Obama: Cuts Could Lead to Recession

Hi all,

I've been talking with a friend about Obama's argument made today that cutting spending could lead to a decline in economic activity/another recession (if we even left the first one). My friend agrees with him, but says that the short term economic pain from the spending cut far outweighs the pain of a government default in the future if spending is not cut.

I completely disagreed with him, saying that  if anything, a cut in government spending would lead to growth in the private sector and expansion, rather than recession (as was the case during the Depression of 21). After all, government spending is just based on confiscated or borrowed wealth that is sucked from the private sector, and thus if given back to the private sector where it belongs would lead to growth. The whole argument just seems like a bunch of Keynesian crappola that doesn't have any economic truth.

So with that said, does Obama's argument have any validity whatsoever from an Austrian point of view? If it doesn't, why? Also, am I explaining why it would lead to expansion instead of recession correctly? If I'm not, please correct me.

Peace

I agree that it will lead to a minor recession. If there were a sudden decrease in spending in certain areas of the economy then certainly there is going to be some significant difficulty as these lines of industry will have to readjust to other areas of buisness. A decrease in spending does not result in an increase in the amount that the private sector spends unless there is a corrusponding decrease in taxes, if I taxed everyone fifty dollars and kept it in a big vault then this would just result in a net loss of 50 dollars to the economy, so if the government keeps taxes constant and decreases spending then this is what will happen.

The only upside is that a decrease in government borrowing will lead to a drop in the interest rate and the supply of loanable funds, however as banks are already sitting on a pile of reserves and interest rates are at rock bottom this probably won't amount to much.

So I agree that economic ramifications would result, how severe and how far reaching depends upon the extent of the cuts and where the cuts are done, however this is a positie thing in the long term economic growth because now there is more capital and scarce resources for firms to use now that they are not being utilized by the government.

So recession, yes. But this will lead to profitable long term growth in the private sector.

It will lead to a recession in those sectors where the government spends its money. Defense industry (aerospace, munitions, etc.), retailers will be hurt if welfare entitlements are cut back, you get the idea. However, as those who are laid off re-enter the workforce, the economy will re-adjust and rebuild in a sound, sustainable, healthy, consumer-oriented direction. Bastiat dealt with this issue very well in his discussion of decommissioning unneeded troops "causing unemployment" or other bad economic effects (such as lowering prices due to a glut of cheap labor).

Clayton -

So I'm completely wrong? Doesn't this validate Keynesians' focus on consumer spending and how it causes downturns than? If I'm understanding what you guys are saying?

WallStreetAce:

So I'm completely wrong? Doesn't this validate Keynesians' focus on consumer spending and how it causes downturns than? If I'm understanding what you guys are saying?

 

You're right but for the wrong reasons. Obama's committing the broken window fallacy. Cutting government spending will cause a recession in the affected industries for the same reason that not throwing a brick through the tailor's window causes a decrease in the revenues of the glazing industry. Hardly an argument for continued government spending.

Clayton -

Oh ok, that makes sense. But does the fact that a recession will be caused by a fall in spending back up the importance placed on consumption by Keynesianism? Can you possibly explain to me the reason that focusing on consumer spending, versus producers, is wrong?

Can you possibly explain to me the reason that focusing on consumer spending, versus producers, is wrong?

Keynes makes a value judgement that always spending 100% of your income is good.  Nothing else is considered.  Oddly, the inventor of GDP said to not use it as measure of welfare.  Of course, that is its sole purpose for Keynesians.

Ace,

1. Your original post was right, big picture. What the other posters are pointing out are the short term effects of cutting spending.

2. The reason is very simple. When someone goes for a job interview, does he put into his resume that he eats tons of potoato chips, that he consumes a lot, and that therefore he should get the job? Of course not. He tries instead to make a case that he can be productive and thus make money for the company.

The same is true, obviously, for a whole country. If it was just full of mouths to feed but did not produce anything, it would be poor. Production is the cornucopia that produces wealth. Consumption, by definition, destroys wealth. It is only possible if you have first produced.

The Keynesians see it like this. If there is a pizza shop on the street that doesn't make money, they way to make the owner rich is to get people to buy pizza.He will then buy cheese and flour and sauce from his suppliers, making them rich. They point out, the better ones, that they are only talking about a situation like a recession, where there is plenty of supply, plenty of cheese, flour, sauce, and pizza on the shelves, but nobody buying them. Solution: give people money to but pizza, or have the govt buy it.

The Austrian dissent from the Keynesian story is based on two points. The problem is wrongly described, and the solution [even if we grant the Keynesians their flawed analysis of the problem] is all wrong. But the post is getting long.

Even in the best case for Obama (which I completely doubt, btw), spending ourselves into oblivion is a sure way to lead to a depression and ruin our currency. So is your friend saying he prefers a slow, guaranteed decline into despair versus allowing the free market to run its course, which has proven to be effective throughout American history?

Stop associating the word "recession" here with necessarily bad. Yes, no one wants a recession and everyone wants consistent growth. But the point is that what is currently being made by the government is not valued by people. If the government taxed everyone to dig holes out in the middle of nowhere and fill them back up again then GDP would be extremely high and spending would soar, but the number of people who benefited would be very low to say the least. The government spending is being spent on useless things that people do not want, but after the recession they will be spent on profitable and beneficial things. Would you object to a recession in the "hole economy" if it then meant an economy where people actually received things that they want.

The usual analogy is to someone who is on drugs. If you keep him high he'll be happy and he won't go through withdrawal, but for the sake of the argument let's say that he'll also be living a half-life, a shadow of the real one. Would you say that he should stay on the drugs forever and never actually live?

So sure, the Keynesians are right about an overall decrease in spending causing a recession in this case, so what? The recession is a good thing in any but the short run view. The Keynesians are right about the cause of the withdrawal symptoms in this case, but not of the nature of the withdrawal itself

WallStreetAce:

Oh ok, that makes sense. But does the fact that a recession will be caused by a fall in spending back up the importance placed on consumption by Keynesianism? Can you possibly explain to me the reason that focusing on consumer spending, versus producers, is wrong?

 

The focus should be on neither producers nor consumers, Say's law aside. The important thing is the market process (voluntary exchange of private property). The recessions caused in specific sectors of the economy by cutting government spending are a localized problem within specific industries... the lie comes in painting out that this will cause a general, long-term recession, which is false. The dishwashing soap industry will continue just fine whether or not government cuts its spending because the government just isn't a big dishwasher. For many items that the government consumes, let's say toilet paper, the cuts from government spending in such industries would revert back to the very same industries just from private hands instead of public ones. Demand for toilet paper cannot fall across the board, even if the government shuts down a bunch of offices and stops buying toilet paper for them. Think about it.

 

The root problem with Keynesian analysis is not its focus on conumer demand, it is that it does not comprehend the time-structure of the economy. Robert Murphy explains it all here.

 

Clayton -