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The False Promise of Deficit Spending

May 23, 2012 9 minute Read by Carl J. Schramm

“Austerity is out, growth is in.” This line — from a May 8 editorial in The San Francisco Chronicle — captures the change in economic vocabulary following the May elections in France and Greece. The new turn to the left in Europe is premised on a simple declaration: We are tired of austerity and we want to grow. That’s it. No one seems to be bothered with the rules of economics. Debt is good because it brings growth. Right? Many of America’s policy intellectuals seem to agree. The New York Times never tires of promoting more deficit spending as the answer to getting the world’s biggest economy growing again. This Keynesian argument will intensify this summer as Europe’s economic future becomes yet bleaker and our own economy turns toward recession all over again. The “debt equals growth” formula could work, but only if the debt-supported government spending created such large productivity gains that the resulting economic growth would retire the debt. This bet seems less and less likely because today’s government spending is being used to sustain social-welfare payments rather than to make honest-to-goodness investments that will yield higher levels of growth. For example, publicly financed college loans made to students who study subjects like leisure management will not make society more productive; more likely-than-not they may end up impoverishing the poorly counseled student. Actually it’s becoming harder to distinguish real from bogus public investment. Railroads were an undeniable improvement over horse-drawn wagons, stagecoaches, and canals. But although wind turbines do make electricity, they are less efficient than other sources. There seems to be a social-virtue dimension that has crept into public spending that confuses the idea of spending for increased productivity and wealth generation and explains why we are not seeing even the possibility of public “investment” spending causing any growth. The triumphant populism in Greece and France may have as much to do with sticking it to the Germans and ultimately the Americans as it does with growth. But Greek and French leaders don’t seem to care that borrowing money to create government jobs will inevitably bring more chaos that will become increasingly more painful. A national bankruptcy with international reverberations will bring horrific disruptions to already anemic growth. Keynes’s famous long run — as in “in the long run we will all be dead” — is coming so fast that some political leaders will be facing career death. In a few months from now the armies of citizens who see their connectedness to the state as that of recipients of social welfare, people who are totally dependent on government largesse, are unlikely to be stopped in their rioting by an epiphany of economic insight. Even darker worries cannot be dismissed. A global crisis touched off by a Greek bankruptcy could usher in a new taste for totalitarianism. The troubling admiration that the intellectual elites have voiced in the last years for “autocratic democracies” is real. Its popular voice is found in the writing of Thomas Friedman. And, of course, based as these countries are on state planning and industrial policy, an elite of social planners sees an unelected way to power. It wasn’t all that long ago that Europe travelled this path, dragging the world into war. Societies seeking more bailout are desperate because they see no other way to survive. What is so sad is that the real way to grow the economy has been forgotten. Over the past 20 years, the creation of wealth by the exertions of indigenous populations has been replaced with a dependence on the state as the dispensary of benefits sufficient to enjoy a decent lifestyle. The expanding notion of rights — no longer civil but beneficiary rights — has sapped away the sense that people might better their condition by working harder and becoming smarter. And, herein, is a cautionary tale for the U.S. to consider. For at least a decade, without any apparent link to the business cycle, the number of new firms being started in the U.S. has remained rather constant, between 600,000 and 700,000 per year. But the number of new U.S. start-ups has fallen rather significantly since 2009, to roughly 400,000 per year. Of even greater interest, these new firms now employ just over four people, down from an average of nearly seven. This is of great consequence in two ways, neither of which is apparently of any particular interest to economists shaping governmental policy. First, the drop-off in new firm formation and the decline in new jobs per firm mean we are forgoing over 1 million new jobs a year. Entrepreneurs and the new businesses they create are engines of job growth. There is a reason that we should be looking to entrepreneurs to start the economy! Second and perhaps of greater importance, every new firm that survives generates more and more jobs every year. It is, in fact, these new firms that power economic recoveries. But with fewer and less robust new firms, the implications for the whole economy are evident. No one can be 100% sure why new firm-formation has slowed. But Keynesian government policies seem to be a major factor. Polls suggest new firms are discouraged by the uncertainty that has resulted from the government’s rapidly growing presence in the lives of businesses, in the form of expanding regulation and the imposition of new burdens related to mandatory health insurance. The rising threat of more taxes, something that already has become real at the state and local level, is another impediment to would-be entrepreneurs. A third cause might be the rising costs of labor. As states and cities raise minimum wages (San Francisco’s is now over $10 per hour — the city ranks 51st in job growth) new businesses find just existing even harder. Fourth, with an expanding safety net of extended unemployment benefits and food stamps, the incentives to accommodate individual ambition are attenuated. Finally, the risk of starting a new business correlates with the unemployment rate. When the unemployment rate is low, failing in business does not spell personal disaster because the entrepreneur can find a new job. The lesson in all this is that economics is more like physics and less like the religion that some of its practitioners want us to believe in. For over 70 years Keynes has served as the high priest of deficit spending in the face of declining economic activity. The empirical record remains in doubt as to whether his prescription ever worked. While his theories have been a miraculous talisman to politicians who want to leave today’s spending to the next generation, they have failed at creating economic growth. What we are seeing in Greece and likely in France, if President François Hollande keeps his promises, is that the future will visit very soon, and the result won’t be pretty. This is the only outcome the physics of financial markets can produce. It was best explained by Margaret Thatcher in her famous declaration, “The problem with socialism is that eventually you run out of other people’s money to spend.” Self-pampering populations may throw the fits of children and riots may ensue, but the cold reality is that other nations might not care so much anymore. On the other hand, citizens in Europe and America might begin to believe their eyes. Their retirement statements, their tax bills, and the joblessness that they see around them tell us that government spending can’t solve this problem. If we resolve to stop unneeded deficit spending, start paying for what we consume through the public budget in real time, insist that when government says “investment” it does not mean more social spending, we might leave an unleveraged and more secure world to their children.


Author

Carl J. Schramm
Carl J. Schramm

2012 Economic Growth Fellow

Carl J. Schramm is recognized internationally as a leading authority on entrepreneurship, innovation, and economic growth. Currently he is university professor at Syracuse University. For 10 years he served as president of the Kauffman Foundation, making it into the world’s premier organization dedicated to the development of high-growth firms and understanding the role they play in economic growth. He serves as a visiting scientist at MIT and as a fellow of the Bush Institute. He is a Batten Fellow at the University of Virginia’s Darden School of Business and is a member of the Council on Foreign Relations. Schramm's most recent book, "Better Capitalism" (co-authored with Robert Litan) was published by the Yale University Press in September 2012. He has written several other books, including “Good Capitalism, Bad Capitalism” and “The Entrepreneurial Imperative.”

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