Government and the Lack of Prosperity

By Dr. Jeff Mirus ( bio - articles - email ) | Oct 21, 2010

It’s economics, but perhaps we should talk about it anyway. In a recent column in the New York Post (First the stimulus, now the hangover), Nicole Gelinas argues that the State has contributed to and extended our current recession, first by continuing to expand bureaucracies long after tax revenue had declined, and then by devoting huge amounts of stimulus money to preserve jobs in those same bureaucracies once the recession began. It is not surprising that Gelinas’ column was tagged as one of the best drawn from around the world in the October 22nd issue of The Week magazine.

Though still bloated almost beyond belief, government is finally now reducing staff rapidly. But this means that unemployment is still rising even though private business has begun to add jobs. Gelinas’ point is that this waste of stimulus money has thus substantially delayed recovery.

Now why, you may ask, has the State acted in this counter-intuitive way? Apart from political interests, some commentators believe the answer can be found in the fallacies of Keynesian economic theory. In an interesting article in the October 2010 issue of First Things (“The Keynes Conundrum”, not yet available online), Reuven Brenner and David P. Goldman argue that the reigning economic theory of the past seventy-five years, based on the work of John Maynard Keynes in response to the Great Depression, is deeply flawed. An extended quotation will make the problem fairly clear:

Keynes’ idea is simple. In fact, it is simple by construction, for it focuses on the very short term within a closed economy. If consumers won’t spend, the government will spend for them; if businesses won’t invest, the government will invest for them; and if investors won’t take risks, the central bank will reduce the yield on low-risk investments to almost nothing. The risk-taking of entrepreneurs, the cleverness of inventors, the skills and motivation of the workforce, the competitiveness of industries—all the granular reality of a dynamic society, chugging along through trial and error—vanish into Keynesian aggregates like gross domestic product, price indices, productivity, and so forth. Behind all the technical language stands the assumption that bureaucracies, with no business experience whatsoever, can somehow make wise decisions about allocating capital—and do so quickly. These gross simplifications take on the aura of academic theurgy when packaged into seemingly complex mathematical models that occult their ridiculous assumptions.

The result, say Brenner and Goldman, is inevitable. First, politicians love Keynes because his theories help them maintain the illusion that government can solve all economic problems. Second, “after two years of the largest peacetime deficit the modern world has ever known, and the lowest global level of interest rates in history, Keynes’ remedy has clearly failed. The world economy has not recovered.” What has happened instead is that “the locus of the crisis has shifted to the balance sheets of the governments whose spending powers were supposed to have been the solution to the crisis.”

I believe Brenner and Goldman's argument to be both sound and important, and I intend to shield readers from my relatively limited expertise in economics by continuing to draw from their article. They point out, for example, that the Keynesian reliance on aggregate indicators of economic health tends to produce politically-altered numbers to match whatever indicators “ought” to show. They cite the cases of Italy in 1987 and Greece in 2010, in which national governments quite simply lied for as long as possible about the size of their gross domestic products, national debts, and other aggregate measures. They call attention to the misuse of tax policy by the G20 nations to manage aggregate demand, and they lament the “sad case of Western Europe” in which the constant reshuffling of debt between private and public balance sheets only “infects public credit with systemic risk and ultimately leads to the collapse of both public and private credit.”

And here’s a telling passage about the United States:

Washington has turned the financial industry into the equivalent of a quasi-governmental public utility. The federal government provides emergency capital and cheap money to the banks, and the banking system in turn finances the federal deficit. The present administration has turned American capital markets into a state-influenced oligopoly, antithetical to entrepreneurial innovation. It is not surprising that venture capital, business start-ups, and other indicators of entrepreneurial activity remain depressed, and the economy shows little sign of recovery.

What is needed, argue Brenner and Goldman, is economic policy which helps individuals and firms to sustain entrepreneurial risk-taking over an extended period of time. This, and this alone, creates a cycle of building wealth. And this objective suggests the following basic policies:

1. Maintain confidence in the currency and the payments system so that systemic risk does not overwhelm portfolio decisions, which would eliminate a willingness to take long-term risks.
2. Foster independent sources of risk capital by reducing taxes on capital income and eliminating taxes on capital gains.
3. Cut spending, but only in the second place, after tax reductions have generated more risk capital and rising employment, to avoid lowering employment without collateral benefits.

In conclusion, Brenner and Goldman argue that the “worst course of action” is for government to take over the role of private institutions that have been built slowly through the talents and efforts of thousands of individuals. Long-lasting prosperity requires investments that create assets, which in turn create seed capital for new entrepreneurs, “in a virtuous cycle”. Government job creation, by contrast, produces only temporary incomes, while diverting capital away from creating assets.

Again I’m not an expert, but a great deal of this is common sense, which it does not take expertise to grasp. This approach is also far more compatible with Catholic social teaching than are government-directed economies. It is firmly rooted in the principle of subsidiarity, which not surprisingly plays an important role in the creation of wealth. God calls the human person to exercise dominion over creation, in order to perfect it and build it up for His glory. Though their motives may vary, creative individuals can derive tangible personal benefit from taking risks in response to this call. But bureaucracies can neither respond nor derive a benefit; their interests lie in transferring wealth out of productive assets and into public funds for the purpose of self-preservation.

Though we obviously face far more pressing moral concerns, it is likely that economic frustration will dominate the upcoming November elections. Insofar as this is so, I hope voters will think more seriously about a fundamental rule of economic life. This rule is drawn at once from Catholic social thought and from the correct understanding of human nature on which Catholic social doctrine is based: Government can create conditions favorable to activities which lead to prosperity through sound fiscal policy. But government cannot create or control prosperity itself, and its attempts to do so will almost always make things worse.