Rebirth of Reason


Subsidy Versus Investment, Part 2
by Merlin Jetton

Barack Obama, his administration, and numerous others believe government spending has the power to boost an economy. How that allegedly happens in terms of revenues (R) and costs (C) is beyond my comprehension. While consumer and investment spending is a big part of an economy (about 2/3rds for consumer spending), the assumption that any government spending can boost an economy makes little sense at best. In contrast investment spending, resulting in R > C, can produce economic growth. Here I mean investment spending in the narrower sense -- spending on capital equipment, supplies, inventory, or labor in order to produce goods or services intended to generate revenues that will more than recoup the costs. I don't include investment spending in the form of buying stocks or bonds, although this surely helps the former. Dividends on stocks and interest on bonds rely on R > C.

The Wikipedia article goverment spending classifies it into three types -- consumption, investment, and transfer payments. Oddly, subsidy is not a type. But hardly any government spending is really investment. Mostly it only transfers money, producing nothing in the way of real goods or services. Indeed, government is a drag on businesses that do produce real goods and services. Government spending might "trickle down" via spending by persons who receive a transfer payment or subsidy and the further effects therefrom. Consider how a government subsidy might be spent. It may only make a losing business less of a loser in terms of R - C. Amtrack is a great example. That is not a boost, but the opposite. It might be spent to draw down surplus inventory, e.g. vehicles made by the big three U.S. automakers. However, I question whether or not R > C and the makers of such inventory will use the sales proceeds for more production of that particular kind of inventory. If a federal government subsidy goes to state and local governments in order to reduce their deficits, like the current "stimulus" bill, it near certainly is a money loser and the opposite of a boost.

In the ongoing financial turmoil, unemployment has risen sharply. A big part of Obama's and his cronies' response is more jobs that rely on government spending. It is not just temporary unemployment benefits at a fraction of normal pay, but pay at full wages for a much longer time.

In the first part of Subsidy and Investment I portrayed investment as a revenue inducer for the firm itself and subsidy as a revenue agent for somebody else, not the government itself. Barack Obama and his crony friends try to obliterate the distinction between subsidy and investment by calling what is really a subsidy an "investment." Real investment induces revenues from the firm's customers, who provide it voluntarily. Government expropriates most of its revenue from taxpayers, coercively, and deficits mean R < C.

Two asides follow. There are some things a government should "subsidize." These are its essential functions, like national defense, courts, police, and penal system. I used the quotes since such spending is not usually considered subsidy. However, it is in terms of R - C, which has been my focal point from the start. Such spending has little or no potential to induce revenues to the government. Secondly, the government spending money to fight illegal drugs is a revenue inducer for dealers in illegal drugs!

Savings is also key to an analysis. Investment ultimately requires savings -- foregone present consumption -- from somebody. Businesses, of course, tap the savings of others -- via issuing stocks and bonds -- in order to invest. Banks make loans to businesses using the savings of its depositors. Business people often have the capital ideas, but not the savings, to implement their ideas. Savers are often in the opposite position. Financial markets play an intermediary role between the two. On the other hand, government sops up savings and does not invest. It even makes it more difficult to channel savings to business investment. Money used to buy government bonds can't be used to make profitable investments in the private sector (R > C). Like Austrian economists such as Ludwig von Mises have held, government intervention causes malinvestment, i.e. spending which results in losses (R < C). The savings that the government sopped up in the latest few years were wasted by the government, and now we see the consequences, including the value effects in capital markets. The government and banks can create money "out of thin air." In capital markets money can vanish "into thin air." Yet Obama and his cronies want to do more of the same.

Savings is deemed largely irrelevant to politicians and many economists. The formula for GDP doesn't even recognize it. They may even regard it as hoarding and a drag on the economy, since the savings could be spent on consumption instead. In the formula $1 of government spending is as good as $1 of private investment spending -- even if the government spending pays people to dig holes and then refill them.

Not all investment leads to growth since businesses can make bad investments, too. Also, some investment is only sufficient to cover its cost. But that's acceptable. It is self-supporting and not a drag on the economy. Also, people quickly recognize business failure and take steps to correct it. In contrast, politicians rarely recognize their "investment" (really subsidies) mistakes and act quickly to correct them. Indeed, they usually perpetuate or compound their mistakes, making them an even larger drain on productivity.
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