjoy more consumption for a period of time by borrowing from overseas. So if deficit spending is financed to a degree by foreigners, overall spending in the economy will be higher and people will feel more prosperous.

But these caveats aren’t arguments for more spending. The ongoing damage of counterproductive government outlays is much larger and more serious than the transitory costs of redeploying resources when spending is reduced. And overseas borrowing at best creates illusory growth that will be more than offset when the bills come due.

Ultimately, the real-world evidence is probably the clincher for most people. As noted above, it’s hard to find a successful example of Keynesian spending.

Yet we have good evidence of nations growing faster when government outlays are being controlled, including Canada in the 1990s and the United States during both the Reagan years and Clinton years.

And the Baltic nations imposed genuine spending cuts and are now doing much better than other European countries that relied on either Keynesian spending or the tax-hike version of austerity.

P.S. Here’s a funny video on Keynesian Christmas carols. And everyone should watch the famous Hayek v Keynes rap video, as well as its equally clever sequel.

P.P.S. Switching to another topic, we have an encouraging update to the post I wrote last year about an Australian bureaucrat who won a court decision for employment compensation after injuring herself during sex while on an out-of-town trip. Showing some common sense, the Australian High Court just ruled 4-1 to strike down that award.

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President Bush imposed a so-called stimulus plan in 2008 and President Obama imposed an even  bigger “stimulus” in 2009. Based upon the economy’s performance over the past five-plus years, those plans didn’t work.

Japan has spent the past 20-plus years imposing one Keynesian scheme after another, and the net effect is economic stagnation and record debt.

Going back further in time, Presidents Hoover and Roosevelt dramatically increased the burden of government spending, mostly financed with borrowing, and a recession became a Great Depression.

That’s not exactly a successful track record, but Paul Krugman thinks the evidence is on his side and that it’s time to declare victory for Keynesian economics.

Those of us who have spent years arguing against premature fiscal austerity have just had a good two weeks. Academic studies that supposedly justified austerity have lost credibility; hard-liners in the European Commission and elsewhere have softened their rhetoric. The tone of the conversation has definitely changed.

“Victory for us Keynesians. Now we get the cheerleaders!”

But Krugman doesn’t just want to declare victory. He also spikes the football and does a dance in the end zone.

I’m always right while the people who disagree with me are always wrong. And not just wrong, they’re often knaves or fools. …look at the results: again and again, people on the opposite side prove to have used bad logic, bad data, the wrong historical analogies, or all of the above. I’m Krugtron the Invincible!

So why does Krugman feel so confident about his position, notwithstanding the evidence? Veronique de Rugy has a concise and fair assessment of the Keynesian rationale. Simply stated, no matter how bad the results, the Keynesians think the economy would have been in even worse shape in the absence of supposed stimulus.

…the country’s economic performance of the last four or five years can hardly be described has a rousing success for Keynesian economics, at least as implemented by the administration. In fact, measured by the unemployment rate, it hasn’t been a success by the administration’s own standards. To that, Krugman says that the stimulus implemented by the administration wasn’t big enough and, as such, that Keynesian economics hasn’t been tried yet.

Veronique, by the way, points out why this argument is utterly unpersuasive by using the same logic to declare victory for markets.

But by this logic, free-market economics is doing pretty well, too: I think we can all agree that free-market economics wasn’t tried. The economy hasn’t really recovered properly. This must mean free-market economics has won.

But I think the best part of Veronique’s article is the section explaining that not all austerity is created equal. Simply stated, why expect better economic performance if “austerity” means that taxes go up and the burden of government spending stays the same?

Here’s some of what Veronique wrote on this issue.

…austerity, as defined by economists, represents the measures implemented by a government in order to reduce the debt-to-GDP ratio. Unlike Keynesians, I do not think that debt is good for economic growth, but I would prefer the word “austerity” to describe the measures implemented to shrink the size and scope of government… In other words, the important question about austerity has less to do with the size of the austerity package than what type of austerity measures are implemented. …when governments try to reduce the debt by raising taxes, it is likely to result in deep and pronounced recessions, possibly making the fiscal adjustment counterproductive. …austerity measures implemented in Europe are not the kind of austerity we actually need. In fact, the data shows that it has mostly consisted in raising taxes.

Since I’ve repeatedly made these same points, you can understand why I’m a big fan of her analysis.

Moreover, I think this gives us some insight into why Krugman may actually think he has prevailed. Simply stated, he’s comparing Keynesianism to the IMF/European version of austerity.

But that type of “austerity” – as you can see from one of Veronique’s charts – is overwhelmingly comprised of tax hikes.

Yet is anybody surprised that we haven’t seen much – if any – growth in tax-happy nations such as Greece, Portugal, Italy, Ireland, Spain, and the United Kingdom?

What we really need are examples of nations that have reduced the burden of government spending. Then we can compare those results with nations that have tried Keynesianism and nations that have tried tax increases.

Sadly, we only have a few examples of this smaller-government approach. But we get very positive results.

The burden of government spending was reduced during the Reagan years and Clinton years, for instance, and the economy enjoyed good growth in both periods.

Canada was even more aggressive about reducing the size of the state during the 1990s. Their economy also did quite well, notwithstanding Keynesian dogma.

I suspect Keynesians would respond to these examples by asserting it’s okay – at least in theory – to restrain spending if the economy isn’t in recession.*

But then how do they respond to the experience of the Baltic nations? When the financial crisis hit a few years ago, those governments imposed genuine spending cuts and largely avoided the big tax hikes that have plagued other European nations.

Now Estonia, Lithuania, and Latvia are enjoying impressive growth while the nations that raised taxes seem stuck in perpetual recession.**

So let’s recap. When nations try Keynesianism, they get bad result because more government spending isn’t conducive to growth.

When nations raise taxes, they get bad results because you don’t get more growth by penalizing work, saving, investment, and entrepreneurship.

But when nations reduce the burden of government spending and leave more resources in the productive sector, the economy recovers.

Seems like one side can declare victory and spike the football, but it’s not Paul Krugman and the Keynesians.

*I’m guessing one would be hard pressed to find any examples of modern-day Keynesians ever supporting fiscal restraint.

**Krugman tried to undermine the Baltic model of fiscal restraint by attacking Estonia, but wound up with egg on his face.

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Fighting against statism in Washington is a lot like trying to swim upstream. It seems that everything (how to measure spending cuts, how to estimate tax revenue, etc) is rigged to make your job harder.

A timely example is the way the way government puts together data on economic output and the way the media reports these numbers.

Just yesterday, for instance, the government released preliminary numbers for 4th quarter gross domestic product (GDP). The numbers were rather dismal, but that’s not the point.

I’m more concerned with the supposed reason why the numbers were bad. According to Politico, “the fall was largely due to a drop in government spending.” Bloomberg specifically cited a “plunge in defense spending” and the Associated Press warned that “sharp government spending cuts” are the economy’s biggest threat in 2013.

To the uninitiated, I imagine that they read these articles and decide that Paul Krugman is right and that we should have more government spending to boost the economy.

But here’s the problem. GDP numbers only measure how we spend or allocate our national income. It’s a very convoluted indirect way of measuring economic health. Sort of like assessing the status of your household finances by adding together how much you spend on everything from mortgage and groceries to your cable bill and your tab at the local pub.

Wouldn’t it make much more sense to directly measure income? Isn’t the amount of money going into our bank accounts the key variable?

The same principle is true – or should be true – for a country.

That’s why the better variable is gross domestic income (GDI). It measures things such as employee compensation, corporate profits, and small business income.

These numbers are much better gauges of national prosperity, as explained in this Economics 101 video from the Center for Freedom and Prosperity.

The video is more than two years old and it focuses mostly on the misguided notion that consumer spending drives growth, but you’ll see that the analysis also debunks the Keynesian notion that government spending boosts an economy (and if you want more information on Keynesianism, here’s another video you may enjoy).

The main thing to understand is that GDP numbers and the press coverage of that data is silly and misleading. We should be focusing on how to increase national income, not what share of it is being redistributed by politicians.

But that logical approach is not easy when the Congressional Budget Office also is fixated on the Keynesian approach.

Just another example of how the game in Washington is designed to rationalize and enable a bigger burden of government spending.

Addendum: I’m getting ripped by critics for implying that GDP is Keynesian. I think part of the problem is that I originally entitled this post “Making Sense of Keynesian-Laced GDP Reports.” Since GDP data is simply a measure of how national output is allocated, the numbers obviously aren’t “laced” one way of the other. So the new title isn’t as pithy, but it’s more accurate and I hope it will help focus attention on my real point about the importance of figuring out the policies that will lead to more output.

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I’m understandably partial to my video debunking Keynesian economics, and I think this Econ 101 video from the Center for Freedom and Prosperity does a great job of showing why consumer spending is a consequence of growth, not the driver.

But for entertainment value, this very funny video from EconStories.tv puts them to shame while also making important points about what causes economic growth.

The video was produced by John Papola, who was one of the creators of the famous Hayek v Keynes rap video, as well as its equally clever sequel.

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Beginning with the very first policy-oriented post on this blog, I’ve been criticizing Keynesian economics, usually with lots of cheering and support from the GOP. Indeed, more than 98 percent of Republicans in the House and Senate voted against Obama’s so-called stimulus.

They understood – or at least seemed to understand – that you don’t create jobs by diverting money from the private sector so it can be spent by politicians in Washington.

And they have the satisfaction of seeing history justify their votes. Unemployment rose after the faux stimulus was enacted and the joblessness rate has stayed above 8 percent.

But some Republicans are now sounding like born-again Keynesians. They object to the automatic budget savings – known as sequestration – that are scheduled to take effect next year, and they are warning that less government spending means fewer jobs. Here’s a small sampling of their statements.

I would have no objection to these lawmakers arguing against a sequester if they based their concerns on national security, even if I think those concerns are exaggerated.

And I would understand if they objected to a sequester because defense is disproportionately impacted (the Pentagon accounts for only about one-fourth of the budget, yet it absorbs one-half of the sequester).

And I wouldn’t even complain if they claimed that a sequester is painful because of short-term economic dislocation and transition costs. Heck, I even said that might be a legitimate excuse when Mitt Romney said something that sounded suspiciously Keynesian.

But it doesn’t seem like those caveats apply.

Let’s close with some good news and bad news. The good news is that I don’t actually think any of the anti-sequestration lawmakers are genuine Keynesians.

The bad news is that they are genuine politicians, so they think there is nothing wrong with using the coercive power of government to take as much from the rest of the country as possible and redistribute those resources to their states or districts.

They may vaguely understand that big government undermines economic performance, but that’s a secondary concern. They’re main goal is buying votes with other people’s money.

P.S. You can peruse some good cartoons about Keynesian economics by clicking here, here, here, and here.

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I’ve run across very few good cartoons about Keynesian economics. If my aging memory is correct, I’ve only posted two of them.

But at least they’re both very good. We have one involving Obama, sharks, and a lifeboat, and another one involving an overburdened jockey.

Now we have a third cartoon to add to the collection.

To provide a bit of additional background, the cartoon is channeling Bastiat’s broken-window insight that make-work projects don’t create prosperity, as explained in this short video narrated by Tom Palmer.

I make similar points in this post mocking Krugman’s wish for an alien invasion and this post explaining why Obama’s green energy programs lead to net job destruction.

P.S. This Wizard of Id parody is the best cartoon about economics, but it teaches about labor markets rather than Keynesianism.

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With Obama’s dismal record on jobs, there’s a lot of debate about how to improve the employment situation.

I take the pro-market position in this special report on Fox News.

The discussion focuses on the following questions.

In other words, there is no secret to job creation. Just get government out of the way.

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Remember back in 2009, when President Obama and his team told us that we needed to squander $800 billion on a so-called stimulus package.

The crowd in Washington was quite confident that Keynesian spending was going to save the day, even though similar efforts had failed for Hoover and Roosevelt in the 1930s, for Japan in the 1990s, and for Bush in 2008.

Nonetheless, we were assured that Obama’s stimulus was needed to keep unemployment from rising above 8 percent.

Well, that claim turned out to be quite hollow. Not that we needed additional evidence, but the new numbers from the Labor Department re-confirm that the White House prediction was wildly inaccurate. The 8.2 percent unemployment rate is 2.5 percentage points above the Administration’s prediction.

Defenders of the Obama Administration sometimes respond by saying that the downturn was more serious than anyone predicted. That’s a legitimate assertion, so I don’t put too much blame the White House for the initial spike in joblessness.

But I do blame them for the fact that the labor market has remained weak for a lengthy period. This chart, which I just generated this morning on the Minneapolis Fed’s interactive website, shows employment data for all the post-World War II recessions.

The current business cycle is the red line. As you can see, some recessions were deeper in the beginning and some were more mild. But the one thing that is unambiguous is that we’ve never had a jobs recovery as anemic as the one we’re experiencing today.

Job creation has been extraordinarily weak. Indeed, the 8.2 percent unemployment rate actually masks the bad news since it doesn’t capture all the people who have given up and dropped out of the labor force.

By the way, I don’t think the so-called stimulus is the main cause of today’s poor employment data. The vast majority of that money was pissed away in 2009, 2010, and 2011.

Today’s weak job market is affected by things such as the threat of higher taxes in 2013 (when the 2001 and 2003 tax cuts are scheduled to expire), the costly impact of Obamacare, and the harsh regulatory environment. This cartoon shows, in an amusing fashion, the impact of these policies on entrepreneurs and investors.

P.S. Click on this link if you want to compare Obamanomics and Reaganomics. The difference is astounding.

P.P.S. Obama will probably continue to blame “headwinds” for the dismal job numbers, so this cartoon is definitely worth sharing.

P.P.P.S. Since I’m sharing cartoons, I can’t resist recycling this classic about Keynesian stimulus.

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It seems that any argument about the economy eventually boils down to the core issue of whether government spending acts as a stimulus or whether it is – in the words of Thomas Sowell – a sedative that undermines prosperity.

So when Robert Reich and I went on Erin Burnett’s CNN show to discuss Obama’s stumbling economic performance, much of our discussion focused on whether to further expand the burden of the public sector.

Here are a couple of observations about the interview.

  1. Reich admitted that spending is a problem and in the “long term” needs to be reduced. I suspect “long term” never arrives in Reich’s world, but this is nonetheless a startling concession on his part.
  2. Reich claimed World War II was an example of successful Keynesian stimulus, but if he wants to make that argument, then he needs to explain why we didn’t fall back into the Great Depression after the war – which is what all the Keynesians warned would happen.
  3. For reasons outlined in my beat-down of Krugman, I’ve become a cheerleader for Estonia and used the interview to promote that country’s fiscal restraint.

If you want to understand more about Keynesian economics and why it doesn’t work, this video will be more instructive than my food fight with Reich.

P.S. Obama is monotonously repetitive in his claim that the economy is facing headwinds. As this Ramirez cartoon illustrates, he’s right, but not in the way he thinks.

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Writing in today’s Washington Post, former Obama economist Larry Summers put forth the strange hypothesis that more red ink would improve the federal government’s long-run fiscal position.

This sounds like an excuse for more Keynesian spending as part of another so-called stimulus plan, but Summers claims to have a much more modest goal of prudent financial management.

And if we assume there’s no hidden agenda, what he’s proposing isn’t unreasonable.

But before floating his idea, Summers starts with some skepticism about more easy-money policy from the Fed.

Many in the United States and Europe are arguing for further quantitative easing to bring down longer-term interest rates. …However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative rate. There is also the question of whether extremely low, safe, real interest rates promote bubbles of various kinds.

This is intuitively appealing. I try to stay away from monetary policy issues, but whenever I get sucked into a discussion with an advocate of easy money/quantitative easing, I always ask for a common-sense explanation of how dumping more liquidity into the economy is going to help.

Maybe it’s possible to push interest rates even lower, but it certainly doesn’t seem like there’s any evidence showing that the economy is being held back because today’s interest rates are too high.

Moreover, what’s the point of “pushing on a string” with easy money if it just means more reserves sitting at the Fed?

After suggesting that monetary policy isn’t the answer, Summers then proposes to utilize government borrowing. But he’s proposing more debt for management purposes, not Keynesian stimulus.

Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position, even assuming no positive demand stimulus effects of a kind likely to materialize with negative real rates. They should accelerate any necessary maintenance projects — issuing debt leaves the state richer not poorer, assuming that maintenance costs rise at or above the general inflation rate. …Similarly, government decisions to issue debt, and then buy space that is currently being leased, will improve the government’s financial position as long as the interest rate on debt is less than the ratio of rents to building values — a condition almost certain to be met in a world with government borrowing rates below 2 percent. These examples are the place to begin because they involve what is in effect an arbitrage, whereby the government uses its credit to deliver essentially the same bundle of services at a lower cost. …countries regarded as havens that can borrow long term at a very low cost should be rushing to take advantage of the opportunity.

Much of this seems reasonable, sort of like a homeowner taking advantage of low interest rates to refinance a mortgage.

But before embracing this idea, we have to move from the dream world of theory to the real world of politics. And to his credit, Summers offers the critical caveat that his idea only makes sense if politicians use their borrowing authority for the right reasons.

There is, of course, still the question of whether more borrowing will increase anxiety about a government’s creditworthiness. It should not, as long as the proceeds of borrowing are used either to reduce future spending or raise future incomes.

At the risk of being the wet-blanket curmudgeon who ruins the party by removing the punch bowl, I have zero faith that politicians would make sound decisions about financial management.

I wrote last month that eurobonds would be “the fiscal version of co-signing a loan for your unemployed alcoholic cousin who has a gambling addiction.”

Well, giving politicians more borrowing authority in hopes they’ll do a bit of prudent refinancing is akin to giving a bunch of money to your drug-addict brother-in-law in hopes that he’ll refinance his credit card debt rather than wind up in a crack house.

Considering that we just saw big bipartisan votes to expand the Export-Import Bank’s corporate welfare and we’re now witnessing both parties working on a bloated farm bill, good luck with that.

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With both France and Greece deciding to jump out of the left-wing frying pan into the even-more-left-wing fire, European fiscal policy has become quite a controversial topic.

But I find this debate and discussion rather tedious and unrewarding, largely because it pits advocates of Keynesian spending (the so-called “growth” camp) against supporters of higher taxes (the “austerity” camp).

Since I’m a big fan of nations lowering taxes and reducing the burden of government spending, I would like to see the pro-tax hike and the pro-spending sides both lose (wasn’t that Kissinger’s attitude about the Iran-Iraq war?). Indeed, this is why I put together this matrix, to show that there is an alternative approach.

One of my many frustrations with this debate (Veronique de Rugy is similarly irritated) is that many observers make the absurd claim that Europe has implemented “spending cuts” and that this approach hasn’t worked.

Here is what Prof. Krugman just wrote about France.

The French are revolting. …Mr. Hollande’s victory means the end of “Merkozy,” the Franco-German axis that has enforced the austerity regime of the past two years. This would be a “dangerous” development if that strategy were working, or even had a reasonable chance of working. But it isn’t and doesn’t; it’s time to move on. …What’s wrong with the prescription of spending cuts as the remedy for Europe’s ills? One answer is that the confidence fairy doesn’t exist — that is, claims that slashing government spending would somehow encourage consumers and businesses to spend more have been overwhelmingly refuted by the experience of the past two years. So spending cuts in a depressed economy just make the depression deeper.

And he’s made similar assertions about the United Kingdom, complaining that, “the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback.”

So let’s take a look at the actual data and see how much “slashing” has been implemented in France and the United Kingdom. Here’s a chart with the latest data from the European Union.

I’m not sure how Krugman defines austerity, but it certainly doesn’t look like there’s been a lot of “slashing” in these two nations.

To be fair, government spending in the United Kingdom has grown a bit slower than inflation in the past couple of years, so one could say that there’s been a very modest bit of trimming.

There’s been no fiscal restraint in France, however, even if one uses that more relaxed definition of a cut. The only accurate claim that can be made about France is that the burden of government spending hasn’t been growing quite as fast since the crisis began as it was growing in the preceding years.

This doesn’t mean there haven’t been any spending cuts in Europe. The Greek and Spanish governments actually cut spending in 2010 and 2011, and Portugal reduced outlays in 2011.

But you can see from this chart, which looks at all the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), that the spending cuts have been very modest, and only came after years of profligacy. Indeed, Greece is the only nation to actually cut spending over the 3-year period since the crisis began.

Krugman would argue, of course, that the PIIGS are suffering because of the spending cuts. And since there actually have been spending cuts in the last year or two in these nations, does that justify his claims?

Yes and no. I don’t agree with the Keynesian theory, but that doesn’t mean it is easy or painless to shrink the burden of government. As I wrote earlier this year, “…the economy does hit a short-run speed bump when the public sector is pruned. Simply stated, there will be transitional costs when the burden of public spending is reduced. Only in economics textbooks is it possible to seamlessly and immediately reallocate resources.”

What I would argue, though, is that these nations have no choice but to bite the bullet and reduce the burden of government. The only other alternative is to somehow convince taxpayers in other nations to make the debt bubble even bigger with more bailouts and transfers. But that just makes the eventual day of reckoning that much more painful.

Additionally, I think much of the economic pain in these nations is the result of the large tax increases that have been imposed, including higher income tax rates, higher value-added taxes, and various other levies that reduce the incentive to engage in productive behavior.

So what’s the best path going forward? The best approach is to implement deep and meaningful spending cuts, and I think the Baltic nations of Estonia, Lithuania, and Latvia are positive role models in this regard. Let’s look at what they’ve done in recent years.

As you can see from the chart, the burden of government spending was rising at a reckless rate before the crisis. But once the crisis hit, the Baltic nations hit the brakes and imposed genuine spending cuts.

The Baltic nations went through a rough patch when this happened, particularly since they also had their versions of a real estate bubble. But, as I’ve already argued, I think the “cold turkey” or “take the band-aid off quickly” approach has paid dividends.

The key question is whether nations can maintain spending restraint, particularly when (if?) the economy begins to grow again.

Even a basket case like Greece can put itself on a good path if it follows Mitchell’s Golden Rule and simply makes sure that government spending, in the long run, grows slower than the private economy.

The way to make that happen is to implement something similar to the Swiss Debt Brake, which effectively acts as an annual cap on the growth of government.

In the long run, of course, the goal should be to shrink the overall burden of government to its growth-maximizing level.

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There’s an old saying that insanity is doing the same thing over and over again while expecting different results. This certainly is a good description of Keynesians, who relentlessly push more government spending as some sort of magic potion for the economy – notwithstanding a record of failure.

The latest example if Larry Summers, the former economist for the Obama White House, who says Europeans need to make government bigger.

Here is some of what he writes for today’s Washington Post.

European efforts to contain crisis have fallen short. …Much of what is being urged on and in Europe is likely to be not just ineffective but counterproductive to maintaining the monetary union, restoring normal financial conditions and government access to markets, and reestablishing economic growth. The premise of European policymaking is that countries are overindebted and so unable to access markets on reasonable terms, and that the high interest rates associated with excessive debt hurt the financial system and inhibit growth. The strategy is to provide financing while insisting on austerity, in hopes that countries can rein in their excessive spending enough to restore credibility, bring down interest rates and restart economic growth.

The good news is that Summers recognizes that there has been “excessive spending.” The bad news is that he uses the wrong definition of austerity.

Many European nations seem to think higher taxes are a sign of fiscal conservatism (see this post by Veronique de Rugy for a good discussion of this confusion). Summers accepts that approach, and says that policy makers should choose a Keynesian policy instead.

Unfortunately, Europe has misdiagnosed its problems in important respects and set the wrong strategic course. …Europe’s problem countries are in trouble because the financial crisis underway since 2008 has damaged their financial systems and led to a collapse in growth. High deficits are much more a symptom than a cause of their problems. And treating symptoms rather than underlying causes is usually a good way to make a patient worse. …The right focus for Europe is on growth; in this dimension, increased austerity is a step in the wrong direction.

There’s more good news. Summers is right in stating that Europe suffers from low growth. And I agree with him that the European version of austerity – higher taxes – is not a solution.

But, as always, there is a catch. Summers has the wrong approach on how to encourage growth. He wants Keynesian spending, and here is his defense.

 Skeptics will rightly wonder how a prescription for more spending by countries that already have trouble borrowing can be correct. The answer lies in the difference between borrowing by individuals and countries. Normally, an individual helps his creditors by borrowing less; but a person who stops borrowing to finance commuting to his job does his creditors no favor. A country’s income is determined by spending, so a country that pursues austerity to the point where its economy is driven into a downward spiral does its creditors no favor.

Sounds semi-reasonable. After all, everyone understands that it is important to get to their place of employment. Sometimes you spend money to make money.

But here’s the problem. Can anyone name anything in so-called stimulus schemes that actually increase a nation’s productive capacity? As we saw with Obama’s failed stimulus, lots of money gets distributed, but the main purpose seems to be buying votes and creating dependency.

What about jobs? A miserable failure.

Adding insult to injury, you probably won’t be surprised to learn that American taxpayers are supposed to pick up the lion’s share of the tab for the new spending in Europe since Summers wants the IMF to be the sugar daddy.

Going forward, the IMF and international community should condition further support not merely on individual countries’ actions but on a common European commitment to growth.

This approach is illogical, as explained in this video.

And let’s consider the historical record. Nations that have tried this type of “stimulus” have not fared well. Big spending increase under Hoover and Roosevelt failed in the 1930s. Japan tried several Keynesian packages and failed in the 1990s. Bush failed in 2008 and Obama failed in 2009.

Germany did not go with a big program of government spending, and they did better than the United States. The same is true about Canada. But the real success story is the Baltic nations. They imposed real spending restraint, not the fake austerity found in places such as the United Kingdom.

And even though it caused some short-term pain since there’s a short-term cost when labor and capital get redeployed to more productive uses, the Baltic nations are now in much better shape that the European nations that have floundered because they limited themselves to the no-win choice of Keynesianism and tax hikes.

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President Obama imposed a big-spending faux stimulus program on the economy back in 2009, claiming that the government needed to squander about $800 billion to keep the unemployment rate from rising above 8 percent.

How did that work out? One possible description is that the so-called stimulus became a festering pile of manure. About three years have passed, and the joblessness rate hasn’t dropped below 8 percent. But the White House has been sprinkling perfume on that pile of you-know-what and claiming that the Keynesian spending binge was good policy.

But not every politician is blindly ideological like Obama. Vitor Gaspar, Portugal’s Finance Minister, is willing to admit error. Here are some relevant excerpts from a New York Times report.

Unlike Obama, willing to admit mistakes

Mr. Gaspar, speaking to The New York Times last week, has a message for observers who say Europe needs to substantially relax its austerity approach: We tried stimulus and it backfired. Like some other European countries, Portugal tried what Mr. Gaspar called “a Keynesian style expansion” in 2008, referring to a theory by economist John Maynard Keynes. But it didn’t turn things around, and may have made things worse.

Why does the Portuguese Finance Minister have this view? Well, for the simple reason that the economy got worse and more spending put his country in a deeper fiscal ditch.

The yield on Portuguese government bonds – more than 11 percent on longer-term bonds — is substantially higher than the yields on debt issued by Ireland, Spain or Italy. …The main fear among investors is that Portugal is going to have to ask for a second bailout from the International Monetary Fund and the European Union, which committed $103 billion of financial aid in 2011.

Maybe the big spenders in Portugal should import some of the statist bureaucrats at Congressional Budget Office. The CBO folks could then regurgitate the moving-goalposts argument that they’ve used in the United States and claim that the economy would be even weaker if the government hadn’t wasted more money.

But perhaps the Portuguese left doesn’t think that will pass the laugh test.

Amazingly, the Germans, who have a disturbing affinity for powerful government, decided against Keynesianism and that’s paid dividends for their economy.

In any event, some of us can say we were right from the beginning about this issue.

Not that being right required any keen insight. Keynesian policies failed for Hoover and Roosevelt in the 1930s. So-called stimulus policies also failed for Japan in 1990s. And Keynesian proposals failed for Bush in 2001 and 2008.

Just in case any politicians are reading this post, I’ll make a point that normally goes without saying: Borrowing money from one group of people and giving it to another group of people does not increase prosperity.

But since politicians probably aren’t capable of dealing with a substantive argument, let’s keep it simple and offer three very insightful cartoons: here, here, and here.

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I realize the title of this post sounds like the beginning of a joke, along the lines of “A priest, a minister, and a rabbi walk into a bar…”, but this is a serious topic.

A big problem in fiscal debates is that people can’t even agree on what they mean by certain words. For instance, what’s the definition of austerity? Is it budget cuts, higher taxes, or both? Why are people saying the United Kingdom is practicing austerity, when the burden of government spending is going up?

Or how do we define responsible fiscal policy? Should politicians try to balance budgets, or should they shrink the burden of government? Is it reasonable for some people to call Obama a conservative because he wants higher taxes and claims the money would be used to reduce red ink?

I grapple with some of these questions in this appearance on Fox Business News.

But I’m not happy with my performance, largely because there needs to be a simple way of categorizing the various approaches to fiscal policy. So that’s what I’ve done in this Table. This is a first draft, so I welcome suggestions.

I’m serious about looking for input, For instance, I would like to come up with some way to describe Bushonomics without sullying the name of supply-side economics.

But perhaps I am just sensitive to that issue because supply-side economists tend to be serious and sober people who favor smaller government, but some of the politicians associated with supply-side economics – such as Jack Kemp – have been unapologetic big spenders.

I’m also unhappy with the division between IMFers and Keynesians, which is strange because it seems like half of my time is devoted to battling statists who argue for more government spending and the other half is consumed by fights against proponents of higher taxes.

What makes this so frustrating, though, is that Keynesians and IMFers are usually the same people, even though the philosophies are supposedly inconsistent.

I suspect that all they really want is bigger government, and they use any sign of weakness to argue for more spending, and then they quickly pivot and ask for higher taxes because of red ink. The biased analysis of the Congressional Budget Office is a good example.

The right approach, needless to say, is libertarianism. Small government and low tax rates are the pro-growth, pro-freedom recipe. That’s the one part of the Table that’s right on the mark.

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What is it about Mitt Romney? The United States desperately needs smaller government, lower taxes, and less intervention, yet his comments and track record on issues such as the  value-added tax, healthcare, Social Security reform, budget savings, ethanol subsidies, and the minimum wage leave a lot to be desired.

We can now add something else to the list. The former Massachusetts governor has come out of the closet as a Keynesian.

This is worrisome, particularly since he is speaking extemporaneously and thus more likely to be letting us see his real views.

To be fair, Romney’s statement doesn’t automatically make him a big-spending Keynesian. Even I have written that, in the short run, “there will be transitional costs when the burden of public spending is reduced.”

But when I say something like that, it is also in the context of explaining the myriad ways that the economy benefits when a bloated public sector is pared back.

And I like to think that I’m second to none in disseminating the medium-term and long-term advantages of less government.

Mitt Romney, needless to say, doesn’t seem to fully share those views.

For more information on this issue, here’s my take on Keynesianism.

I made a snarky comment in a previous post that, “If the answer is bigger government, you’ve asked a very strange question.” I’m worried, though, that Romney doesn’t think that’s a joke.

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Demonstrating that he’s probably not a fan of Mitchell’s Golden Rule, Paul Krugman recently asserted that fiscal austerity has failed in the United Kingdom.

Citing Keynesian theory and weak economics numbers, he warned about “the austerity doctrine that has dominated elite policy discussion” and says that the British government made a mistake when it decided to “slash spending.”

In support of the New York Times columnist, another blogger commented on the “sharp retrenchment in public spending” in the U.K. And a Bloomberg editorial also supported Krugman’s position, stating that recent events “undermine the conservative idea that slashing government spending will somehow bring about a confidence-driven economic boom.”

There’s only one small, itsy-bitsy, teeny-weeny problem with all of these statements. They’re based on a falsehood. Government spending in the United Kingdom has not been slashed. It hasn’t been retrenched. It hasn’t even been cut.

I first made this point back in 2010. And I also noted that year that the supposedly conservative Chancellor of the Exchequer advocated a big increase in the value-added tax was good since it would generate “13 billion pounds we don’t have to find from extra spending cuts.”

I then repeated myself last year, pointing out once again that government spending was expanding rather than shrinking.

To be fair, spending hasn’t been growing as fast in the past couple of years as it did last decade. According to European Union data, government spending in the United Kingdom grew by an average of 7.6 percent each year between 2000-2008, so the recent annual increases of 2 percent-4 percent may seem frugal by comparison.

But at the risk of stating the obvious, slower spending increases are not budget cuts. Unless, of course, proponents of big government decide to use the dishonest political definition that spending is cut when the budget doesn’t increase as fast as previously planned. But if that’s the case, then they are turning Keynesian economics into a political gimmick.

Not only haven’t there been any spending cuts in recent years, but it also appears that there won’t be any in future years. The Centre for Policy Studies just put out a report comparing “austerity” in the United Kingdom today with the fiscal discipline that took place in Canada during the 1990s.

As seen in the table, and as I noted in a previous post, Canada actually reduced spending.

In the United Kingdom, by contrast, spending has been climbing. And that’s projected to happen even in future years.

To be sure, spending in the U.K. won’t grow very fast (assuming the government sticks to its plans, which may be an unrealistic assumption).

But spending that grows slowly is not austerity or retrenchment.

Which is unfortunate, because that’s precisely what is needed in the United Kingdom. And the Canadian experience shows how genuine fiscal restraint generates big benefits.

Let’s also look at some more information from the CPS report.

The Canada of 1994 in many ways resembled the Greece of today. …Spending was to fall 8.8% over two years. Large cuts in transportation, industry, regional development, and scientific support were made. The size of the federal government was to decline from 16.2% of GDP in 1994 to 13.1% in 1996. Public-sector employment was to fall by 14%. The new discipline paid off quickly. Federal government spending as a share of the economy fell more rapidly than planned. Provincial government spending also decreased significantly from 25% of GDP to 20%. …Ottawa offered a historic deal to the provincial governments: unprecedented freedom to make their own welfare policies. This was localism in action – and it unleashed a wave of fruitful experimentation and innovation in the provinces, while spending was cut at the national level. The results were stunning. Large numbers of Canadians, previously trapped in poorly designed benefit programmes, returned to the workforce. By 2000, the number of welfare beneficiaries in Canada had declined by more than a million people, from 10.7% in 1994 of the population to 5.1% in 2009. …Cuts  ranged  from  5%  to 65% of departmental budgets and included cuts to health budgets. In the end, programme spending (everything except interest payments on the debt) fell by 9.7% in nominal terms (or C$11.9 billion) between 1994-95 and 1996-97.

So what were the results of this fiscal discipline? Let’s go back to the report.

Fast-forward again to 2007, and Canada seemed to be back on track. The country’s economy grew at an average rate of 3.3% between 1997 and 2007, the highest average growth among the G-7 countries, including the US. Canada’s job-creation record was nothing short of stellar. From 1997 to 2007, Canada’s average employment growth was 2.1%, doubling that of the US and exceeding employment growth in all other G-7 countries. Perhaps most importantly for future economic prosperity, during the same period Canada outperformed the G-7 average almost every year on business investment. …Canada weathered the recent recession  better than its G-7 partners. … None of Canada’s major financial institutions had to be bailed out

And this also was a period of tax cuts.

…coupled with stronger economic performance than expected, meant Ottawa could then cut taxes, including personal and corporate income taxes, capital gains taxes, and the corporate capital tax. In this period:

  • Corporate Income Tax (federal) was reduced from 28% to 21% with further cuts planned;
  • Capital Gains Tax were reduced to 14.5%;
  • Personal Income Tax rates were finally indexed to inflation;
  • Federal capital taxes were abolished.

It certainly seems that genuine fiscal restraint worked in Canada.

To be fair, though, Krugman isn’t arguing against small government in his column. He’s arguing for short-run Keynesian stimulus policy. And it’s possible to be in favor of more spending in the short run and smaller government in the long run.

Moreover, I’m not arguing that genuine spending cuts are immediately expansionary, as some research has indicated. I’m sure that happens in some cases, but it’s not a hard and fast rule.

And I imagine that there are cases where the economy does hit a short-run speed bump when the public sector is pruned. Simply stated, there will be transitional costs when the burden of public spending is reduced. Only in economics textbooks is it possible to seamlessly and immediately reallocate resources.

My argument is that the short-term impact of spending restraint – whether positive or negative – is trivial compared to the long-run benefits of better fiscal policy. A small public sector means labor and capital get used more productively, and it presumably also allows a less punitive tax system.

This video has more information about Canada’s fiscal policy success, along with data about similar episodes of genuine austerity (properly defined) in Ireland, Slovakia, and New Zealand.

Even the United States has enjoyed periods of semi-impressive fiscal discipline, most notably during the Reagan and Clinton years. Unfortunately, the modest progress achieved during those periods has been wiped out by the profligacy of the Bush-Obama years.

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People often ask why I put so much political humor on this site. The easy answer is that I like a good joke.

But I also find that some cartoons and jokes do a very good job of helping people understand economics. I’ve always liked this cartoon, for instance, because it cleverly illustrates the impact of government handouts on the labor market. And looking at that cartoon is a lot quicker than taking a class about labor economics.

Well, you can also skip the class about public finance. Here’s a cartoon that shows the economic burden of government “stimulus” spending.

Very funny and very intellectually sound. Indeed, the only thing that would have made the cartoon even better would have been showing that the jockey became bloated by eating the horse’s food. But I reckon it’s not easy making multiple points with one picture.

Anyhow, I’m disappointed that I didn’t notice it at Reason.com a couple of years ago when the debate on the faux stimulus was taking place. It probably would have helped more people understand that you don’t boost economic performance by draining resources from the productive sector of the economy to finance a larger government.

By the way, if you want to understand in greater detail why the cartoon is accurate, this video on Keynesian economics is helpful, as is this video explaining the failure of Obama’s $1 trillion boondoggle.

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Much of the “stimulus” debate has revolved around macroeconomic issues. Obama squandered about $800 billion, supposedly to “jolt” the economy, but growth has been anemic and the employment situation has been miserable.

But it’s equally instructive to look at the microeconomic impact. And that’s exactly what the folks at Reason TV did with this expose of how money was wasted in a suburb of Washington, DC.

While the video is a damning indictment of how the faux stimulus failed, it actually is too generous in its analysis.

It looks at how much money was misallocated in Silver Spring, MD, and shows how few jobs were created, but it also should have asked what would have happened if the so-called stimulus never happened and the $800 billion was left in the productive sector of the economy.

In other words, As I wrote back in September, how much stronger would the economy be if the government had not diverted all that money to Washington?

..to paraphrase Bastiat, we want to look not only as the “seen” of government spending, but we also want to look at the “unseen” of how the money otherwise would have been allocated. What modern economists sometimes refer to as the “opportunity cost” …The relevant question, from an economic perspective, is whether the government can utilize resources more efficiently and productively than the private sector. Needless to say, there are not many types of government spending that meet this test.

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By fighting for freedom in Washington, I’ve condemned myself to a life of frustration and aggravation. One of my many pet peeves is that so many people in DC believe that economic growth depends on consumer spending.

Back in the early days of this blog, I wrote the following.

Many people assume that consumer spending drives growth because it is roughly two thirds of the economy. But this puts the cart before the horse. Higher levels of consumer spending do not cause prosperity. Instead, more consumer spending is best understood as a symptom of prosperity.

So you can imagine how irritating it is for me to see news reports about how Black Friday spending will goose the economy.

This video debunks this notion, while also explaining that Keynesian economics is flawed because it misinterprets the role of consumer spending.

If you like this video, also check out this video on IRS complexity.

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Last week in New York City, during my Intelligence Squared debate about stimulus, I pointed out that Germany is doing better than the United States and explained that they largely avoided any Bush/Obama Keynesian spending binges.

One of my opponents disagreed and asserted that I was wrong. Germany, this person argued, was dong better because it was more Keynesian thanks to “automatic stabilizers” that resulted in big spending increases.

This claim was made with such certainty that I wondered if I made a mistake.

Well, we were both right about Germany doing better. In the past few years, it has been enjoying yearly growth of about 3.5 percent while growth in the United States has remained below 3 percent.

But who was right about the key issue of whether Germany has been more Keynesian? At first, I was going to be lazy and not bother combing the data. But then I got motivated after reading an excellent post about Germany’s pro-growth reforms, written for National Review by Veronique de Rugy of the Mercatus Center.

So I looked up the data on annual government spending in the United States and Germany and discovered that I was right (gee, what a shock). As the chart shows, the burden of government spending has increased faster in the United States. And that is true whether 2007 or 2008 is used as the base year.

To make sure the comparison was fair, I sliced the numbers every possible way. But the results were the same, regardless of whether state and local government spending was included, whether TARP spending was included, which base year was selected, or whether I used annual spending increases or multi-year spending increases.

In every single case, the burden of government spending grew faster in the United States from 2007 to 2011.

This does not mean Germany is a role model. Government spending in Germany is far too high and it continues to grow. All we can say is that Germany is not going in the wrong direction as fast as the United States.

Oh, I suppose we also can say that I was right and my opponent was wrong. The United States has been more Keynesian than Germany.

Speaking of Germany, I combed my archives and found only one post that said anything nice about German politicians.

My other German posts mocked the country’s scheme to tax prostitutes, mocked the government for losing the blueprints for its new spy headquarters, mocked the government for a money-losing scheme to tax coffee, and even mocked the supposedly conservative Chancellor for wanting to impose new taxes.

So even though Veronique is correct about some positive changes, the Germans have a long way to go.

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I’ve criticized the Congressional Budget Office for generating biased and inaccurate numbers. These are the clowns, after all, who say deficit spending stimulates the economy in the short run but they also rely on a model which seemingly predicts 100 percent tax rates maximize growth in the long run.

About the only nice thing that can be said about this collection of bureaucrats is that they’re consistent, though I’m not sure being wrong all the time is something to brag about – especially when even cartoonists start to make fun of CBO’s flawed approach.

This is why I’ve argued it may be best to shut down CBO, and also written that – at a minimum – sweeping reform of the Capitol Hill bureaucracy is a test of GOP seriousness.

I’m not alone in my disdain for CBO. In a column for The Hill, Veronique de Rugy of the Mercatus Center makes two excellent points about the Congressional Budget Office: 1) the general inability of economists to predict (we’d be rich if we knew how to do that) and 2) the use of inaccurate models.

The CBO’s consistently flawed scoring of the cost of bills is used by Congress to justify legislation that rarely performs as promised and drags down the economy. Whether it scores the recent healthcare bill or the cost of the Capitol Hill Visitor Center, an ambitious three-floor underground facility, the price for taxpayers always ends up larger than originally predicted. …Like many economists, its analysts suffer from a misplaced belief in their forecasting prowess. …CBO relies heavily on Keynesian economic models, like the ones it used during the stimulus debate. Forecasters at the agency predicted the stimulus package would create more than 3 million jobs. …But unemployment stubbornly remained around 10 percent. What was wrong with the CBO’s numbers? …the stimulus and the ACA should serve as yet more evidence that Congress should take budget scores and economic projections with a grain of salt. What looks good in the spirit world of the computer model may be very bad in the material realm of real life because people react to changes in policies in ways unaccounted for in these models.

Let’s now move from the general to the specific. Peter Suderman reports from Reason on new research suggesting that costs for just one provision of Obamacare may be far higher than predicted by the jokers at CBO.

The Congressional Budget Office’s official cost estimate for last year’s health care overhaul projected that the law would cost a little less than $950 billion over its first decade. About half of that cost came from the law’s Medicaid expansion, which was projected to enroll 16 million new individuals in the joint federal-state health care program for the poor and disabled. But researchers at Harvard University are now warning that policymakers should be prepared for substantial uncertainty about the true enrollment effects of the Medicaid expansion. In a paper published in the journal Health Affairs earlier this week, a team of health economists estimated that, under the law, new Medicaid enrollment could be as low as 8.5 million people, but also as high as 22.4 million people—with additional costs to match…meaning that a full decade of the Medicaid expansion alone could end up costing nearly $1 trillion—more than the entire law was supposed to cost in its first ten year out of the gate.

The article does note that it’s possible that costs also might be lower than forecast, but Peter explains why the upper-bound estimate is more likely to be accurate because the law creates perverse incentives.

Indeed, CBO’s failure to recognize that new programs will lure people into greater dependency is one of the biggest reasons that the bureaucracy routinely under-estimates the cost of new programs. This is a point I stressed in my video explaining why Obamacare will be far more costly than CBO predicted.

Heck, even CBO is beginning to acknowledge that Obamacare will be more expensive than forecast, and most of the legislation hasn’t even been implemented.

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Professor Allan Meltzer of Carnegie Mellon University has a must-read column in today’s Wall Street Journal, beginning with what should be an obvious statement.

Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.

He then asks a rather important question.

Why is the economic response to increased government spending so different from the response predicted by Keynesian models?

He gives four reasons, beginning with the threat of higher taxes.

First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing.

I especially like how he highlights Obama’s actions, which clearly show the link between more spending and more taxes. I also would have added the European fiscal crisis, which has made more people aware of the negative long-run consequences of excessive government.

He then lists the negative impact of having the government distort the allocation of resources, a point that is music to my ears.

Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment.

He then discusses the impact of red tape, a point which I’ve never addressed, but obviously is very important if politicians use Keynesian spending as an excuse for expanding the scope of government as well as the size of government.

Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy. Who can guess the size of the cost increases required by these programs? ObamaCare is not the only source of this uncertainty, though it makes a large contribution.

He then dings the short-term mentality of Keynesians.

Fourth, U.S. fiscal and monetary policies are mainly directed at getting a near-term result. The estimated cost of new jobs in President Obama’s latest jobs bill is at least $200,000 per job, based on administration estimates of the number of jobs and their cost. How can that appeal to the taxpayers who will pay those costs? Once the subsidies end, the jobs disappear—but the bonds that financed them remain and must be serviced. These medium and long-term effects are ignored in Keynesian models.

The only thing I would change about this argument is that he also could have explained that so-called stimulus spending actually destroys jobs, on net, when you also measure the loss of private-sector jobs that takes place when government diverts resources from the productive sector of the economy.

A minor oversight, though, in a blistering indictment of Keynesian economics. Heck, Prof. Meltzer should have taken my place at the NYC debate on stimulus.  I suspect, however, that the crowd would have been reached the wrong conclusion even if the ghosts of Milton Friedman and Friedrich Hayek has been resuscitated for the event (yes, I’m still sulking).

In addition to explaining why Keynesian economics does not work, Prof. Meltzer also outlines the policies that should be implemented.

Clearly, a more effective economic policy would aim at restoring the long-term growth rate by reducing uncertainty and restoring investor and consumer confidence. Here are four proposals to help get us there: First, Congress and the administration should agree on a 10-year program of government spending cuts to reduce the deficit. The Ryan and Simpson-Bowles budget proposals are a constructive start. (Note to Republican presidential candidates: Permanent tax reduction can only be achieved by reducing government spending.) Second, reduce corporate tax rates and expense capital investment by closing loopholes. Third, announce a five-year moratorium on new regulations. Fourth, adopt an enforceable 0%-2% inflation target to allay fears of future high inflation.

These are all good ideas, though I would have written that we need a “10-year program of government spending cuts” rather than saying  we need “10-year program of government spending cuts to reduce the deficit.”

After all, the federal government is too big, and the damage to the economy would still exist even if the deficit disappeared because $1 trillion of new revenue magically floated down from heaven.

The problem is spending. That’s the fiscal disease facing America. Deficits and debt are just symptoms of that disease.

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Folks of a certain age, who watched ABC’s Wide World of Sports, will remember the phrase “the agony of defeat.”

Well, that’s what Richard Epstein and I endured Tuesday night at the Intelligence Squared debate in New York City.

We were battling against two Keynesians, Mark Zandi and Cecilia Rouse, in hopes of convincing the audience to reject the proposition that “Congress should pass Obama’s jobs plan.”

The good news is that only 16 percent of the audience were on our side before the debate, and we managed to push that number up to 22 percent.

The bad news, however, is that 45 percent of the audience began the night agreeing with the Keynesian position and that number rose to 69 percent.

Cornelius Vanderbilt is rumored to have said, “the people be damned.” I’m tempted to stamp my feet and say the same thing, but I already did plenty of whining in a recent post, so I guess I’ll just have to suck it up and admit I somehow should have been more persuasive.

Here is some of what Elizabeth Weingarten wrote in her report for Slate.

The audience at last night’s Slate/Intelligence Squared U.S. live debate at NYU’s Skirball Center vehemently agreed with the president: After the conclusion of the debate, 69 percent voted forthe motion “Congress should pass Obama’s jobs bill—piece by piece”; 22 percent voted against the motion; and 9 percent were undecided. …NYU law professor Richard Epstein and Cato Institute senior fellow Dan Mitchell endured hisses and boos, while chief economist of Moody’s Analytics Mark Zandi and Princeton University economics professor Cecilia Rouse won laughter and applause as they took the president’s side. …Mitchell and Epstein began the debate strongly, especially when Mitchell engaged the audience in a clever “quiz” to show that the American Jobs Plan is simply a repeat of failed economic policy. “Let’s divide this room in half,” he began. “Let’s borrow all the money out of the pockets of the people on this side of the room and give it to the people on this side of the room. Now here’s the quiz. Raise your hand if you think there’s more money in the room.” The audience chuckled. This stimulus, he explained, is simply a redistribution of national income. “Our goal should be not to redistribute national income; we want to increase national income,” Mitchell said. “We want a bigger pie so everyone can get a bigger slice; that’s what economic growth is all about.”But soon, Mitchell and Epstein seemed to fall from grace. …After the debate, Donvan reflected on Mitchell’s debate strategy. “Dan Mitchell’s willingness to play the ogre, as he put it, read fun and bold, but I think it didn’t help sell the side,” he said. He even thought Mitchell and Epstein “presented a more comprehensive argument” than the other team. But it “was also the view from 30,000 feet, and less satisfying for an audience asking for a jobs solution right now.” …When I asked Mitchell why he lost after the debate, he told me it was because he was forced to play the villain. “The challenge of defending free markets and limited government is that you’re telling people there’s no Santa Claus,” Mitchell said. “Everyone likes to think that there’s some magic wand the government can wave, and especially if you’re in a position where you can be pigeonholed as somehow defending the interest of the wealthy, it makes it even harder.”

I’m not sure how I should feel about being described as an ogre, but I suppose it’s good that the moderator basically said that Richard and I presented a better argument.

In other words, maybe I should put the blame on the denizens of New York City!

But that’s no excuse. If we’re going to save America from becoming another Greece, we better figure out how to educate people who have been lured into thinking government is Santa Claus.

At some point, the people from Intelligence Squared will post a video of the debate. In the meantime, you can watch this video of me debunking Keynesian economics and this video eviscerating Obama’s faux stimulus.

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I’m going to be in New York City next week to join with Richard Epstein as we participate in an Intelligence Squared debate against Mark Zandi and Cecilia Rouse.

I’m looking forward to this event because Richard Epstein is a rock star for freedom.

It also gave me an opportunity to pontificate on growth issues for Slate. Here’s what I wrote about Keynesianism.

Keynesianism is the economic version of a perpetual motion machine. It assumes you can take money out of the economy’s left pocket, put it in the economy’s right pocket (probably spilling a lot of it in the process), and somehow be richer as a result. A major problem with the theory is that supporters focus on how an economy’s output is allocated. Is it better for more of the economy’s output to be used for consumption? Or for investment? Or, as Keynesians often argue, should more of our output be used for government spending? But economic growth isn’t boosted by redistributing how gross domestic product is allocated. Economic growth happens when we get more gross domestic product. That is why policies that focus on incentives and disincentives are more likely to generate positive results.

And here’s what I suggested to get the economy going.

…tax reform, such as a flat tax, would be so helpful for job creation and competitiveness. But interim measures also would help, such as lowering the corporate tax rate (especially since the U.S. is tied with Japan for the highest corporate tax burden in the industrialized world). Implementing policies to restrain the burden of government spending also would be critically important. On the macro level, some sort of cap on government spending would help, such as the plans proposed by Sen. Corker of Tennessee and Rep. Brady of Texas. On the micro level, it’s important to figure out the programs, agencies, and departments that should be mothballed, both because they are not appropriate functions of the federal government and because they hinder prosperity.

The NYC debate is open to the public, by the way, though they do charge.

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The folks at U.S. News & World Report have posted an online debate on the never-ending topic: “Does Stimulus Spending Work?

You know my thoughts on the topic, including my thumbs-down to Obama’s latest stimulus scheme, so it won’t surprise you to know that I think Veronique de Rugy of the Mercatus Center beat her three left-wing opponents (there was also a participant who served in the Bush Administration, but I don’t view his section as credible since he basically argued that stimulus spending is okay when GOPers are the ones wasting money).

Here’s some of what Veronique wrote.

…let’s look at the latest attempt to use government spending to jump start the economy: the American Recovery and Reinvestment Act. Three years after Congress passed that law, unemployment lingers over 9 percent, far above the promised 7.25 percent, and the economy remains weak. Clearly, the stimulus didn’t work as advertised. …The data show that stimulus money wasn’t targeted to those areas with the highest rate of unemployment. In fact, a majority of the spending was used to poach workers from existing jobs in firms where they might not be replaced. Finally, a review of historical stimulus efforts shows that temporary stimulus spending tends to linger. Two years after the initial stimulus, 95 percent of the new spending becomes permanent. …Research from Harvard Business School shows that federal spending in states causes local businesses to cut back rather than to grow. In other words, more government spending causes the private sector to shrink, the exact opposite of the intended result.

If anything, Veronique is too kind in her analysis. I would have pointed out that Keynesian stimulus didn’t work for Hoover and Roosevelt in the 1930s, Japan in the 1990s, or Bush in 2001 or 2008.

But how often do you find someone from France arguing for smaller government?

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Thomas Sowell just completed a three-part “Back to the Future” series, looking at a couple of fiscal policy issues. His unifying theme is how the political class fails (perhaps deliberately) to learn from mistakes.

In Part I, he decimates President Obama’s new stimulus scheme.

Once we get past the glowing rhetoric, what is the president proposing? More spending! Only the words have changed — from “stimulus” to “jobs” and from “shovel-ready projects” to “jobs for construction workers.” If government spending were the answer, we would by now have a booming economy with plenty of jobs, after all the record trillions of dollars that have been poured down a bottomless pit. Are we to keep on doing the same things, just because those things have been repackaged in different words? …When it comes to specific proposals, President Obama repeats the same kinds of things that have marked his past policies — more government spending for the benefit of his political allies, the construction unions and the teachers’ unions, and “thousands of transportation projects.” The fundamental fallacy in all of this is the notion that politicians can “grow the economy” by taking money out of the private sector and spending it wherever it is politically expedient to spend it — so long as they call spending “investment.”

In Part II, he exposes the historical illiteracy of folks who think government intervention ended the Great Depression.

The grand myth that has been taught to whole generations is that the government is “forced” to intervene in the economy when there is a downturn that leaves millions of people suffering. The classic example is the Great Depression of the 1930s. What most people are unaware of is that there was no Great Depression until AFTER politicians started intervening in the economy. There was a stock market crash in October 1929 and unemployment shot up to 9 percent — for one month. Then unemployment started drifting back down until it was 6.3 percent in June 1930, when the first major federal intervention took place. That was the Smoot-Hawley tariff bill, which more than a thousand economists across the country pleaded with Congress and President Hoover not to enact. But then, as now, politicians decided that they had to “do something.” Within 6 months, unemployment hit double digits. Then, as now, when “doing something” made things worse, many felt that the answer was to do something more. Both President Hoover and President Roosevelt did more — and more, and more. Unemployment remained in double digits for the entire remainder of the decade. Indeed, unemployment topped 20 percent and remained there for 35 months, stretching from the Hoover administration into the Roosevelt administration.

And in Part III, he explains how tax changes in the 1920s provide great evidence for the Laffer Curve.

Those who believe in high taxes on “the rich” got their way. The tax rate on people in the top income bracket was 73 percent in 1921. On the other hand, the rich also got their way: They didn’t actually pay those taxes. The number of people with taxable incomes of $300,000 a year and up — equivalent to far more than a million dollars in today’s money — declined from more than a thousand people in 1916 to less than three hundred in 1921. …More than four-fifths of the total taxable income earned by people making $300,000 a year and up vanished into thin air. So did the tax revenues that the government hoped to collect with high tax rates on the top incomes. …Mellon eventually got his way, getting Congress to bring the top tax rate down from 73 percent to 24 percent. Vast sums of money that had seemingly vanished into thin air suddenly reappeared in the economy, creating far more jobs and far more tax revenue for the government.

We could shorten all three of Sowell’s columns into one simple statement: Obama’s agenda of bigger government and class-warfare taxation will undermine America’s economy.

But that would be short-changing ourselves. Sowell’s writing is a model of clarity and logic – characteristics sorely lacking in Washington.

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Herman Cain probably had the best reaction to the President’s speech: “We waited 30 months for this?”

My reaction yesterday was mixed. In some sense, I was almost embarrassed for the President. He demanded a speech to a joint session of Congress and then produced a list of recycled (regurgitated might be a better word) Keynesian gimmicks.

But I was also angry. Tens of millions of Americans are suffering, but Obama is unwilling to admit big government isn’t working. I don’t know whether it’s because of ideological blindness or short-term politics, but it’s a tragedy that ordinary people are hurting because of his mistakes.

The Wall Street Journal this morning offered a similar response, but said it in a nicer way.

This is not to say that Mr. Obama hasn’t made any intellectual progress across his 32 months in office. He now admits the damage that overregulation can do, though he can’t do much to stop it without repealing his own legislative achievements. He now acts as if he believes that taxes matter to investment and hiring, at least for the next year. And he now sees the wisdom of fiscal discipline, albeit starting only in 2013. Yet the underlying theory and practice of the familiar ideas that the President proposed last night are those of the government conjurer. More targeted, temporary tax cuts; more spending now with promises of restraint later; the fifth (or is it sixth?) plan to reduce housing foreclosures; and more public works spending, though this time we’re told the projects really will be shovel-ready.

And let’s also note that Obama had the gall to demand that Congress immediately enact his plan – even though he hasn’t actually produced anything on paper!

And then, for the cherry on the ice cream sundae, he says he wants the so-called supercommittee to impose a bunch of class-warfare taxes to finance his latest scheme.

What began as tragedy has now become farce.

If you didn’t see it when I posted it a month or so ago, here’s the video I did last year when Obama was proposing a second faux stimulus. Now that he’s on his fourth of fifth jobs-bill/stimulus/growth-package/whatever, it’s worth another look.

Though I must confess that I made a mistake when I put together this video. I mistakenly assumed the economy would have at least managed to get back to a semi-decent level of growth. More confirmation that economists are lousy forecasters.

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President Obama will be unveiling another “jobs plan” tomorrow night, though Democrats are being careful not to call it stimulus after the failure of the $800 billion package from 2008.

But just as a rose by any other name would smell as sweet, bigger government is not good for the economy, regardless of how it is characterized.

Here are the most likely provisions for Obama’s new stimulus, as reported by the Associated Press, along with a grade reflecting whether the proposals will be effective.

o Payroll tax relief – C – This proposal won’t do any harm, but it probably won’t have much positive impact because people generally don’t make permanent decisions on creating jobs and expanding output on the basis of temporary tax cuts.

But, to be fair, if the tax cut keeps getting extended, people may begin to view it as a semi-permanent part of the tax code, which would make it a bit more potent.

o Extended unemployment benefits – F – I agree with Paul Krugman and Larry Summers, both of whom have written that you extend joblessness when you pay people to be unemployed for longer and longer periods of time.

And I recently produced a chart showing how long-term unemployment has jumped sharply since Obama entered the White House, a dismal result that almost surely is related to the numerous expansions of unemployment benefits.

o New-hire tax credit – D – This proposal actually would subsidize employment rather than joblessness, so it’s an improvement over extending unemployment benefits, but it’s unclear how the IRS can effectively enforce such a scheme.

This approach was tried already, as part of HIRE Act of 2010 (which was infamous for the FATCA provision), and it obviously didn’t generate great results. Simply stated, giving special tax breaks to companies with high employee turnover is not an effective approach.

o School construction subsidies – F – The federal government should have no role in education. Period.

That being said, the economic flaw of school construction spending-cum-stimulus is that government spending must be financed with either taxes or borrowing, both of which divert resources from the productive sector of the economy. Simply stated, Keynesian spending does not work.

o Temporary expensing of business investment – B – The current tax code penalize new business investment by forcing companies to “depreciate” those costs rather than “expense” them, thus forcing companies to artificially overstate profits. Temporary expensing mitigates this foolish bias.

But temporary tax cuts, as noted above, are unlikely to have a permanent impact on growth. Temporary expensing, however, will encourage companies to accelerate planned investment to take advantage of better tax treatment, so it can lead to more short-term economic activity (albeit perhaps by reducing economic activity in future years).

The only good news – at least relatively speaking – is that Obama supposedly will propose to misallocate $300 billion of resources, significantly less than what was squandered as part of he 2009 faux stimulus.

But the bad news is that the AP story also notes that “Obama has said he intends to propose long-term deficit reduction measures to cover the up-front costs of his jobs plan.” Translated into English, that means the gimmicks and new spending in the plan proposed tomorrow night will lead to proposed tax hikes at some point in the future.

More taxes and more spending. Hey, it worked for the Greeks, right?

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