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Governmental Spending Damages Economic Recovery

Posted by Steve Markowitz on January 20, 2015

Tonight President Barack Obama will make his State-of-the-Union address to Congress and the American people.  Leaked material indicates it will be pure Obama, on the one hand touting the success of his economic programs of the first last six years, but then claiming the need for additional governmental programs and interventions to fix other “inequities.  This includes two years of free community college to any who desire it, as well as taxing some for the benefit of others.  The macro result will be increased government spending.

melting dollarThere two drivers of governmental programs/spending promoted by Obama other big-government politicians.  The first and most egregious is political.  Politicians learned early in the development of their art that giving rewards (programs, tax refunds, handouts, etc.) greases the way towards their reelections, irrespective of long-term consequences.

The second aspect is a belief in Keynesian economic principles that state when economies are slower the government should use deficit spending to offset the lower demand.  While there are questions as to the efficacy of this basic Keynesian principal, one important part of Keynesian economics is that during good times governments need to run budget surpluses to prepare for economic downturns that require deficit spending.  Progressive politicians either have forgotten or purposely ignore this important piece of Keynesian theory.

There is growing evidence that governmental stimulus programs are counterproductive to real economic growth.
For example, the United States has had special government spending since the 2008 economic meltdown.  Given the size of these expenditures it would be reasonable to expect robust economic growth if Keynesian economic theory worked.  Instead, the recovery has been the slowest since the Great Depression.  In addition, while the official unemployment numbers are down, numbers that are already doctored in favor of a positive outcome, wage growth has been stagnant for a decade.

Ruchir Sharma, head of emerging markets at Morgan Stanley, posted an op-ed in the Wall Street Journal titled How Spending Sapped the Global Recovery that offers further evidence that worldwide government stimulus programs have hindered economic recovery.  Sharma points out that political leaders are urging European countries, i.e. developed countries, to significantly ramp up stimulus and deficit spending programs.  However, this focus on additional stimulus spending ignores evidence that similar programs have already failed in emerging countries.  Sharma points out the following examples:

  • Emerging countries including China, Russia and Brazil have had massive stimulus spending programs since 2008 that failed. For example, the aggregate growth rate for emerging economies has decreased to 2.5% from over 7% at the peak of the stimulus spending.  5% this is the lowest growth rate in non-recessionary times.
  • The stimulus programs in emerging markets were much larger than those in developed countries. Emerging markets in the G-20 had stimulus spending of approximately 4.2% of GDP during 2009 and 2010.  Emerging countries stimulus was just shy of 7%.
  • Exemplifying the size of stimulus in emerging countries, there is now more money circulating in China than in the United States, even though the US has a much larger economy.
  • Since 2010, the peak of their stimulus spending program, China’s growth rate has decreased by 33% and is heading below 7%.
  • Russia spent 10% of GDP on stimulus, but its economy is now contracting significantly.
  • The stimulus spending has created significant governmental debt in emerging countries. These countries had an aggregate surplus of 1.5% of GDP in 2007, but now have a total deficit of about 2%.
  • In some countries delinquency on commercial bank loans has significantly increased. For example, in India over 10% of these loans have gone bad.  Many were initially made as part of stimulus bailout programs.

The above data points help demonstrate the failure of stimulus programs to fix the world’s significant and long-lasting economic dislocations.  Adding a nail in the coffin of this discussion is the fact that the International Monetary Fund (IMF) recently lowered its forecast for emerging market growth for the next five years to less than 4% of GDP, not a healthy sign.

Given the evidence, governments should be having serious discussions as to the efficacy of deficit and stimulus spending programs.  Instead, governments are doing the opposite, doubling down on these failed policies.  Many Western leaders are now calling for even more stimulus spending.  That is not the case in emerging countries that already admit the fallacy of these programs.

There are signs that the failed worldwide stimulus effort is creating significant economic imbalances with consequences.  Cheap money allowed oil prices to remain artificially high, with that market now collapsing.  The Russian economy is in freefall.  European unemployment remains high, especially among the youth creating unrest.  Recently the Swiss completely disconnected its currency (Franc) from the Euro leading to its 12% currency revaluation overnight and further weakening of the Euro.

While the problems caused by stimulus spending are transparent, corrective actions are not.  When people and companies become dependent on governments for subsistence and/or economic well-being, canceling related programs become politically unfeasible.  Unfortunately this tune has played out many times throughout history and the endgame is typically not pretty.  Corrective action requires a movement backed by a large portion of the population willing to forgo personal gain for the benefit of the whole.  Not an easy proposition.

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