Mandated spending is pushing on thread.
The folks over at Econ Stories made history in January of this year when they released Fear the Boom and Bust, the first popular, Ke$ha-endorsed rap video about economics. The video depicts world-renowned economists John Maynard Keynes and Friedrich August Hayek arguing about how the federal government’s fiscal and monetary policies affect the “Boom and Bust” business cycle, focusing on the parallels between the Great Depression and the housing and lending collapse which began near the end of the Bush administration and has continued throughout the Obama administration.
As with any rap, the main feature of the video is its lyrics, which contain the topic of today’s discussion: “Your focus on spending is pushing on thread.” This line is a rather esoteric reference, by way of clever metaphor, to monetary asymmetry. These are daunting words, but they actually refer to a very intuitive concept which has eluded policy-makers and even many economists for over a century. The aim of this post is to help the average observer understand just what is meant by the phrase “pushing on thread,” as well as to provide a conceptual base for further investigation of how ignorance of economics has had grave consequences for nations around the world.
The best way to discover economic principles is through thought experiments that investigate cause-and-effect relationships. Suppose, for example, that the average individual eats out at restaurants or bars about twice a week. If the government were to impose a law mandating that no person may eat out more than once a week, it would obviously have a negative impact on economic activity. In fact just about everyone can guess this if asked. Unfortunately, not so many of us can really explain precisely what is meant by “economic activity” or how the government’s new rule reduces it. Nevertheless, we understand instinctively that economic activity must be depressed by forbidding people from eating at restaurants.
What actually happens in a situation like this is as follows: Consumers, who at any given time have only a certain amount of liquid assets (money) they can spend, are willing to spend some of their assets at restaurants. However it may be that they decided to eat out twice a week, that’s what they’re willing to do. When the government declares that they may not do this, it prevents economic transactions from occurring. This is “bad” for one simple reason – people wanted those transactions to occur. Specifically, restaurant owners and restaurant customers wanted to make an exchange of money for food. They wanted to do this because each of them valued what the other had more than what they were giving. The customer would rather have a meal, and the owner would rather have cash. If the transaction occurs (the customers eat at the restaurant), everyone feels better off than before. If the government prevents this, economic activity – specifically, the exchange of assets in a beneficial way – is diminished.
Such a law won’t cause all of the consumers’ wealth to go to waste, of course. By preventing people from patronizing restaurants, the government induces them to do something else with their money. However, whatever it is that they decide to do, it is important to remember that it will always be their second choice. They would rather have spent their money on eating at a restaurant than whatever they spend it on instead. Therefore, the value of what they buy with the money they would have used at restaurants will be less to them. They will be worse off. Similarly, the restaurant owners will be worse off, even if they leave the restaurant industry and take up another profession. This is their second choice profession – it was not the most appealing and profitable venture for them. The transactions that people wanted to make to increase their lot in life have been prevented by the government, and whatever is substituted is by definition less beneficial.
Thus it is now clear precisely how a government mandate against eating out more than once per week reduces economic activity, in the sense of forcing a real reduction in beneficial transactions. The concept of pushing on thread enters if the government attempts to employ the reverse idea. Suppose, now, that a law is passed which requires each person to eat out at least three times per week. Remember the assumption that the average individual eats out twice per week. If limiting the amount that people can eat out has the effect of reducing economic activity, perhaps mandating that people eat out more often will increase economic activity. Certainly, restaurant owners might tend to think so. As there will be more transactions in the restaurant industry, revenue will go up for restaurant owners, some of which will be passed on to their employees. Indeed, more restaurants will be built, and that will create jobs in construction, cooking, and waiting. Consumers will have more meals, and probably better ones, too.
It would be great – right? Not at all. Mandating more consumption of products and services does not have the opposite effect as mandating less. If anything, it actually has the same effect, as total per-capita product still declines. This is the essence of the “pushing on thread” metaphor. If the government’s policies impacted the economy in a manner that were so easily manipulable and reversible as, say, a door – pull to open, push to close – then it is doubtful such highly educated experts would be hired to determine the government’s policies. Instead, though, the effects of policy are complicated, and the more they are analyzed, the more depressing the conclusions become. Mandates and regulations pull down, but can not push up, on the health of the economy.
To see how this is so, recall that consumers have only a certain amount of money to spend at a time. They must budget this money somehow; spending infinitely is not an option. Therefore, as people are forced to spend more and more at restaurants, they must by definition make sacrifices elsewhere. Perhaps before a person went out to eat twice a week and went to the theater once. Now he goes out to eat three times, but stops going to the theater to compensate. This, again, is not an even trade-off. He is actually worse than before, because he has stopped doing something he wanted to do – going to the theater – in favor of a second choice option. He didn’t want to spend all that money at a restaurant, so he is by definition worse off if he is required to do so.
Similarly, the business owners also take a hit in productivity. Obviously the owners of pre-existing restaurants will see a rise in profits if a law were passed requiring more visits to restaurants. Yet what is also true is that the owners of theaters must see a decline in profits, as well. As restaurants are built in the weeks and months after the law is passed, so also theaters are closed. Small business owners and their employees will shift industry. People will quit their jobs as theater directors and go to work in food service. Again, this is a second choice. Again, it is by definition worse than what was in place before. The converts from other industries to the food industry are taking jobs they weren’t trained to do in order to satisfy a fabricated demand that doesn’t really exist except that the government requires that it does.
Economists and politicians may preach about the stimulus effects of increased spending in the restaurant business. The newspapers scream headlines about the new jobs created by constructing more restaurants to meet the growing demand. Yet all of this is in the spirit of the broken window fallacy, commenting on the visible benefits of a transaction while ignoring the unseen opportunity costs. The idea put forth is that any economic transaction is by definition a good one, when in fact only a voluntary exchange benefits both parties involved. When praising the activity generated from a mandate to consume, it is necessary to ignore or dismiss the activity which would have occurred in the absence of the mandate – and that activity would have been preferable to both consumers and producers.
One might imagine that policymakers and politicians had by now come to understand the lesson in this simple parable of restaurants. At the very least, they certainly have hired economists and analysts who are too educated to fall for the basic fallacy of pushing on thread – of assuming that the opposite of an action which produces a result will produce the opposite result. Since elected officials tend to be of above average intelligence and education level, and since the federal government has many panels of experts with decades of experience in economics, it is to be expected that, although government policies may not always be perfect, they aren’t as utterly naive as requiring people to eat at restaurants and then declaring an improvement in the economy.
Aren’t they? It seems not, as the past three years have revealed an ever-increasing role of government spending and government-supported consumer spending in the name of “stimulating” the economy, without much consideration for the fact that it is impossible for such policies to increase total productivity at all. Remember the Bush package, when you and your significant other got mailed a check for six hundred dollars in order to stimulate the economy? The stated goal of this policy decision was to prevent an economic collapse and help boost GDP in the face of an expected moderate decline.
Well, it didn’t work at all. GDP ended up dropping far more than predicted, not in spite of the stimulus, but because of it. In fact, Bush’s idea failed so completely that Obama expanded upon it and extended it to affect more people. At every turn, with every new stimulus program, of which there have been about a half dozen since the housing crisis began three years ago, the federal government has sworn that there would be a demonstrable increase in GDP as a result, and every time real GDP (adjusted for inflation) has actually fallen.
This is by no means the extent of the damage – examples of government destruction rationalized as construction abound. It turns out that Barack Obama actually pulled the “mandate that people eat out” trick, only he did so with cars. The infamous Cash for Clunkers program, which one might argue is better termed “the General Motors bailout,” required Americans to buy new cars – with their own money, funneled through the federal government by taxes. Essentially, Obama offered a subsidy, funded out of tax-payer money, for people to scrap old cars and buy new ones. The program was sold on the claim that the act of buying new cars would spur economic growth.
It did not accomplish this, and it could not have under even the most generous interpretation. The philosophy of the program was flawed at its core, because it presumed that the activity generated by purchasing new cars must be good activity – ignoring the fact that, if it were beneficial to buy a new car, people would simply do that on their own. By taking tax dollars, which are of course collected by force, and demanding that they be applied to the purchase of automobiles, the government incentivized allocating resources to one particular sector of the economy, but by definition took resources away from other sectors where consumers would rather have used them. Requiring that people spend their money on a new car is no different from requiring that they spend it at a restaurant, and the damage done is exactly the same. Whatever else people would have spent their money on instead if given the choice, that was better for them than the purchase they were forced into. Ultimately, though, this was lost on policymakers, because they rationalized their decisions by observing the economic activity of buying cars and ignored everything else that money could have been used for.
When the government gets worried by how much of people’s money it is taking to fund purchases they didn’t choose to make, it has another card to play, which is monetary inflation and deficit spending. For a hundred years, Keynesian economists and federal-level politicians have struggled to convince the world – both the people in it and physics itself – that monetary policy allows the government to spend money it doesn’t actually have, if it’s careful enough. All manner of nuanced methods have arisen towards this aim. From the esoteric quantitative easing to tried-and-true manipulation of bonds and printing presses, an academic field and a sector of industry has grown up around selling the notion of the free lunch. The government, it is claimed, can fund programs with other methods besides simply taking money from individuals.
This, unfortunately, is not true. The government cannot create wealth out of thin air, no matter what elaborate practices its banks may employ. Whatever government money is not taken from individuals expressly through taxation is ultimately taken through inflation, the devaluation of savings accounts. When the government bails out banks with trillions of dollars of unofficial spending, this money is taken from the savings accounts of all Americans, especially the middle class, whose combined liquid assets represent the bulk of non-industrial capital. Literally, dollar bills and other written representations of money are created by the government, which the elites call “injecting money into the economy,” and the result is that the value of the dollar declines.
As the dollar is weakened, the ability of savings to buy real products and services decreases proportionally. That means that a person who used to be within a month of having enough money saved up to buy a boat, or who had savings to support his family for a year in case he lost his job, or who was preparing to send his children off to college, is now able to buy less than he otherwise would have with the same amount of dollars. This, then, is the cost of the bailout, and fits the exact same model as the fabled restaurant mandate. The government forces individuals to forgo purchases they otherwise would have made voluntarily in order to pay for a mandated bailout of corporations whose unwanted products and services failed to produce profits – all in the name of stimulating the economy.
The economic crisis has lead to the government fully doubling the monetary base in just a few short years. The long-term consequences of this will be the establishment of recession conditions as the “new normal.” The economy will not improve – it cannot improve – so long as the government continues its policy of mandating spending at levels above what would naturally occur. The American middle class individuals do not want to dig into their savings to bail out enormous banking corporations that have mismanaged their money. They do not want to buy new cars at a time when their income level is uncertain and the bare necessities are of immediate concern. When the government disrespects their decisions in managing their finances, it is only destroying any hope of recovery. Policies that focus on spending are pushing on thread, trying to create a stimulus but ultimately just allocating precious resources where they don’t belong. If Americans want a better future for themselves, the only option is less spending, less mandating, and less government.
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